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OIL INDUSTRY ROUNDTABLE DISCUSSION GROUP
OIL INDUSTRY ROUNDTABLE DISCUSSION GROUP
“Trends and Best Practices in Corporate Governance of Executive Compensation
Post-Enron”
June 4, 2002
“Trends and Best Practices in Corporate Governance of Executive Compensation
Post-Enron”
June 4, 2002
Frederic W. CookFrederic W. Cook & Co.,
Inc.
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PRESENTATION TOPICS . . .
A. COMPENSATION GOVERNANCE PRINCIPLES
B. BRT PRINCIPLES OF CORPORATE GOVERNANCE
C. FWC SUGGESTED BEST PRACTICES FOR EXECUTIVE COMPENSATION
D. STOCK OPTION ACCOUNTING
E. COMPENSATION COMMITTEE USE OF OUTSIDE ADVISORS
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COMPENSATION ISSUES . . .
“In the last decade, management has faced increased market pressures for short-term stock price performance and corresponding pressures to satisfy market expectations on a quarterly basis. This, coupled with increasing grants to senior executives of stock options and other incentives that are focused on short-term stock appreciation, may have created incentives that tipped the balance toward the promotion of self-interest rather than the protection and promotion of long-term shareholder value.”
Ira M. MillsteinWeil, Gotshal & Manges LLPCo-Chair of Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit CommitteesTestimony -- Senate Banking CommitteeFebruary 27, 2002
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PUBLIC PERCEPTIONS . . .
• Executive greed and duplicity contributed to Enron debacle
– Mega-options drove management to falsify accounting to keep stock prices high and rising
– Executives used inside information to exercise and sell options while price high
– Executives urged employees to buy while they were selling
• Stock option accounting contributed to the speculative bubble in stocks by inflating the growth rate in EPS
• Stock options cause short-term behavior and are misaligned with long-term interests of shareholders
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A. COMPENSATION GOVERNANCE PRINCIPLES . . .
Forces influencing change in executive compensationpractices
• Regulatory– Congress– SEC– NYSE/Nasdaq
• Investor Advocates– CalPers – CII– TIAA-CREF – ISS
• “Best Practices” Initiatives– The Business Roundtable (“BRT”)– Financial Executives Int’l– Frederic W. Cook & Co.– Wachtell Lipton– National Association of Corporate Directors
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B. BRT PRINCIPLES OFCORPORATE GOVERNANCE . . .
• Comprehensive statement issued May 20, 2002
– Replacing 1997 statement
• BRT represents CEOs of 150 large corporations
• Urges adoption of new governance principles by all U.S. public companies to restore public trust in American business
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BRT PRINCIPLES -- GENERAL . . .
• Companies should adopt and publicize statements of corporate governance principles
• Core committees (audit, compensation, governance) should be composed entirely of independent directors
• Committee members and chairs should be appointed by Board on recommendations of the Corporate Governance Committee
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BRT -- COMPENSATION COMMITTEE GOVERNANCE PRINCIPLES . . .
• Committee should have a written charter, approved by Board, clearly defining its responsibilities
• Core responsibilities of Compensation Committees
– Overseeing company’s overall compensation programs
– Setting CEO and senior management compensation
– Establishing director compensation
• Compensation and Governance Committees should evaluate CEO annually on behalf of Board
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BRT -- MANAGEMENT COMPENSATION PRINCIPLES . . .
• Adopt diverse mix of compensation and incentives
– Prevent short-term focus
– Avoid narrow focus on particular aspect of company’s business
• Carefully design equity compensation to avoid unintended incentives for short-term market value changes
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BRT -- MANAGEMENT COMPENSATION PRINCIPLES (cont’d) . . .
• Directly link interests of management to long-term interests of stockholders
• Require shareholder approval of all stock option and restricted stock plans in which directors and executive officers participate
• Engagement by the Committee of separate compensation consultants may be useful
– BRT believes access to outside advisors is an important element of effective governance system
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BRT -- DIRECTOR COMPENSATION PRINCIPLES . . .
• Directors should be incentivized to focus on long-term value
• Meaningful portion of total remuneration should be in long-term equity
• Equity compensation should be carefully designed to avoid unintended incentives for short-term market value changes
• Boards may wish to require directors to acquire and hold meaningful ownership positions while active
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C. FWC SUGGESTED BEST PRACTICES FOR EXECUTIVE COMPENSATION . . .
Financially-Driven Incentives
• Pick the critical and conservative measures of operating performance
• If formula driven, have audit firm confirm calculations
• Preserve discretion to deviate from accounting numbers
• Include strategic/qualitative measures
• Consider effect on current awards of prior-period restatements
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Suggested Regulatory Initiatives
• Increase frequency of reporting of OD stock transactions
– Gain control over shares
• Permit recapture of stock gains in bankruptcy
• Permit recapture of lump sum SERPs in bankruptcy
• Preclude option grants on inside information
C. FWC SUGGESTED BEST PRACTICES (cont’d) . . .
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“Best Practices” Initiatives
• Adopt policy on stock transactions and conflicts of interests by ODs
• Adopt stock “retention ratios” instead of ownership guidelines
• Prohibit 100% “cashless exercises” by ODs
• Use “reloads” only for ownership purposes
C. FWC SUGGESTED BEST PRACTICES (cont’d) . . .
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“Best Practices” Initiatives (cont’d)
• Prohibit loans for exercising options, purchasing stock or paying taxes
• Prohibit purchases of stock on margin and use of stock as collateral
• Prohibit “hedging” or similar techniques
• Encourage (or require) use of SEC 10b5-1(c) selling programs by ODs
• Prohibit incentives on piece-parts of business where conflicts exist
C. FWC SUGGESTED BEST PRACTICES (cont’d) . . .
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Directors’ Remuneration “Best Practices”
• Discontinue stock options*
– Use deferred stock instead
• Discourage (or prohibit) stock sales while an active director
C. FWC SUGGESTED BEST PRACTICES (cont’d) . . .
* Except for startups or pre-IPO companies
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D. STOCK OPTION ACCOUNTING . . .
• Intense debate underway whether to require P&L expense for option value:
For
Alan Greenspan
Arthur Levitt
Warren Buffet
New York Times
CII/TIAA-CREF
Against
President Bush
Chairman Pitt
Walter Schuetze
Business Week
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D. STOCK OPTION ACCOUNTING (cont’d)
Concerns of Change Advocates
• Present accounting leads to excessive use and dilution
• Earnings and EPS growth overstated
• Incentives misaligned
• Options have value; therefore must have a cost
• Expense is not zero
• Better design would result from expensing
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D. STOCK OPTION ACCOUNTING (cont’d)
Arguments for Status Quo
• Option “fair values” impossible to measure
• Black-Scholes overstates option value
• FV doesn’t meet conceptual definition of expense
• FV would be only expense estimate never trued up
• Cost to shareholders already measured by diluted EPS
– FV charge would be double counting
• Value of option privilege in financial instruments not expense
• No other country requires option expense
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E. COMPENSATION COMMITTEE’S USE OF INDEPENDENT ADVISORS . . .
• (Materials handed out at the meeting; not available for general distribution or on our website)
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OTHER LIKELY IMPLICATIONSOF “ENRON”
• More power to board/committees, less to management
• Harder to attract/retain qualified directors
– Smaller boards
• More staff time spent serving board/committees
• More transparency
• “Best Practices” statements
– Possible “comply or explain” disclosure