Compensation in the Technology Sector
Issues and Current Trends
Presenter's Name
Overview
The goal of this presentation is to discuss the major compensation issues impacting the tech sector
Plus, answers to the following questions
How has compensation changed in the tech sector since 2000?
How is the tech sector comparable to the general industry and in which way does it remain unique?
Interactive discussion about how your company is dealing with issues such as dilution and performance management in the post bubble era
Presenter's Name
Agenda
Backdrop
Canadian Tech Sector Compensation Surveys
Cash Compensation
Salary and Bonus Levels
Annual Incentive Plan Design
Long-term incentives
Stock options
Dilution
New option reserve regulations
Alternatives to stock options
Changes in long-term incentive valuation
Presenter's Name
375
0
25
50
75
100
125
150
175
200
225
250
275
300
325
350
Sep 2000
Mar 2001
Sep 2001
Mar 2002
Sep 2002
Mar 2003
Sep 2003
Mar 2004
Sep 2004
Mar 2005
Sep 2005
Relative Index Value
S&P/TSX COMPOSITE INDEX Information Technology (Sector)
S&P/TSX COMPOSITE INDEX Oil, Gas & Consumable Fuels
NASDAQ Index Composite
S&P 500
S&P/TSX Composite Index
12
S&P/TSX Tech
367
S&P/TSX Oil and Gas
59
NASDAQ
86
S&P 500
116
S&P/TSX Composite
Backdrop
Presenter's Name
Canadian Tech Sector Compensation Surveys
All of the major HR consulting firms offer a tech sector compensation survey covering executive and professional level positions
HR Tech Group Survey (Watson Wyatt) – cash compensation
Towers Perrin’s Connect Surveys – total direct compensation
Radford (Aon) – total direct compensation
Mercer’s Information Technology Compensation Survey – total direct compensation
Caveat emptor – not all compensation surveys are created equal
Presenter's Name
Canadian Tech Sector Compensation Surveys
Select the surveys that best fit your company's characteristics
Use multiple survey sources
Understand survey methodology, especially with respect to long-term incentive valuation
Not a substitute for good judgment
Quality compensation decisions evolve from three complementary perspectives
Outward view - appropriate compensation survey
Inward view – internal equity
The incumbent’s performance
Presenter's Name
Towers Perrin’s 2005 Connect Survey
Data in this presentation is drawn primarily from Towers Perrin’s 2005 Connect surveys
Profile by Industry
Presenter's Name
Towers Perrin’s 2005 Connect Survey
1,033
496
123
Revenues ($M)
75th Percentile
50th Percentile
25th Percentile
Accenture LLP
Adobe Systems
Alcatel Canada Inc.
Aliant Inc.
ATI Technologies Inc.
Autolog, Production Management Inc.
Ballard Power Systems Inc.
Bell Canada
Bell Helicopter Textron Canada Ltd.
Bombardier Aerospace
Bombardier Inc.
CAE Inc.
Cedara Software Corp.
Celestica Inc
CGI Consulting Services to Bell
CGI Group Inc.
Cisco Systems
Cogeco Cable Inc.
Cognos Inc.
Connexim Network Management
Creo Inc.
Curtiss Wright Controls Embedded Computing.
Dell Canada Inc.
E*TRADE Technologies Corporation
Accenture LLP
EDS Canada Inc.
Emergis Inc.
Ericsson Canada Inc.
Fincentric Corporation
General Dynamics Canada
Gennum Corporation
Honda of Canada Manufacturing
Husky Injection Molding Systems Ltd.
IBM Canada Ltd.
IKON Office Solutions
IMS Health
Intel Corporation
International Financial Data Svcs
Microsoft Canada
Mitel Networks Corporation
NAV Canada
Nokia
Nortel Networks Corporation
Northern Telephone Limited
Northwestel
Novatel Inc.
Optimal Services Group
Panduit Canada
Philips Electronics Ltd.
Positron Inc.
Pratt & Whitney Canada
Premier Tech Ltd.
Psion Teklogix Ltd.
Quebecor Media Inc.
Raytheon Canada Limited
Research In Motion Ltd.
Rogers Wireless Inc.
SANYO Canada Inc.
Schneider Electric
Sierra Wireless
Smart Systems for Health Agency
SNC-Lavalin
Softchoice Corporation
Spectrum Signal Processing Inc.
Sprint Canada Inc.
Teleglobe Canada ULC
TELUS Mobility
Teranet Inc.
