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Executive Pay Topics for 2011 Proxy | March 2011

The increased scrutiny of executive compensation, resulting from both recently passed and pending legislation, as well as shareholder advisory group policies, will require regular updates to public company’s Compensation Committees. Although there are many issues that will come about in the near future, we have identified the following topics in regard to executive compensation that companies should keep on their radar screens.

SAY-ON-PAY

Final Rule 14a-21(a) requires each public company to include in its proxy statement a separate shareholder advisory vote to approve or disapprove the compensation of the company’s NEO’s as disclosed pursuant to Item 402 of Regulation S-K, including the Compensation Discussion and Analysis, the compensation tables and other narrative executive compensation disclosures. The required vote is a “yes” or “no” indication on the entirety of the NEO compensation arrangements described in the proxy statement. Compensation of directors is not required to be included in the vote. It is worth noting that Riskmetrics has recommended votes against approximately 15% of the proxies filed so far in 2011, and of those companies only two have failed Say-on-Pay shareholder votes (Jacobs Engineering and Beazer Homes).

Key Take-away: Say-on-Pay requires companies to address in their proxy statement’s “Compensation Discussion and Analysis” (CD&A) section whether and how they took into account the results of the say-on-pay vote.

SAY-ON-FREQUENCY

Under final Rule 14a-21(b), public companies are required to include in their proxy statements a separate shareholder advisory vote to indicate the frequency of future votes on the compensation of executives preferred by the shareholders. Shareholders must be given four choices (annual, biennial, triennial, or abstain). As of March 15, 2011 approximately 55% of early filers prefer annual, 6% biennial and 39% triennial. This is a shift from earlier results of 40% annual, 8% biennial and 52% triennial (March 1, 2011).

Key Take-away: NFPCCmp;A recommends Companies provide a recommendation to shareholders for votes on a triennial basis. Triennial voting is consistent with longer term compensation awards and planning, allows institutions to provide “thoughtful” votes and the majority of institutional shareholders already vote with their stock. HOWEVER, if a company’s majority shareholders follow RiskMetric’s voting guidelines, the Company may consider recommending an annual say-on-pay vote.

CLAWBACKS

The Dodd-Frank Act includes a requirement that all public companies have a clawback policy for incentive compensation paid to executive officers. The clawback applies to all executive officers, not just the CEO and CFO as under the Sarbanes-Oxley Act. Dodd-Frank further expands the reach of mandatory recoupment policies. Under the Act, the SEC will direct the national securities exchanges and national securities associations to amend their listing standards to require that every listed company adopt a compensation recovery policy containing two key components: 1) Companies must provide disclosure of clawback policies for any incentive-based compensation that was paid out based on erroneous financial information reported under securities laws; 2) Companies must seek repayment from any current or former executive officer of any incentive-based compensation (including stock options) paid during the three-year period preceding the “date that the company is required to prepare the accounting restatement” that was based on the erroneous data.

Key Take-away: The final provisions of clawbacks have yet to be determined. The SEC is expected to provide final guidance by the second quarter of 2011.

CHANGE OF CONTROL

The Dodd-Frank Act requires a tabular disclosure of the compensation arrangements covered by the new rules that is somewhat different from, and more extensive than, the narrative disclosure of change-in-control and post-termination arrangements currently required under paragraph (j) Item 402 of Regulation S-K. The new tabular disclosure must quantify for each NEO the following: Cash severance payments; Accelerated stock awards; accelerated vesting option awards; payments made in cancellation of stock and option awards; Pension and nonqualified deferred compensation benefit enhancements; perquisites; tax gross-ups; any other benefits; and the aggregate of all such compensation.

Key Take-away: The new rules also require additional narrative disclosure of the following: any material conditions or obligations applicable to the receipt of payment (including non-compete and non-solicitation agreements, their duration, and provisions regarding waiver or breach); a description of the specific circumstances that would trigger payment (whether lump sum or annual, their duration, and who would provide the payments); and any material factors regarding each agreement.

CEO PAY VS. MEDIAN EMPLOYEE

Companies must disclose the median annual total compensation of all employees under the CEO, the annual total compensation of the CEO, and the ratio of the median employee total compensation to the CEO total compensation. In 2007, CEOs in the S&P 500, averaged $10.5 million annually, 344 times the pay of typical American workers, but that was a steep drop in the ratio from 2000 when CEOs earned 525 times average pay.

Key Take-away: Final rules regarding the calculation of the total compensation as well as which employees are to be included in the calculation, have not been determined. This disclosure is not required for the 2011 proxy season, and many question the utility of such a calculation.

PAY FOR PERFORMANCE

The single most important factor in “getting to yes” in Say-on-Pay votes will be demonstrating the link between pay and performance. This must be done in the “Compensation Discussion and Analysis” (CD&A) disclosure in the proxy statement. It will be important to craft the summary section of CD&A carefully. The section should summarize the pay for performance link. In this first proxy season involving mandatory Say-on-Pay, advisory services such as Riskmetrics, as well as institutional investors, will be scrambling to sort out the practices of many companies in a short time. Issuers will want to make it easy for investors to determine quickly that the company has sound pay practices.

Key Take-away: The Dodd-Frank Act will require a “Pay for Performance” disclosure in the proxy statement. However, the enabling regulations won’t be adopted until April – July 2011, and the table will likely not be in effect until the 2012 proxy statement for most companies. Experts speculate that the table will be based on a total shareholder return (TSR) measure.

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