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NECC Executive Compensation Forum Trends in Long-Term Incentives March 6, 2008

NECC Executive Compensation Forum Trends in Long-Term Incentives March 6, 2008. Melissa Means Vice President Pearl Meyer & Partners (508) 630-1487 Melissa.means@pearlmeyer.com www.pearlmeyer.com. Agenda. Trends in Long-Term Incentives: Changing Landscape Long-Term Incentive (LTI) Usage

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NECC Executive Compensation Forum Trends in Long-Term Incentives March 6, 2008

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  1. NECC Executive Compensation ForumTrends in Long-Term IncentivesMarch 6, 2008 Melissa Means Vice President Pearl Meyer & Partners (508) 630-1487 Melissa.means@pearlmeyer.com www.pearlmeyer.com

  2. Agenda • Trends in Long-Term Incentives: • Changing Landscape • Long-Term Incentive (LTI) Usage • Total Overhang • Burn Rates • New Share Requests • Mix and Instruments Usage • Mix • Stock Options • Stock • Performance-Based Awards • Other • Exchange Ratios • Ownership Guidelines • RiskMetrics Group (formerly ISS)

  3. The Changing Landscape • External influences significantly changing the use of LTI • Perceived abuses • Option backdating and other scandals • SEC disclosure rules (CD&A) • Increased transparency • Mandated quantification • Tax and accounting rules • SFAS 123R • 162(m) • Unprecedented investor scrutiny • Greater visibility and power • More stringent requirements • RiskMetrics (formerly ISS) • As a result: • LTI remains in the forefront of public interest for the coming years • Companies continue to re-evaluate the efficacy of their existing LTI programs

  4. Usage – Total Overhang • Headline – Another consecutive year of reduced overhang levels • Reality of expensing and shareholder pressures continue to drive companies to reduce total equity usage • The following outlines current total overhang levels for companies in the high technology industry (by industry and revenue):

  5. Usage – Burn Rates • Headline – Another consecutive year of reduced burn rate levels • To reduce total equity usage on an annual basis companies are: • Reducing participation levels • Reducing grant values • Changing use of LTI instruments to deliver more value using fewer shares • The following outlines current total burn rate levels for companies in the high technology industry (by industry and revenue):

  6. Usage – New Share Requests • Headline – companies seeking more frequent authorization of smaller pools of available shares • The following outlines the percent of companies in the high technology industry seeking share approval in the past 3 years (by industry and revenue):

  7. Mix & LTI Instrument – Mix • Headline - Companies continuing to evaluate and rebalance the mix of LTI instruments • Companies are also using multiple instruments to deliver LTI awards

  8. Mix & LTI Instrument – Stock Options • Headline - Stock options are on the decline for another straight year • Companies are continuing to use other LTI instruments in lieu of options to address: • Mandatory accounting issues (SFAS 123R) • Constraints on dilution and burn rates (vs. competitors who shifted to restricted stock) • Incentivize the proper behaviors • The following outlines option usage levels in the high technology industry (by industry and revenue) over the past 3 years:

  9. Mix & LTI Instrument - Restricted Stock • Headline - Use of restricted stock (RS) continues to increase ~20% • Restricted stock can deliver the same value as options using fewer shares • Continued investor pressure when using restricted stock • Time-based awards minimum vesting over 3 years • Performance-based awards must have at least 1 year of vesting • The following outlines restricted stock usage levels in the high technology industry (by industry and revenue) over the past 3 years:

  10. Mix & LTI Instrument – Performance-Based LTI • Headline - Many companies are implementing or investigating the use of performance metrics in an LTI plan • Stronger link between pay and performance • More in line with shareholder and institutional expectations • 44% of the Fortune 1000 and 62% of the S&P 500 have implemented a performance-based LTI plan • Typically a 3 year plan that pays out in stock • However, performance-based plans can be challenging to design and administer. The following outlines key deign considerations for a performance-based plan: • Single vs. multiple measures • Shorter vs. longer time periods • Absolute vs. relative measures • Cumulative vs. point-in-time measures • Performance/payout leverage and scaling • Consecutive vs. overlapping cycles

  11. Mix & LTI Instrument – Performance-Based LTI • The key to performance-based plans: • Keep them as simple as possible • Limit the plan initially to the top executives, consider expansion once plan is successful • Consider shorter measurement periods for companies of high growth or acquisitive industries • Selection of an appropriate performance metric • Develop an appropriate performance/payout scale • Discuss how to address unexpected financial circumstances • Start slowly – consider consecutive cycles

  12. Mix & LTI Instrument –Exchange Ratios • Headline - 3 ways to think about LTI exchange ratios: • Cost Neutral Ratio • Assume SFAS 123R option cost is 33% of FMV and RS cost is 100% FMV • Cost neutral ratio is 3 options : 1 restricted share • 1 RS more valuable than 3 options until FMV increases 50% • Premium Ratio • Whatever cost neutral ratio is “+1” • Risk Adjusted – looking forward

  13. Stock Ownership Guidelines • Headline – Continued movement towards stock ownership guidelines • Ownership guidelines – mandate number of shares to be owned at all times • Best for firms using full value instruments (e.g., restricted stock) • Often serves as quid pro quo for implementing time-based restricted stock • Disposition guidelines – mandate number of shares to be retained on post-exercise basis • Best for firms using appreciation only instruments (e.g., options) • Programs are encouraged and well received by institutional shareholders • Actual guidelines and compliance periods vary by position

  14. RiskMetrics Group (formerly ISS) • Average Burn Rates continue to trend downwards • Shareholder Value Transfer (SVT) increased in many segments due to changes in methodology in 2007 • Full value awards valued at full 200-day average share price • Option cancellations/forfeitures and warrants/convertible debt not considered • SVT and Burn Rate allowable caps remain about the same as in 2007 • Poor Pay Practices • Could result in a “Withhold” vote for a Director up for re-election • Pay for Performance Policy in 2008 • ~1/3 of the Russell 3000 had negative 1 and 3-year TSR as of 12/31/07

  15. Looking Forward • More long-term plans driven by non-market measures • Continuing shift from options to restricted stock • Desire to link executives with financial performance • Recent trend of higher option concentration at top executive level • Time-based restricted stock for mid-to-lower level employees • Continuing evolution of linking pay and performance

  16. About Pearl Meyer & Partners Pearl Meyer & Partners is the leading independent compensation consultancy serving as a trusted advisor to Boards and their senior management in the areas of governance, strategy and compensation program design. Learn more about our expertise in: • Employee Compensation • Compensation Surveys • Executive Compensation • Board Compensation www.pearlmeyer.com

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