TSX Group
Vidéotron Ltée
Waters Corporation
Xerox Research Centre of Canada
Zarlink Semiconductor
Presenter's Name
Salary Management
In contrast to 2000, actual and projected salary increases in the tech sector are now more modest and comparable to general industry practice
General Industry
Tech Sector
%
%
%
2006
%
%
%
2001
%
%
%
2006
%
Salaried
%
Mgt & Professional
2001
Employee Group
%
Executive
General Industry
Tech Sector
%
%
%
2005
%
%
%
2000
%
%
%
2005
%
Salaried
%
Mgt & Professional
2000
Employee Group
%
Executive
Median Actual Salary Increases
Median Projected Salary Increases
Presenter's Name
Salary Management
During 2004 there were no salary reductions
100% of companies provided increases
The tech sector, however is typically better than the general industry at performance management
73% of tech sector companies provided salary increases to some employees rather than providing across-the-board increases
Presenter's Name
Annual Incentives
In terms of annual incentives…
Cost of last year’s bonuses ranged from 0% to 19% of EBIT:
The tech sector created the “circuit breaker” which has now been adopted by the general industry
82% of plans incorporate a ‘circuit breaker’ requiring a minimum level of corporate performance for any payout
%
5%
%
% of EBIT
75th Percentile
50th Percentile
25th Percentile
Presenter's Name
Annual Incentives
Tech sector target and maximum short-term incentive levels are consistent with general industry practice
Maximum incentive levels are typically 2x target
6%
Production/Mfg
30%
Executives
20%
Directors
14%
Managers
10%
Professionals
5%
Admin/Support
50% of Salary
CEO
2005 Median Target
Incentive Levels
Employee Group
Presenter's Name
Annual Incentives
2004 Actual bonus payouts in the tech sector fell below target. In contrast, actual payouts five years ago were close to maximum (2x target)
33%
Production/Mfg
66%
Executives
51%
Directors
77%
Managers
71%
Professionals
70%
Admin/Support
60% of Target
CEO
2004 Median Actual Incentive Paid
(% of Target Incentive Levels)
Employee Group
Presenter's Name
Annual Incentives
How are annual incentives different in the tech sector?
The tech sector remains unique in terms of eligibility
virtually all employees from administrative staff to executives participate
Consistent with salary administration, the tech sector is superior to general industry in terms of performance management
89% of survey participants paid bonuses to some incumbents and only 3% paid bonuses to all incumbents
Presenter's Name
Long-Term Incentives – Stock Options
Stock options are still the primary form of long-term incentive compensation for tech companies
Interestingly, option plan design in the tech sector is similar to general industry practice
About 85% provide annual grants and the rest provide ad-hoc, on-hire or promotion grants
50% of options have a 10 year term; 5, 6 and 7 year terms are also popular
The tech sector somewhat lags general industry in terms of performance vesting
About 15% of tech companies vest options on performance vs. 20% for the general industry
Presenter's Name
Long-Term Incentives – Stock Options
Tech companies generally have option grant guidelines
Tech companies are more likely to provide a fixed number of shares per salary grade/level, rather than an expected value grant. This practice is not surprising given volatility
Consistent with general industry practice, share ownership guidelines are becoming more common in the tech sector
44% have established guidelines (up from 20% in our 2004 survey)
Levels are at or below general industry, 1x-5x CEOs, 1x-3x for executives
Presenter's Name
Long-Term Incentive Levels
General Industry
Tech Industry
21%
19%
21%
31%
35%
46%
54%
104%
2005
Median
21%
29%
31%
44%
58%
73%
89%
87%
2000
Median
140%
397%
CEOs
20%
32%
$91-$110
25%
48%
$111-$140
29%
63%
$141-$160
41%
90%
$161-$200
52%
112%
$201-$240
67%
144%
$241-$300
131%
335%
>$300
2005
Median
2000
Median
The estimated value of long-term incentives has decreased dramatically in the tech industry over the last five years along with stock prices, and are now below general industry
Presenter's Name
Long-Term Incentive Levels
Fixed number grants in a falling market have driven roughly half the decline in long-term incentive values for the tech industry
While stock options are still the primary form of long-term incentive compensation for tech companies, recent trends show that a number of tech companies have introduced other forms of long-term incentives as a complement to their existing option plan
Why? High dilution levels and resulting pressures from institutional shareholders and employee disillusion with options
Presenter's Name
Dilution Pressures
Three factors are causing dilution pressures for tech companies
Weak stock prices delay stock option exercise
2% or 3% “run rates” are not sustainable
Shareholders are tightening acceptable dilution, even for tech companies
Run Rate
Overhang
%
%
%
%
General Industry
Tech Sector
Presenter's Name
Dilution Management
New TSX Guidelines provide companies with two choices for option reserve approval
Shareholders approve a fixed number of shares
as options are exercised the company’s overhang will decline until a new reserve must be approved
New approach: Shareholders approve the number of shares issuable as a percentage of outstanding shares (overhang % approved), “evergreen” plan
as options are exercised the pool is replenished
% overhang must be approved by shareholders every three years
Presenter's Name
Dilution Management
Discussion: Would the evergreen method be a better approach for tech companies?
