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Executive Compensation for Dummies
Session 26

Moderator: Scott A. Hittner, JPMorgan
Presenters: John H. Lowell, JPMorgan; Max Schwartz, Sullivan & Cromwell LLP
Recorder: Michael J. Petrauskas, JPMorgan

Fueled by high visibility and various legislative developments, the face of executive compensation has changed drastically over the past few years. In the not too distant past, it was not uncommon for compensation committees to make every effort to ensure that their company’s executives were paid well above average with little focus on benchmarks, performance criteria, or shareholder interests. Furthermore, accounting, taxation, and disclosure standards permitted practices that rewarded executives with lavish perquisites and other incentives, excessive equity compensation, and lucrative protection in the event of mergers or takeovers.

In light of the increased scrutiny devoted to executive compensation in recent years, various factors have contributed towards more stringent requirements aimed at increasing disclosure as well as aligning executive compensation with company goals and shareholder expectations. Looking ahead, the focus for compensation committees is likely to be on remaining compliant with the plethora of regulations while establishing pay structures that retain and attract talented executives. In order to tie executive compensation more closely to performance, it is expected that compensation packages will continue to include more incentives and pay dependent upon the executive achieving various performance metrics. This creates a significant need for detailed analysis aimed at developing fair and effective performance criteria.

Each element of compensation packages needs to be scrutinized from the perspective of various regulations. A few of the most prominent are IRC Section 409A, IRC Section 162(m), FAS 123R, and recent proxy disclosure developments. IRC Section 409A has established a need for employees in receipt of non-qualified deferred compensation to identify a time and form of payment upon earning the compensation. The period of good faith compliance for 409A has been extended to continue through the end of 2008, but most companies already are taking steps to ensure conformity. Penalties for failure to comply with 409Awill be levied upon the employee rather than the employer.

IRC Section 162(m) sets a $1 million pay cap on the highest paid officers of public companies. Pay above this limit, with the exception of commissions, performance-based compensation (if objective performance targets were established by an independent compensation committee), and some employee benefits, becomes nondeductible from the company’s perspective.

FAS 123R, a new accounting development over the past couple of years, has established fair value accounting for equity compensation that requires companies to recognize an expense over time for awards based upon their grant date fair value. This has leveled the playing field among various types of equity awards and essentially has eliminated the possibility of awarding executives with equity compensation without recognizing any expense.

To promote more in depth disclosure, further enhancements to the equity compensation segment of the proxy statement have been added. The key additions include a compensation discussion and analysis section as well as a single “total compensation” value that should ease comparability. High levels of detail on everything from retirement programs and stock grants to perquisites and golden handcuffs are required.

The public scrutiny placed on excessive executive compensation has played a significant role in the increased regulation in the executive compensation arena. Eyes on the impact of these recent developments will come from various parties, including shareholders, unions, competitors, and the end users of products and services. To say that the world of increased disclosure and regulation will resolve all executive compensation abuses would be misleading, but nonetheless the past few years certainly have had a positive effect on the perception of executive compensation and its alignment with corporate goals and shareholder interests.

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