The OverCompensation Trap

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The Over-Compensation Trap

• Dave Swinford Dan Lynch
• Pearl Meyer Partners Pulte Homes, Inc.
• New York, NY Bloomfield Hills, MI
• 212-644-2300 248-593-5775

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The Over-Compensation Trap

• How We Fall Into The Trap
• How To Avoid The Trap
• If Youre In It, How You Get Out

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The Over-Compensation Trap
How We Fall Into The Trap (or, Worst Practices in
Executive Compensation

• Assuming pay equals or will cause performance
• Peer group bias
• Percentiling
• Piece-mealing
• Incrementalizing
• Special arrangements
• Not validating degree of difficulty

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The Over-Compensation Trap
How We Fall Into The Trap

• Truncating risk, or forgiving failure to perform
• Ignoring retirement benefits
• Minimizing value of non-monetary rewards

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The Over-Compensation Trap
Percentiling

• 75th percentile target position
• 75th percentile total compensation does not equal
  75th salary 75th bonus 75 LTI

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The Over-Compensation Trap
Piece-mealing

• One piece at a time, gradually
• Looking at the trees, ignoring the forest
• De-emphasizing one year fixing it the next

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The Over-Compensation Trap
Incrementalizing

• Improving specific compensation elements a bit at
  a time
  
• Raising target bonuses to increase pay for
  performance

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The Over-Compensation Trap
Special Arrangements

• Guarantees
• One-time incentives for extraordinary
  results
  
• Take care to validate goals

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The Over-Compensation Trap
Truncating Risk
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The Over-Compensation Trap
Truncating Risk
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The Over-Compensation Trap
Truncating Risk
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The Over-Compensation Trap
How to Avoid the Trap

• Focus on total value of package
• Test all changes for impact on value and risk
  profile
  
• Never piece-meal
• Need to think about timing as well as value
• Measure relative performance
• Performance-justify departures from median
  philosophies

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The Over-Compensation Trap
How to Avoid the Trap

• Follow the performance contract
• Keep executive careers in perspective
• Dont dis-respect non-monetary rewards

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The Over-Compensation Trap
Focus on Total Value of Package
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The Over-Compensation Trap
Measure Relative Performance

• Aggregate cost of management compared to income
  (net or operating)
  
• Our company, over time
• Compared to peers (Top 5 only)
• Beware of funny numbers (FAS123R DB accruals)

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The Over-Compensation Trap
Measure Relative Performance

• Other measures that may be useful to compare
• Revenue growth
• Gross margin
• Returns (ROE, ROIC)
• TSR (over longer term only)

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The Over-Compensation Trap
Measure Relative Performance
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The Over-Compensation Trap
Measure Relative Performance
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The Over-Compensation Trap

• Dont Disrespect Non-monetary Rewards
• Companys reputation and stability
• Development track record
• Culture and climate

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The Over-Compensation Trap
How to Get Out of the Trap

• Rigorously define nature and extent of problem
• Must get all parties to acknowledge the problem
• Identify areas of acceptable program
  modification
  
• Some cows are more sacred than others
• Develop desired outcome
• Develop and implement transition plan
• Communicate, communicate, communicate