Principles of Executive Compensation

1. Executive compensation should be closely aligned with the long-term interests of shareholders and with corporate goals and strategies. It should include significant performance-based criteria related to longterm shareholder value and should reflect upside potential and downside risk.

2. Compensation of the CEO and other top executives should be determined entirely by independent directors, either as a compensation committee or together with the other independent directors based on the committee’s recommendations.

3. The compensation committee should understand all aspects of executive compensation and should review the maximum payout and all benefits under executive compensation arrangements. The compensation committee should understand the maximum payout and consequences under multiple scenarios, including retirement, termination with or without cause, and severance in connection with business combinations or sale of the business.

4. The compensation committee should require executives to build and maintain significant continuing equity investment in the corporation.

5. The compensation committee should have independent, experienced expertise available to provide advice on executive compensation arrangements and plans. The compensation committee should oversee consultants to ensure that they do not have conflicts that would limit their ability to provide independent advice.

6. The compensation committee should oversee its corporation’s executive compensation programs to see that they are in compliance with applicable laws and regulations and aligned with best practices.

7. Corporations should provide complete, accurate, understandable and timely disclosure to shareholders concerning all elements of executive compensation and the factors underlying executive compensation policies and decisions.

Introduction

Business Roundtable, an association of CEOs of 160 leading corporations, is committed to policies and actions that stimulate economic growth and foster investor confidence and public trust in businesses. Roundtable CEOs take seriously their responsibilities to improve corporate governance and promote the highest standards of accountability and ethical behavior.

Business Roundtable CEOs lead companies with more than $4.5 trillion in annual revenues and more than 10 million employees. Member companies comprise nearly a third of the total value of the U.S. stock market, collectively returned more than $110 billion in dividends to shareholders and the economy in 2005, and represent nearly a third of all corporate income taxes paid to the federal government. The CEOs advocate public policies that encourage economic growth in the United States and across the world and have been leaders in developing the well-trained and productive U.S. workforce essential for future competitiveness.

For the past three decades, compensation has played an increasingly significant role in attracting, retaining and motivating executive officers and employees at all levels. In March 1992, when Business Roundtable released Executive Compensation/Share Ownership, we noted the intense interest in compensation paid to corporate executives. The stock market boom of the late 1990s and the corporate failures in the early part of this decade have heightened the focus on executive compensation. Moreover, there has been a growing concern among investors and the public that pay has not always been commensurate with performance, with a perception that some executives have reaped substantial financial rewards even at times of declining stock prices and large losses to employees and shareholders. Roundtable CEOs share that concern and believe that executive compensation should be clearly linked to company performance.

Since the publication of our executive compensation principles, there has been continuing scrutiny of executive compensation and developments relating to compensation committees. Major securities markets have adopted listing standards that require compensation committees’ or independent directors’ oversight of executive compensation, along with prescribed minimum responsibilities for compensation committees.

Given the ongoing development of best practices in executive compensation, Business Roundtable is updating our principles of executive compensation. In addition, the Roundtable urges all corporations to make their compensation policies and practices as responsible and transparent as possible.

Compensation should serve the objectives of a corporation’s business. Accordingly, the structure and components of an appropriate executive compensation program will vary widely among corporations due to such factors as a corporation’s size, industry, competitive challenges and culture. Nevertheless, the executive compensation program of every publicly owned corporation should adhere to two fundamental characteristics. First, it should reflect the core principle of pay for results. Although this concept is not new, it means that a corporation’s executive compensation program not only rewards success, but also incorporates a meaningful element of risk. Additionally, it should reflect the performance of the corporation, not just the stock market in general. Second, the executive compensation program of every publicly traded corporation should be established and overseen by a committee comprised solely of independent directors who, among other things, set the goals and objectives for executive compensation and determine whether those goals and objectives have been achieved. In doing so, compensation committees should be aware of all aspects of their corporation’s executive compensation and see that the compensation arrangements are in the best interests of shareholders.

Building on these characteristics as a foundation, Business Roundtable has developed seven interrelated principles to serve as best practices for the design, implementation and oversight of executive compensation programs at publicly held corporations.

We urge all corporations and their compensation committees to consider these practices as they develop and implement executive compensation arrangements.

Commentary on Executive Compensation Principles

1. Executive compensation should be closely aligned with the long-term interests of shareholders and with corporate goals and strategies. It should include significant performance-based criteria related to long-term shareholder value and should reflect upside potential and downside risk.

