Changing Behavior in the Wealth Economy WorldatWork 2001 Annual Conference and Exhibition

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Changing Behavior in the Wealth
EconomyWorldatWork2001 Annual Conference and
Exhibition
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About the Speaker
Fred Whittlesey is the Director, Compensation/HR
Technology for Broadcom Corporation and the
former founding Principal of Compensation and
Performance Management, Inc. (CPM), a management
consulting firm based in Newport Beach, CA. CPM
helps organizations allocate financial capital to
human capital. Fred specializes in improving
organization performance through the evaluation,
design, and implementation of performance-based
compensation programs and the underlying
performance management processes. His 16 years
of management consulting experience included
positions with Towers Perrin and William M.
Mercer. Prior to founding CPM, he was director
of the Western Region compensation consulting
practice at KPMG Peat Marwick. Fred is an
instructor for the WorldatWork, UCLA Anderson
Graduate School of Management, and UCLA Extension
on financial aspects of managing people in
organizations. His recent articles include
"Changing Employee Behavior in a Changing
Workplace" appearing in Compensation and Benefits
Management and "Designing Shorter-Tem Cash
Incentive Compensation Plans" published in the
book Incentive Compensation in Employee
Ownership Companies by the National Center for
Employee Ownership. Fred received his MBA from
UCLA with concentrations in human resource
management and marketing. He graduated Phi Beta
Kappa and Magna Cum Laude from San Diego State
University with a BA in industrial/organizational
psychology. He also earned the Certified Equity
Professional (CEP) designation from the Santa
Clara University Leavey School of Business
Administration.
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Presentation Overview

• What is the Wealth Economy (and is there one?)
• Characteristics of the Wealth Economy
• Human Capital Management Challenges of the Wealth
  Economy
• Human Capital Management Alternatives for the
  Wealth Economy
• The Wealth Economy at Broadcom Corporation
• Solutions for the Wealth Economy

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What is the Wealth Economy?

• Macroeconomically
• Record levels of equity prices and multiples
• Record levels of equity holdings by investors and
  employees
• Record levels of liquid assets
• Record levels of real estate prices
• Resulting in
• Lower savings rates
• Higher consumption rates
• Reliance on capital asset appreciation

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What is the Wealth Economy?

• Managerially, an economic climate created by
• Decades of wealth creation in the technology
  sector and the economy overall
• Easy money from the bull market
• Market factors overriding internal pay strategies
• Realization of the need for self-funded capital
  accumulation
• Growing use of equity-based compensation as a
  compensation vehicle
• Workforce with fundamentally different financial
  needs and expectations

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Characteristics of the Wealth Economy

• Prevalence of and media attention to
  millionaires creating higher standards and
  expectations
• Trend toward individual decision making vs.
  corporate and government administration
• Political initiatives that seek to change
  traditional approaches to capital formation
  Social Security funds invested in the stock
  market

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The Internal Wealth Economy of a Corporation

• The challenges of
• Voluntary workers
• Vastly changed ideas about financial independence
  thresholds
• Multi-class society
• Depending on original and ongoing staffing
  strategies, the advantages of
• Population with a blurred line between work and
  play life always organized around the workplace
• Workers with diverse interests and corresponding
  alternative work roles
• Candidates attracted by the success stories

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Human Capital Management Challenges

• For the Haves
• Retention vs. retirement, competitor, new
  industry
• Commitment vs. changing to a lower-sacrifice
  lifestyle
• Balancing the small-company memories with
  larger-company business needs
• For the Have-Nots
• Heightened expectations based on early joiners
  risk-reward outcome
• Consequences of extreme risk-taking to catch-up
  to the Haves
• Highly visible reference points underscore
  timing is everything
• Retention vs. a faster get-rich opportunity

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The Four Elements of Remuneration
Cash
Goods and Services
Wage and salary Short-term incentive
programs Long-term incentive programs Liquidation
of other forms of payDeferred cash
(savings/retirement) Expense reimbursement
Health and welfare benefits Work tools Leisure
items Education and trainingSocial activities
Securities
Time and Place
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The Impact on Remuneration Systems

• For the Haves
• Traditional financial programs are
  meaninglessBase salary unnoticedBusiness
  expense reimbursement unimportantMost benefit
  plans inconsequential and too rigidCompany car
  policy insulting
• Equity compensation still important but scale is
  unaffordable through traditional plans
• Fourth quadrant now primary area of
  interestTimePlaceChoice
• Interesting work, etc. assumed as a given

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The Impact on Remuneration Systems

• For Have-Nots
• Traditional programs needed as short-term
  bridgeBase salary provides cash flowBusiness
  expense reimbursement neededBenefit plans value
  seen in terms of cash conservationCompany car
  policy a temporary form of assistance
• Special deals requested due to ratchet effect
• Equity compensation is critical and the primary
  focusUpside opportunity expectedGuarantees
  increasingly expected if things go wrong
• Fourth quadrant is for future dreaming
• Interesting work, etc. assumed as a given

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Broadcom Company Characteristics

• Ultra high-growth resulting from multiple
  high-growth market segments Growth from 1,100
  to 2,800 employees in 9 months
• Aggressive MA strategy supplementing internal
  development 40 of employees from 18
  acquisitions closed in 24 months
• Focus on Execution, Execution, Execution
• Flat organization structure
• Decentralized business units
• Minimal corporate policy/structure

