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Grant Thornton LLP. All rights reserved.

Top 10 executive compensation ideas to use in

todays environment

Eric Gonzaga, JD

Managing Director

Executive Compensation Practice

[email protected]


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2 Grant Thornton LLP. All rights reserved.

Learning objectives

Be aware of how the current environment may be affecting yourexecutive pay programs

Identify executive pay strategies that you may be interested inconsidering in the current environment


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AgendaTop 10 executive compensation ideas

1. Consider changing bonus plans

2. Assess the right mix of cash and equity awards

3. Consider repricing strategies for underwater options

4. Assess whether plans should foster executive retention

5. Grade your compensation practices against emerging standards

6. Update your compensation benchmarking

7. Consider taking advantage of low stock prices and uncertain future

tax rates8. Consider restricted share plans

9. Consider whether to continue deferred compensation plans

10. Plan for parachute payments in future transactions


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Does the companys bonus plan reflect the current economic

environment?

Cash bonus plan design features may need to change

Amount of the bonus leverage

Performance metrics

Should a percentage of bonus be withheld once performance metricsare satisfied?


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Focus on long-term performance goals

Adjust mix of short-term and long-term performance metrics

Short-term: Is increased revenues of X% each year right?

Long-term: Improve shareholder value by managing risk

Enterprise risk management

Metrics based on how the company would like to emerge from thecurrent economic environment


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Example of how a company could change itsbonus plan

Begin with pay philosophy (Compensation Discussion and Analysis)

Revise key performance metrics

Reconsider X% growth in revenue (too short-term focused goal)

Replace with a goal that promotes diversification of revenuestreams

Establish performance periods that are greater than 1 year


7/477 Grant Thornton LLP. All rights reserved.

Example of how a company could change itsbonus plan

Pay the bonuses over a multiyear schedule

Include a clawback feature

Ensures long-term growth was not sacrificed for short-termresults




What is the typical mix of cash and equity awards?

Is there a difference in the mix between public and private?

The difference is due to lack of marketability or desire to restrictownership of closely-held company stock

Should private companies consider a different mix if an exit strategy is

in place (i.e., sale or IPO)?




Design considerations

Short-term (cash) vs. long-term (equity) incentives

As green shoots sprout, make adjustments to award levels

Timing is everything: with stock values at historic lows, increased equitygrants may be appropriate

Consider linking awards to executive ownership guidelines



Accounting and tax considerations with equityawards

Financial statement issues to consider

ASC 718 (formerly SFAS 123(R))

Performance vs. service vesting

Code Section 409A

Issues of establishing fair market value for private companies

Need for third-party valuation

Payroll withholding and reporting requirements



3. Consider repricing strategies for underwateroptions

Approach Description Advantages Disadvantages

Options-for-Options

Cancellation ofunderwater optionswith immediate re-grant of new options

Employees maintaincontrol of taxableevent

Some reduction inoverhang

Potential remains for newlyissued options to gounderwater

May not be perceivedpositively by employees ifstock options have notprovided value

Options-for-Stock (restrictedstock or RSUs)

Cancellation ofunderwater optionswith immediate re-grant of restrictedstock/units

Eliminates potentialfuture underwateroptions

Greater reduction inoverhang

Employees lose control oftaxable timing

Reduced upside vs. stockoptions



Example of an option-for-stock exchangeValue-for-value exchange of options for restricted

stock

Employer has 1 million underwater options outstanding

FMV at grant was $10M, fair value (for book purposes) of options was$5M

FMV of the stock now is $2M

Zero current benefit to the employees

Upon valuation, it is determined that the current fair value of theunderwater option is 1/5 of the current value of the company's stock




stock

For every 5 options surrendered, the employees receive 1 share ofrestricted stock

5-for-1 exchange ratio is based on the current fair value of theoptions compared to the current fair value of the stock


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stock

Benefits of the exchange

Employees receive stock with value in exchange for options with novalue

Strong retention incentive for $0 additional compensation cost overwhat has been or will be booked

$0 compensation cost = $5M fair value of restricted stock, less $5Mcurrent fair value of the options

Company reduces overhang by 800K shares

1 million options retired in exchange for 200,000 restricted shares


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4. Assess the need for plans to fosterexecutive retention

Executive retention will be critical in an improving economy

Especially for companies that have experienced:

Pay freezes

Reductions in executive pay

Underwater options

Suspensions in section 401(k) plan matching contributions

Underwater options can be a disincentive to stay


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Foster executive retention

As the economy improves, executives will consider other opportunitiesto enhance their pay with other organizations

To address retention, companies will need to:

Identify those executives that may be at risk

Review alternative retention programs


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Retention programs

Examples of retention programs:

Restricted stock awards

SERPs

Cash compensation tied to years of service

Retention cash bonus

Program features

Extended payout schedules Vesting schedules

Must be employed on payment date to receive payment


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5. Grade your compensation practices againstemerging standards

Why should companies strengthen compensation governance?

Avoid backlash on executive pay practices

Regulators, SEC, IRS, State Attorneys General

Volatile stock market easily influenced by public perception and mediacriticism

Bad employee relations in Employee Free Choice Act environment Optimal strategic compensation programs in a recessionary environment

Be proactive so when new rules go into effect,

the company is prepared.


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Emerging governance expectations andrequirementslets talk risk!

Let the independent compensation committee drive a deliberate, formaland documented process, led by a committee chair who is experiencedin administering compensation programs

Ensure that all decision makers spend ample time to understand theexecutive compensation program, including the risks associated withany pay-for-performance metrics

Review compensation programs on a frequent basis throughout theyear to ensure the programs are consistent with the continuallychanging business environment


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Emerging governance expectations andrequirementslets talk risk!