• Compensation is a primary tool for attracting and retaining the highly qualified individuals necessary for a corporation to succeed in a competitive world economy. The board of directors is responsible for adopting and overseeing the implementation of compensation policies that support the corporation’s ability to compete successfully in the marketplace.
• Executive compensation should directly link the interests of executive officers, both individually and as a team, to the long-term interests of shareholders. Equity-based compensation can be effective in accomplishing this objective. Establishing a meaningful link between executive officer and shareholder interests requires careful consideration of the incentives created by different forms of compensation.
• Compensation committees and boards of directors should establish meaningful goals for performance-based compensation; payment should be tied to the achievement of those goals. A failure to meet performance goals should reduce or eliminate payments.
• Once performance goals have been established, corporations should adhere to them. A corporation should not adjust previously established targets or reprice options prior to the end of a performance measurement period or the options’ term simply because it appears that results for that period or term may fall short of the goals.
• In setting performance goals, corporations should look beyond short-term market value changes and focus on metrics related to long-term shareholder value creation. Compensation plans should further both the near-term objectives and the corporation’s long-term strategy, and they should be consistent with the culture of the corporation and the overall goal of enhancing sustainable shareholder value. They should avoid windfalls due solely to general stock market performance.
• In setting performance measures, consideration should be given to a variety of performance metrics, both qualitative and quantitative. These metrics should not be tied solely to the corporation’s short-term stock price. Examples of quantitative metrics that may be used include such items as cash and debt management, cost containment, dividends and earnings per share, labor relations, margins, market share, mergers and acquisitions, return on equity, revenue and profit growth, sale of assets, stock price, and significant reorganizations. Qualitative metrics include such items as community relations, crisis response, customer satisfaction, employee development and relations, ethics and a culture of integrity, leadership, legal compliance, product quality, succession planning, and workforce diversity. In addition, consideration of performance relative to peer groups as well as absolute performance may be appropriate measures.
• Performance-based incentives should reflect both business and individual accomplishments. Incentives should be tied not only to the corporation’s operating results, but also to the executive’s distinctive leadership in managing the corporation effectively and ethically, which creates long-term value for shareholders.
• A meaningful portion of executive compensation should be performance based, thereby incorporating a greater element of downside risk into compensation arrangements. This can be accomplished, for example, by linking the granting or vesting of equity compensation to the achievement of meaningful performance targets, including a meaningful vesting period. Performance-based or performance-vested stock options, performance share units, or stock appreciation rights that are payable in the corporation’s stock or cash — only if targets are met — put equity-based compensation “at risk” and link pay to performance.
• Restricted stock can be an alternative or supplement to stock options and other equity-based compensation. Although restricted stock can be an appropriate and effective retention device, it also can be more effective as a long-term incentive if it is paid or vests based on the achievement of specified performance targets.
• Performance-based incentives often will measure accomplishments over several years. For example, in a year when the corporation experiences declining financial results, the CEO may receive performance-based compensation keyed to a previously established multiyear target. Similarly, gains realized from option exercises and stock sales in a given year may be the result of options granted over many years and several years’ appreciation in the underlying stock. Corporations should take steps to enhance investor understanding of the relationship between pay and performance by providing meaningful disclosure about this relationship in the corporation’s Compensation Discussion and Analysis (CD&A).

2. Compensation of the CEO and other top executives should be determined entirely by independent directors, either as a compensation committee or together with the other independent directors based on the committee’s recommendations.

• Directors who sit on a compensation committee should be independent in both fact and appearance. Committee members should have, and be perceived to have, the ability to exercise independent judgment free from any relationship or influence that could appear to compromise their ability to approach compensation issues decisively and independently.
• In recommending directors to serve on the compensation committee, the corporate governance/nominating committee should consider the following:

• A diversity of professional backgrounds is important to the effective functioning of a compensation committee.
• Periodic rotation of members and the chair can bring fresh perspectives to the compensation committee.
• All members of the committee should have sufficient knowledge of executive compensation and related issues to perform their responsibilities effectively. In-depth orientation should be provided to new committee members, and all committee members should be encouraged to participate in continuing education programs related to executive compensation.

3. The compensation committee should understand all aspects of executive compensation and should review the maximum payout and all benefits under executive compensation arrangements. The compensation committee should understand the maximum payout and consequences under multiple scenarios, including retirement, termination with or without cause, and severance in connection with business combinations or sale of the business.

• The compensation committee should fully understand all the benefits and consequences to the executive and the costs to the corporation of the compensation arrangement under various circumstances, including under a range of economic results and severance scenarios. The committee should understand how the various elements of cash and noncash compensation, including benefits, deferred compensation arrangements and supplemental retirement benefits, are allocated and work together. In addition, the committee should understand the accounting and tax aspects of different types of arrangements. Executive compensation arrangements should not be unduly complex.
•  The compensation committee should be aware of all elements of the compensation of each executive officer; there should be no surprises. This may be facilitated by the use of tally sheets, which should include all forms of compensation.
• In structuring a compensation arrangement, consideration should be given to whether the amount and mix of compensation is reasonable, appropriate and fair in light of the roles, responsibilities and performance of the individual, the corporation’s circumstances and overall compensation structure, and the need to attract and retain high-quality executive officers.
• The committee should consider building into executive compensation agreements the right to review and consider changes at appropriate time intervals. When a compensation arrangement is modified, the committee should assess and understand how the change will affect the overall compensation of an executive officer.
• Particular attention should be paid to severance arrangements and to all benefits provided to executive officers in connection with termination of employment. Corporations should review such arrangements on a regular basis. They should not offer excessive severance packages that reward executives who have not met performance goals and objectives during the term of their employment. Employment contracts, if any, should clearly articulate the consequences of termination and the circumstances in which an executive can be terminated for cause.