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Broadcoms Approach to Remuneration

• Total Compensation Philosophy
• Focus on total compensation value
• Emphasis on long-term stock-based compensation
• Over time, substantial wealth transfer to
  employees
• Emphasis on financial returns over non-financial
  benefits
• Total Compensation Strategy
• Conservative cash compensation
• Top-of-the-market benefit program
• Top-of-the-market stock equity programs

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Broadcoms Approach to Total Compensation

• Cash Compensation Strategy
• Conservative base salary at hire
• No cash bonuses
• Salary increases governed by total compensation
  perspective
• Internal equity emphasized over market
  competitiveness
• Stock Compensation Strategy
• Largest transfer of wealth to employees in world
  history
• Strong retention focus
• Ongoing review of absolute and relative stock
  position
• Aggressive program to address underwater options

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Broadcoms Approach to Total Compensation

• Cash Compensation a temporary bridge in
  cashflow, not a reward system
• No job descriptions, salary grades, ranges, or
  structures
• No reference to survey data
• No assumption of annual salary increases
• Salary increase elimination being considered
  based on absolute and relative total compensation
  levels
• Base salary reduction/ elimination being
  considered based on similar criteria
• Equity Compensation the source of reward
• Stock options only
• 99th percentile grant amounts
• Creative design of vesting periods to accomplish
  compensation objectives

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Broadcoms Employee Stock Option Position
Note Calculated based on granted stock options
as a of shares outstanding shares taken from
most recent 10Ks, and shares outstanding per
FirstCall 4/11/01.
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Have we Changed Behavior? Created Wealth?

• Staffing
• Focus on hiring top 10 of talent pool
• Less than 0.5 turnover per year since Company
  inception
• Over 90 of candidates from employee referral (no
  referral bonus program)
• Over 90 offer acceptance rate (on top of a
  low-offer-to-candidate ratio)
• Compensation _at_ 12-month stock price high
  (274)
• Over time, 99 of total compensation from stock
  option gains
• Highest proportion of employee millionaires in
  history
• Average unvested option gains of 10 million per
  employee

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And Now?

• Compensation _at_ 24-month stock price low (20)
• All but a few newly-hired employees have some
  underwater options
• Substantial proportion of employees have only
  underwater options
• Still have hundreds of millionaires, based only
  on outstanding options
• Dual-class society of millionaires and
  underwater-only employees
• Compensation Philosophy and Strategy
• No change in philosophy low cash, high equity
• Solutions biased toward those with long-term
  confidence
• Equity-based solutions to equity-based issues
• Cash-based solutions require investing in BRCM

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Broadcoms Wealth Creation Response

• Stock Option Exchange and Supplemental Option
  Program
• Program allowing maximum employee choice for
  addressing underwater option positions, with two
  alternatives
• Six-plus-one cancel/regrant program with 100
  replacement
• Supplemental option grant with grant size based
  on original grant price
• Complete vesting preservation and credit
  regardless of combination of choices

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Broadcoms Wealth Creation Response

• Complementary Strategies and Programs
• Material headcount reduction due to economic
  slowdown
• No change in cash compensation philosophy and
  delivery
• Employee loan program established through
  partnership with financial institution
• Increased flexibility in choice of cash/stock mix
  for new hires
• Exploring cash/equity exchange program for
  current employees

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Why the Strategy Works at Broadcom

• Strong Culture Driven by CEO a company of
  owners
• Exceptionally high expectations
• No excuses (including laws of physics or need for
  sleep)
• 24/7 availability and instant response
• Individual ownership of tasks and results (Who
  owns this?)
• Open communication regarding sacrifices and
  payoffs
• Aggressive but civil focus on results
• No politics
• No resource constraints but rigorous scrutiny to
  expenditures
• Daily vigilance to compensation philosophy and
  strategy
• Intensive work with hiring managers
• Extensive work educating candidates on philosophy
  and potential
• Proactive coaching with acquired companies

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Conclusions Changing Behavior

• Providing a wealth accumulation opportunity will
  be the core challenge in attracting talent
• Competitive salary, benefits, work experience
  will be the ante for consideration
• Key challenge for successful companies will be
  ensuring the commitment and retention of
  employees who have met their initial wealth
  accumulation target
• Traditional compensation delivery approaches will
  be irrelevant
• Behavior change efforts must be linked to wealth
  creation programs most current approaches to
  rewards accomplish neither of these
• Rethinking the entire financial and structural
  basis of the work relationship is required

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Solutions to Managing in the Wealth Economy

• Hire those who want to change the world, not
  become millionaires
• Redefine the organization and peoples
  potential roles in itEmployeeConsultantAdvisor
  Service Provider of Supporting Business
• Redefine the potential financial relationships
  with workersEmployer/compensatorBusiness
  partnerLenderCo-InvestorVenture Capitalist
• Recognize the coming free-agent economy and
  transition from compensation structures to
  deal-making

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Solutions to Managing in the Wealth Economy

• Maintain a consistent position on wealth creation
  and implicit compensation strategy
• Expand the temporal perimeters of the
  organization contrary to work hours
• Expand the physical perimeters of the
  organization contrary to the workplace
• Expand the business perimeters of the
  organization contrary to outsourcing
• Expand the workers opportunities on the balance
  sheet assets, liabilities, equity
• Expand the workers opportunities on the income
  statement revenue, income, cash flow