How to Compete With a dot

Wall Street Compensation and Benefits Association How to Compete With a dot.com Jeffrey M. Kanter Erin Bass-Goldberg Frederic W. Cook & Co., Inc. May 11, 2000

Today’s Objectives • Examine dot.com pay practices • Approaches to make you competitive

Who’s a dot.com? • Line is blurring between old and new economy companies Bricks & Mortar Bricks & Clicks Chase Chase.com DLJ DLJdirect BankOne Wingspanbank.com

dot.com Employee Mentality • Harsh generalization: • Therefore: Little loyalty; lots of greed

dot.com Employee Mentality (cont’d) • Originally a different culture • Existing pay structures/guidelines were irrelevant • Moving too fast • Bureaucracy is a dirty word • Get rich quick • Vs. career and security • Don’t care about old “rules of thumb” • High risk: high reward • Typical pay programs may not work • But seeing shift to old economy structures • Best of both worlds

dot.com Company Mentality • Downplay cash; up play stock • Would like structures • And to create retention • But fighting high turnover rates and lack of available talent at all levels • With market downturn and continued talent flight, more cash and more options required

Option Gains ($000,000) CEO COO CFO Top Sales Recruiting Can Be Expensive • In the money option values: • 18 internet companies

Different Pay Packages • Joseph Galli example:

($000) Internet Internet Internet GI Internet GI GI GI CFO CEO Top Sales General Counsel Generic Job Comparisons

Annual Grants as a % of Outstanding Shares 91% Growth Run Rate Comparisons

99% Growth Potential Dilution as a % of Outstanding Shares Dilution Comparisons

Stock Option Provisions • Relative comparison:

Stock Option Provisions (cont’d) • Relative comparison (cont’d):

Response of Old Economy Companies • Many old economy companies are developing and implementing their own internet- and technology-based strategies • This approach is complementary to their traditional business • Wal-Mart , Barnes & Noble, Toys R Us, GM, Ford, Sears • Others are attempting to convert to a “new economy” focus • Kodak, AT&T

Response of Old Economy Companies (cont’d) • The critical success factor is human capital and the ability to attract and retain “hot skills“ employees • The primary objectives include: 1. Compete with greater upside of new economy • Need a “great stock” 2. Address loss in incentive and retention value associated with share price depreciation • Need to leverage upside and/or decrease perceived riskiness of current employment situation

Innovative Approaches • Tracking stock • Subsidiary stock (external market) • Subsidiary stock (internal market) • Venture capital funds

Tracking Stock • Tracking stock is a separate class of publicly-traded parent company stock whose market value relates to the financial results of a particular business • Not a direct ownership interest • No formal separation of assets • No legal separation of the company • No separate board of directors • Separate P&L statements are prepared for each tracking stock business • But only one annual report and proxy statement

Tracking Stock (cont’d) • Examples:

Tracking Stock (cont’d) • Tracking stock objectives include: 1. Creation of a “pure play” • Allows investors to focus on specific business segments • Provides “currency” for acquisitions 2. Enhance overall market valuation (i.e., eliminate “conglomerate discount”) • Encourages more specific analyst review 3. Provide real equity incentives for business unit employees • Employees in each business receive equity incentives on real shares of their individual businesses

Tracking Stock (cont’d) • Advantages • Provides a direct “line of sight incentive” • Can be used in all the same ways as parent company stock • Taxation and accounting treatment are identical to parent company stock • Does not result in loss of control by parent company (like a spin-off would)

Tracking Stock (cont’d) • Disadvantages • Presents challenging corporate governance issues • Potentially creates “self dealing” opportunities among senior management and Board members • Can be offset by establishing a proper balance of incentives and ownership among different equity classes • Creates divergence of interests among each distinct group of stockholders • Raises the possibility of lawsuits

Tracking Stock (cont’d) • Disadvantages(cont’d) • Requires complete recapitalization of company • Is expensive and time consuming to establish • Would be difficult to unwind • Unlikely to completely capture “full” market valuation • No “take-over” premium

Subsidiary Stock (External Market) • A public market for a free-standing subsidiary is created by selling a small portion (e.g., 15%) through an IPO • Objectives are similar to those of a tracking stock structure, except requires real separation of assets and full disclosure • Advantages • Same as tracking stock • Disadvantages • Same as tracking stock, except: • Reduced corporate governance issues • More difficult to unwind

Subsidiary Stock (Internal Market) • This approach solely supports compensation objectives • Similar to phantom stock, but uses real shares of a freestanding business unit • Shares are valued by third-party appraisal and are traded within an internal market • Employees may be given a “put option” back to Company to provide liquidity • The employer has a “right of first refusal” or “call option” to prevent loss of control over stock

Subsidiary Stock (cont’d) • Advantages • Provides a direct “line of sight” incentive • Can be used in all the same ways as parent company stock • Insulates employees from the vagaries of the financial markets • Can obtain favorable fixed plan accounting under APB Opinion 25 if: • Stock price based on fair market value • Employees hold shares for a minimum of 6 months before sale to the company • Does not result in loss of control by parent company

Subsidiary Stock (cont’d) • Disadvantages • Requires independent appraisal or complex valuation formula • Administration is complex • Six month holding requirement requires employee capital outlay and increased risk • Capital outlay could be addressed with company-sponsored loan or special dividend • No effective solution for stock price risk

Venture Capital Funds • Opportunity to “coinvest” in a company-sponsored venture capital fund • Or, could be just a “carried-interest” program • Fund set up as a wholly-owned management company • Investments are generally targeted to those with strategic value to company; could simply be outside investments • Realized returns are split between company and executives

Venture Capital Funds (cont’d) • Advantages • Provides attractive investment diversification opportunity not available to executives on their own • Can help recreate the partnership and entrepreneurial culture of private ownership • Disadvantages • Can be administratively complex • May be viewed by shareholders as inappropriate use of corporate assets

Company Profile

How to Compete With a dot