The Advisors' Blog

– Jim Reda and David Schmidt, James F. Reda & Associates

There have been substantial changes reported by companies in their 2009 proxy statements following an unprecedented drop in stock prices. In our recent study of 200 of the largest companies (by market capitalization) that comprise the S&P 500 Stock Index we reviewed “forward looking” statements with regard to changes in 2009.

Surprisingly, 70 percent of companies reported changes to their 2009 executive compensation programs. These range from “minor changes” relating to salaries to “major changes” relating to short and long-term incentive programs. We also reviewed changes to severance, retirement and perquisites programs. In our study, we reviewed each proxy statement for a description of prospective changes for 2009 in response to the economic downturn and increased shareholder scrutiny.

Executive compensation program changes reported for 2009 appear to be primarily related to the stock price drop from December 31, 2007 to February 28, 2009. The greater the drop in stock price, the more likely it is that a company reported a change to their program. This relationship also applies to each element of compensation.

To assist in our study, we categorized changes as “minor” or “major”. Minor changes are related to adverse salary changes. Major changes primarily relate to short- and long-term incentive plans, but we have also included changes to severance, retirement and perquisite programs in this category as well.

In general, incentive plans have changed as follows:

– A shift away from long-term incentives to include more focus on short-term incentive plans;

– Short-term incentive (“STI”) plan performance measures shifted to profit and cash flow from capital efficiency and non-financial performance goals;

– Long-term incentive plan performance measures shifted to capital efficiency, cash flow and total shareholder return; and

– Companies are increasing their emphasis on time-vested restricted stock (“RS”) and restricted stock units (“RSUs”).

Specifically, a substantial majority (70 percent) of companies that filed proxy statements disclosed changes to their executive compensation programs effective in 2009 that will impact pay levels reported in next year’s proxy. Highlights of the changes are as follows:

– Base Salary: Eliminated merit increases for 2009 (43 percent) and froze or reduced base salaries for 2009 (13 percent);

– Short Term Incentives: Adjusted short-term incentive program (e.g., move to discretionary plans, changes to Pay for Performance Curve- the relationship between threshold, target or maximum performance levels and the corresponding threshold, target or maximum payout levels).

– Long Term Incentives: Adjusted long-term incentive grants (e.g., awarding the same number of shares regardless of value, decreasing the value of awards, changing the mix of award types, and changes to Pay for Performance Curve) (39 percent); and

– Other Elements of Compensation: Changed various other elements of compensation (e.g., modifying change-in-control (“CIC”) benefits, eliminating tax gross-ups on perquisites, reducing retirement benefits) (15 percent). Modified CEO’s change-in-control benefits (e.g., reducing the severance multiple) (4 percent).

In summary, our findings show:

(i) Greater focus on short-term cash flow results which is counter to the direction suggested by the U.S. Treasury, academics and other expert advisers regarding ways to mitigate risk, which is to encourage a long-term perspective by subjecting more compensation to stock price risk; and

(ii) More reliance on restricted stock and restricted stock units which is not performance-based as it vests simply with the passage of time.

We suggest that companies consider:

(a) Rebalancing their short- and long-term incentive target opportunity levels which may result in (x) a reduction of STI levels, or (y) a combination of reduction of STI levels and a slight increase in LTI levels;

(b) Change the LTI mix away from restricted stock (or units) to a more performance-based award program; and

(c) Revise the pay for performance curves for both short- and long-term incentive plans by reducing maximum payout levels.

These changes collectively will better align corporate risk, corporate performance and executive pay.