Evaluate necessity of severance, change-in-control, and gross-uppayments, with consideration of avoiding, phasing out, or reducing

Annually review the independence of the compensation consultant


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Why should you be concerned about benchmarking?

New benchmarking data are available

Includes new data on total compensation and pay mix

Evidence of how compensation practices have changed between 2007and 2009

Practices have changed greatly, with various alternatives on thetable

2008 surveys are not reliable


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Why should you be concerned about benchmarking?

Business strategies are becoming better defined for long-term growth

Likewise, compensation practices should become better defined

Opportunity to improve morale of executives and refocus them

Ensure talented executives are paid market rates and rewarded atabove-market rates only for above-market performance


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Other considerations for benchmarking

Companies should recognize that market values have changed

For some job positions, the market rate has decreased

Companies need to pay a reasonable amount of compensation

Defend to regulatory agencies

Media attention associated with executive compensation

Incentivize and retain key executives


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7. Consider taking advantage of low stock prices and uncertain

future tax rates8. Consider restricted share plans




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7. Consider tax strategies to take advantage oflow stock prices and uncertain future tax rates

Consider exercising nonqualified stock option now

Executives should measure the costs and benefits of exercising vested

stock options before a possible increase in tax rates.


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Example of a nonqualified stock option

In 2009, executive holds vested stock options:

Aggregate exercise price is $600

Aggregate fair market value (FMV) of the stock is $900

Executive intends to sell the stock in 2011 and she believes the FMV ofthe stock will be $1,200

Highest marginal tax rates and capital gains rates:

2009 2011

Income tax 35% 39.6%

Capital gains 15% 20%


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If the executive exercises in 2009 and sells in 2011:

Income tax in 2009 is $105 ($300 income X 35% tax rate)

Capital gains tax in 2011 is $60 ($300 capital gain X 20% tax rate)

Total tax paid is $165

If the executive exercises in 2011 and sells in 2011:

Income tax in 2011 is $237.60 ($600 income X 39.6% tax rate)

No capital gain Total tax paid is $237.60


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Benefit: $132.60 of lower taxes

Cost: The opportunity cost associated with the $600 paid to exercise

the options in 2009 and the $105 of tax paid in 2009


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8. Consider restricted share plans

Time-based vesting drives retention

Performance-based vesting drives increased performance


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Example restricted share plans

Retention incentive: Initial grant that vests at the end of a 3-yearperiod provided that the executive is still employed

Performance incentive:Additional restricted share grants

Grant conditioned upon meeting performance goals; or

Vesting is conditioned upon meeting the performance goals


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Section 83(b) elections may be attractive toexecutives when stock values are low

Factors to consider

Consider the current stock value and determine the probability that thevalue will increase vs. decrease before the stock vests

Consider the executives estimated marginal tax rate at the time ofvesting versus at grant date

Consider the opportunity cost associated with the cash used to pay the

taxes up front

Consider potential for job loss before vesting

After considering these factors, an executive can make an educated decision of

whether to make a Section 83(b) election.


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9. Consider whether to continue deferredcompensation plans

Potential increases in tax rates may drive changes in deferred

compensation

May be better to pay tax now at lower rate than later at a higher rate

Executives may consider suspending 2010 deferral elections

Decision must be made by Dec. 31, 2009


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9. Consider whether to continue deferredcompensation plans

Consider terminating deferred compensation plans and paying the balancein the plan

Must consider section 409A issues

Payout may not occur until 12 months after the plan termination

Full balance of the plan must be paid in full within 24 months afterplan termination

Must terminate the plan and all like plans for all employees

May not start new plans for 3 years


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10. Plan for parachute payments in futuretransactions

The current economic conditions and credit crunch contributed to adecline in the number of corporate transactions

Transactions were delayed, but may occur in the future

Rules under section 280G apply when there is a change in control

Tax consequences of excess parachute payments under section 280G

20% excise tax is imposed on the employee

Employer may not deduct the expense


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10. Plan for parachute payments in futuretransactions

Excess parachute calculation

Do total parachute payments exceed 3 times the base amount?

Base amount is the average W-2 compensation over past 5

years

If yes, excess parachute payment equals the total parachutepayments less 1 times the base amount


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Planning for a change in control and parachutepayments

Private companies: Obtain 75% shareholder approval of paymentsthat will be made in connection with a change in control

Severance payments

Transaction bonuses Increase the base amount

Exercise stock options

Pay annual bonuses early

Accelerate the vesting of SERP plans and stock options


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Planning for a change in control and parachutepayments

Stipulate in compensation plans that amounts paid upon a change incontrol may not be paid if they would result in excess parachutepayments


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Our presenters will now answer your questions.

Top 10 executive compensation ideas







7. Consider taking advantage of low stock prices and uncertain futuretax rates

8. Consider restricted share plans




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This document supports Grant Thornton LLPs marketing of professional services, and is not written tax

advice directed at the particular facts and circumstances of any person. If you are interested in the subjectof this document we encourage you to contact us or an independent tax advisor to discuss the potentialapplication to your particular situation. Nothing herein shall be construed as imposing a limitation on anyperson from disclosing the tax treatment or tax structure of any matter addressed herein. To the extentthis document may be considered to contain written tax advice, any written advice contained in, forwardedwith, or attached to this document is not intended by Grant Thornton to be used, and cannot be used, byany person for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.

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