Overview of Executive and Director Compensation and Related Trends Third Annual Advanced ALI-ABA Course of Study June 8, 2000 Michael A. Thompson F REDERIC W. C OOK & C O.

The Places We’ll Go

• The Environment • Trends in Executive Pay – Internet and E-commerce • Trends in Director Pay

The Environment

• Volatile and uncertain stock market • Investor dilution concerns • FASB Interpretation 44 • Corporate transactions • Re-emergence of venture capital

Volatile Stock Market

• Nasdaq down 1/3 • Dow back around 10,000 • Many companies have lost 50% or more of their value – Xerox Mattel – Armstrong – Sara Lee – Sears – E-Toys Bank One R.R. Donnelley Toys R Us Red Hat

Stock Plan Dilution

• Higher “burn rates” and “overhang”

% Outstanding Shares Top-200 (P. Meyer Survey) 1989 1999 Annual Grants 1.1% 2.1% Potential Dilution 6.9% 13.7%

• More scrutiny from institutional investors

Stock Plan Dilution

• Smaller more frequent share authorizations • Shares counted on net, as issued basis, not gross, as granted basis • Add back shares re-purchased with option proceeds • Board approved plans for non officers • Best voting outcome because of dilution tests • Add back shares to pool from stock swap exercises, etc.

• Particularly with prevalent buy-back programs • Possible under stock exchange rules

FASB Interpretation 44

• Separate presentation tomorrow • Creates some upheaval – Re-pricing – Reloads – Tax withholding • Subsidiary stock and options – Including pre-IPO options • Restricted stock for u/w options – Be careful of share for share matching

Corporate Transactions

• Mergers • Acquisitions • Divestitures/ Sales • IPOs • Spin-offs • Tracking Stock

Rise of Venture Capital

• Corporate Venture Capital and Private Equity Funds • Creates significant pressure on executive compensation – Internal venture managers • Raises issues regarding “friends and family” shares on IPO

Hot Topics Executive Pay

• Retention, Retention, Retention • Equity use expansion continues • Stock/options for cash • Deferred stock option gains • Impact of Internet companies

Retention, etc.

• Way underwater options • Restore retention & motivation • Avoid re-pricing “penalties” • Implementing “claw-backs” • Reducing post-termination exercise – But expanding for retirement, death and disability

Retention Alternatives

• Front-load future options • Increase in restricted stock • Price-recovery restricted stock • Dividend-equivalents on options • “Claw-back” provisions • “Premium” elective share conversions • Extended stock option vesting

Equity Use Expansion

• Grant sizes explode – Million option grants now common • Annual share usage over 2% • Broader participation in regular annual grants • Continued use of broad-based grants

Stock/Options for Cash

• 28% of Top 250 • Mostly voluntary – Some mandatory • BankBoston-25% of bonus over $300k • Often includes premium to play – Alcoa and Gen’l Mills-one add’l share for every four elected – Dell-discounts from market value

Deferred Option Gains

• Deep in-the-money options expiring • Offers opportunity to protect some carried interest • Must use stock-swap exercise • Deferral in stock units payable in shares • Irrevocable election 6 months in advance • Still owe FICA/Medicare tax

Internet Impact

• Changing the game – Focus on carried interest, not Black-Scholes value – Equity interest in E-commerce units • Raises the ante for retention • Significant salary increases in some sectors, e.g., law firms

Generic Job Comparisons

($000) $2,500 $2,000 $1,500 $1,000 GI $500 $0 Internet CEO GI Internet GI Internet GI Internet CFO Top Sales General Counsel Salary Bonus Long-Term

Run Rate Comparisons

8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% 91% Growth 2.1% 1.1% 5.0% - 7.0% Old Economy 1989 1999 New Economy

Dilution Comparisons

25.0% 20.0% 15.0% 10.0% 5.0% 0.0% 99% Growth 13.7% 6.9% 20.0% - 25.0% Old Economy 1989 1999 New Economy

Director Compensation

• Keep the stock coming • Away from meeting fees • Flexibility Reigns • Ownership guidelines • Interesting variations

Increasing Stock

• Interpretation 44 finalized – Directors considered employees so no P&L charge • Pension debate is over – Replaced with stock grants

Director Stock Usage Top 250 Companies

100% 80% 60% 40% 20% 0% Any Type

Source: FWC&Co. 1999 Top 250

1996 1997 Elective Grants Stock Options Rest.

Stk 1998 Unrest Stk

Retainer-Only Plans

• Move away from meeting fees • Paying for governance, not time spent • More complete disclosure encourages attendance • Eliminates administrative complexity • Facilitates conversion of compensation to stock

Flexibility Reigns

• Trade off everything for everything • Directors from increasingly diverse backgrounds

Ownership Guidelines

• 16% of Top 250 – Not a lot, but increasing • Most use multiple of retainer – 5x most common • Other examples – Citigroup—75% of shares granted – Comcast—60% of vested value – Airtouch--$100k owned before option grants made

Other Variations

• Performance Options – Computer Associates--# based on ROE – SYSCO—options granted only if 10% growth in EPS – UP—options vest on stock price • Reloads for directors – Includes Abbott, Allstate, Sara Lee, US Bancorp, Wells Fargo

Overview of Executive and Director Compensation and Related Trends Third Annual Advanced ALI-ABA Course of Study June 8, 2000 Michael A. Thompson F REDERIC W. C OOK & C O.

Frederic W. Cook & Co., Inc.

provides management compensation consulting services to business clients.

Formed in 1973, our firm has served over 1,000 corporations in a wide variety of industries from our offices in New York, Chicago, and Los Angeles. Our primary focus is on performance-based compensation programs which help companies attract and retain key employees, motivate and reward them for improved performance, and align their interests with shareholders. Our range of consulting services encompasses the following areas:  Total Compensation Reviews  Strategic Incentives  Specific Plan Reviews  Restructuring Services  Competitive Comparisons  Incentive Grant Guidelines  Executive Ownership Programs  All-Employee Plans  Directors’ Compensation  Equity Instruments  Performance Measurement  Globalization  Privatization  Compensation Committee Advisor  Stock Option Enhancements Our offices are located:

New York

90 Park Avenue 35 th floor New York, New York 10016 212-986-6330 phone 212-986-3836 fax

Chicago

19 South LaSalle Street Suite 400 Chicago, Illinois 60603 312-332-0910 phone 312-332-0647 fax Web site address:

www.fredericwcook.com

Los Angeles

2029 Century Park East Suite 1130 Los Angeles, California 90067 310-277-5070 phone 310-277-5068 fax