4. The compensation committee should require executives to build and maintain significant continuing equity investment in the corporation.

• The compensation committee should establish requirements that executive officers and members of the board of directors acquire and hold a meaningful amount of the corporation’s stock to align executive and director interests with the interests of shareholders.
• Stock retention requirements can foster a long-term stake in the corporation among executive officers. The compensation committee should require that executive officers hold a specified amount of the stock for a period of time until they meet the corporation’s stock ownership guidelines or until they leave the corporation.
• To minimize questions and possible concerns about the propriety of particular stock trades, corporations should make available to executive officers and directors prearranged trading plans to the extent they determine to sell some portion of their stock. When executive officers and directors enter into such trading plans, they should be disclosed.

5. The compensation committee should have independent, experienced expertise available to provide advice on executive compensation arrangements and plans. The compensation committee should oversee consultants to ensure that they do not have conflicts that would limit their ability to provide independent advice.

• The compensation committee should have the authority to retain compensation consultants, counsel and other outside experts in compensation matters to provide the committee with independent advice for performing its responsibilities. Nevertheless, decisions with respect to executive compensation are the ultimate responsibility of the compensation committee and the the board.
• The compensation committee should retain and oversee any compensation consultants hired to assist with executive compensation matters, approve the terms of their retention and fees, and evaluate their performance. In doing so, the committee should consider any other work that the consultants may perform for the corporation and whether such work has any impact on the advice provided to the compensation committee. The compensation committee should consider whether it should preapprove any other work the consultant does for the corporation.
• The compensation committee should use information from a variety of sources in determining compensation levels. The committee should resist an over-reliance on surveys and other statistical analyses in determining compensation levels. Although such information can be used as a tool, company-specific factors should be given significant weight in determining Executive Compensation: Principles and Commentary 11 executive compensation. In addition, the compensation committee should carefully examine the composition of any peer groups used in considering executive compensation and consider, among other things, the performance of the other corporations included in the peer group.
• The compensation committee should retain independent counsel that reports directly to the committee to assist in negotiation of the CEO contract and benefits and to assist the committee in addressing its other responsibilities as appropriate.

6. The compensation committee should oversee its corporation’s executive compensation programs to see that they are in compliance with applicable laws and regulations and aligned with best practices.

•  The compensation committee should assess whether executive compensation programs are consistent with the corporation’s goals and strategies.
• The compensation committee should review on an ongoing basis its policies and practices with respect to the granting of stock options and other forms of equity compensation to see that they are in accord with state corporate law, Securities and Exchange Commission (SEC) rules, accounting standards, Internal Revenue Service regulations, and any other applicable requirements. The committee should be sensitive to the timing of such grants (e.g. no “back dating”) and maintain consistent practices.
• Corporations should consider adopting policies and/or provisions in compensation plans or agreements that permit them to seek the return of bonuses and equity compensation from executive officers in the event of a financial restatement or fraud resulting from an executive’s misconduct or fraudulent activity.
• The compensation committee should carefully examine executive perquisites and determine whether they are appropriate and in the interest of shareholders. If not, the corporation should not bear the cost of personal expenses.
• Benefits granted to executive officers should not be safeguarded to a greater extent than regular employee benefits.
• Corporations  should be sensitive to the appearance of executive compensation practices, and special attention should be given to such controversial practices as:

•  Tax gross-ups and supplemental retirement plans beyond those provided to other employees and
•  Preferential investment or above-market interest for deferred compensation.

7. Corporations should provide complete, accurate, understandable and timely disclosure to shareholders concerning all elements of executive compensation and the factors underlying executive compensation policies and decisions.

• Disclosure about executive compensation should be transparent and understandable to shareholders and in plain English. Corporations should disclose the terms of executive officer employment arrangements when they are entered into or materially changed. Disclosure about a corporation’s executive compensation arrangements, as a whole, should address not only the form and amount of executive compensation (including projections of future benefits), but also the interaction of the different elements of compensation, the economic impact of the compensation (such as any dilution resulting from stock options) on the corporation and its shareholders, the material factors underlying compensation policies and decisions, why specific elements of compensation were awarded, and the relationship of executive compensation to corporate goals and strategy.
• Corporations also should disclose the criteria used in performance-based awards to executives and the measurement methods used to determine whether those criteria have been met, unless disclosure of the criteria involves the disclosure of trade secrets or confidential information that could cause competitive harm.
• As required by SEC rules, the CD&A included in the proxy statement or annual report should provide shareholders an explanation of all material elements of compensation for executive officers. The CD&A should include information explaining the objectives of the compensation program, what the compensation program is designed to award, and how each element fits into the corporation’s overall compensation objectives and affects other elements.
• Corporations should use the CD&A to provide shareholders with meaningful and understandable disclosure about their executive compensation philosophy, policies and practices; the factors that the compensation committee and the board consider in making compensation decisions; and the relationship between executive compensation and corporate performance.