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TheFutureofExecutiveCompensationGeorgeB.PaulinPresident&CEO,F.W.Cook&Co.,Inc.October6,20041BackgroundOVERVIEW5-yeartransitioninexecutivecompensation...1stPhase2ndPhasePeriod2002-032004-06CatalystsSarbanes-Oxley,stockexchangerules,institutionalinvestorinitiativesNewFASBrules,option-valuationrefinements,political/laborpressureFocusCorporategovernanceProgramdesignImpactBoardcompensationcommitteeprocessUseofstockoptions2BackgroundTODAY’SDISCUSSION1.2nd-phasemarkettrendsinexecutivecompensationtransition2.Newandproposedregulations3.ShareholderinitiativesandvotingImplicationsandoutcomesfrom3areas...3BackgroundMETHODOLOGYComesfromtheF.W.Cook&Co.database—Generally,large-caps(i.e.,Fortune250)—Butrepresentativeofbroaderpublic-companypracticeValuesoptionsbasedontheBinomialmodelandstandardassumptionsCompetitivedatausedforillustrations...4MarketTrendsTOTALDIRECTCOMPENSATIONTop-quartileoutliersaremovingbacktowardthemiddle(75thpercentileaspercentofmedian)...133%145%131%127%153%142%50%75%100%125%150%175%CEOCEOCEOTop5Top5Top51996200220045MarketTrendsLONG-TERMGRANTSShareusageasapercentofoutstandingshares(“runrates”)continuestodecrease...ShareUsageas%OutstandingShares199620022004MedianOptions0.94%1.38%1.01%Other0.05%0.03%0.10%Total1.07%1.46%1.09%75thPOptions1.32%1.82%1.43%Other0.16%0.13%0.24%Total1.45%1.87%1.55%6MarketTrendsLONG-TERMGRANTS(cont’d.)Runrates(anddilutionoverhang)arenolongermeaningfulasgrantvalueshiftsfromoptionsGrant-valuechangesarefrom2sources—Stockpricevariability—Discountinginconversionfromoptionsforfull-valuegrantsReductioninlower-levelgrantsonlypartiallycomplete—Drivenbystock-exchangerules(notaccounting),andmanyboard-approvedplansstillhavesharesavailableLookcarefullybeyondthesurveynumbers...7MarketTrendsLONG-TERMSTRUCTUREShiftfromoptionstofull-valuegrants(i.e.,restrictedandperformancestock/cash)...AnnualMixYearLevelOptionsFullValue1996CEOTop-573.7%73.2%26.3%26.8%2002CEOTop-579.2%78.0%20.8%22.0%2004CEOTop-551.5%49.8%48.5%50.2%8MarketTrendsOPTIONSTRUCTURE:MorePrevalentSomeformsofoptionswillbewinnersundernewaccounting...GrantTypeAdvantagetoPlain-VanillaOptionsStock-onlySARsFewersharesissuedDiscountOptionsLowcosttointrinsicvalueOptionswithDividendRightsLowcosttointrinsicvaluePerformanceOptionsPay-for-performanceIndexedOptionsPay-for-performance9MarketTrendsOPTIONSTRUCTURE:LessPrevalentOtherformswillbelosers...GrantTypeDisadvantagetoPlain-VanillaOptionsISOsNotaxbenefitReloadsAdditiveexpenseCash-onlySARsVariablecostPremiumOptionsHighcosttointrinsicvalueESPPsFairvalueexpense(noexpensenow)10MarketTrendsOPTIONPROVISIONS3-4yearvestingwillcontinuetospreadexpenseaccruals10-yeartermswillcontinuebecausethecosteffectofshortertermsisnotlinearPost-terminationexercisemaybecomemorelimitedtoconservesharesGrantdatesmaybemovedtolateintheyearsovaluealignswithannualTSRundernewISSguidelinesRegulatoryandshareholderconsiderationswillaffectoptiondesign...11MarketTrendsLONG-TERMGRANTDETERMINATIONAnewapproachfordetermininggrantsizeisnecessarybutcontroversial...OldMethodNewMethodDeterminecompetitiveindividualgrantvaluesConverttocompanyshares(orcash)AddindividualgrantstodeterminetotalgrantsStartwithcompetitiveaggregategrantvalueasapercentofcompanymarketcapAllocatetoindividualsbasedoncompetitivepercentoftotalgrantvalue12MarketTrendsSHAREHOLDERAPPROVEDPLANSEmployeesandoutsidedirectorseligibleAllpossiblegranttypesAdministrativeprovisionsingrantagreements,nottheplanAs-issuedsharecount“Fungible”sharepoolfortrading-offoptionsandfull-valuegrantsPotentialfor3rd-partyoptiontransfersFlexibleomnibus-typestructurewillbecomethestandard...13MarketTrendsSHAREHOLDERAPPROVEDPLANS(cont’d.)TraditionalPool:10millionoptionshareswithupto3.3millionfullvaluesharesFungiblePool:16.6millionoptionshareswitheachfullvaluesharegrantedcountedas3options(assuming33%Binomialoptionvalue):FungiblesharepoolworksbestunderISS-typevotingguidelines...ISS“Cost”inOptionEquivalentsSharesAvailableforGrantTraditionalPool6.7+9.9=16.6million10MillionFungiblePool16.6million5.5to16.6milliondependingonmixofoptionsandfullvalueshares14MarketTrendsEXECUTIVEOWNERSHIPPressurefromshareholdergroupswillincreaseprevalenceandenforcementsanctions...“BestPractice”RealityOwnershipGuidelinesRealownershipofspecifiedsalarymultipleornumberofshares;usuallyafter5yearsAbouthalfoflargecaps;fewsmallcapsandtechsorWestoftheMississippiRetentionGuidelinesHoldnetsharesfromcompensationprogramforatleast1year(i.e.,norun-upandflipping)GE,Citicorp,Lillyandacoupleofotherearlyadopters;fewfollowers15MarketTrendsMISCELLANEOUSSettinggoalsforannualbonusestobetterbalancepayforperformanceandpayforresultsValuingSERPs,above-marketinterestondeferredcompensation,andseverancearrangementsAligningoutsidedirectors’compensationwiththeircurrentresponsibilitiesandrisks—Andcompensationcommitteesagaintakingchargeofdirectors’compensation,whereithasmovedtonominating/governancecommitteesMoretimewillbespenton...16NewandProposedRegulationsINGENERALNYSEruleseffective6/30/03(Nasdaqrulesaregenerallyinparallel)FAS123proposalonacc