What are the other alternatives for dilution management?
Presenter's Name
Dilution Management
Alternative One: Stay with stock options
Revise eligibility and reduce grant sizes to deal with dilution
Risk of unwanted turnover
Add tandem stock appreciations rights (SARS) to stock options
Extends time to replenish the pool, helps to manage dilution, employees keep tax advantage
Need shareholder approval
Cash settlement – mark-to-market accounting and cash cost
Share settlement – fixed accounting
Presenter's Name
Dilution Management
Alternative Two: Introduce an alternative long-term incentive plan
Share Units
Full value phantom shares that vest over a period of up to 3 years (SDA rules)
Restricted share unit (RSUs) – time vesting
Performance share units (PSUs) – time + performance vesting
Cash Performance Plan
Pressures from institutional shareholders have made it difficult to implement an LTIP in Canada without a significant performance feature
Presenter's Name
Alternatives To Stock Options
No tax on grant
50% of gain taxed at marginal tax rate
No tax on date of grant
Tax on full value of cash award at time of payment
RSUs/PSUs: No tax on date of grant (if settled in 3 years).
DSUs: After termination or retirement, when units can be settled.
Taxed on full value of units at settlement (marginal tax rates
Employee Tax
Deduction at settlement = cash value of the award
Full target payout initially charged to earnings over performance, adjust based on actual performance
Cash Performance Plan
No deduction
Deduction equal to value of RSUs at settlement date
Corporate Tax
Fixed expense based on “fair value” at the date of grant
Variable expense (marked-to-market)
Accounting
Stock Options
(Base Case)
Share Units*
(RSUs/DSUs/PSUs)
*Settled in cash or shares purchased on the open market.
Presenter's Name
Alternatives To Stock Options
Cash inflow at time of exercise equal to exercise price
Cash outflow equal to value of award at end of performance period
Cash outflow = value of RSUs at settlement
Cash Flow
None
Cash Performance Plan
Dilution equal to number of exercised options
None
Dilution
Stock Options
(Base Case)
Share Units*
(RSUs/DSUs/PSUs)
*Settled in cash or shares purchased on the open market.
Presenter's Name
Alternatives to Stock Options
Deferred Share Units
Tandem SARs
Stock Options
Restricted
Shares
Stand Alone SARs
Restricted Share Units
Participants (Tax Perspective)
Company/Shareholders
(Accounting Perspective)
Low
Low
High
High
Presenter's Name
Alternatives To Stock Options
Issues in developing alternative long-term incentive plans in the tech sector
For some companies one-year is long-term
Next to impossible to establish performance measures for a three-year period
Affordability
Real cash outflow if the plan is funded through shares purchased on the open market
Cultural impact
Stock options are the norm in the tech sector
Discussion: What is your company’s approach to long-term incentives
Presenter's Name
Long-Term Incentive Valuation
This year, Towers Perrin’s changed its method for valuing long-term incentives for survey purposes
The new methodology was rolled out during 2005 for our general industry survey and will be rolled out for our Connect surveys commencing in 2006
Why?
Better reflect the various performance features
Closer alignment with emerging accounting practices
Consistent global approach
Presenter's Name
Towers Perrin’s New Long-Term Incentive Methodology
Simple
Addresses well-known flaws of Black-Scholes model
One model -- binomial -- for all stock-based vehicles
Target for non-stock-price-based performance plans
Black-Scholes for options
Face value for restricted stock
Target for performance plans
Model
Better estimate of current rates and term of award
Yield curve (different rate for each year)
Spot rate
Interest Rate
Reflects new research and non-transferability
5% per year
3% per year
Turnover
Consistent approach worldwide
Yes -- apply performance factor based on payout curve
Case by case
Performance Conditions
Reflects most recent dividend policy decisions
Volatility: 3 year historical
Yield: 1 year historical
Volatility: 3yr historical
Yield: 3yr historical
Volatility and Yield
Reflects what people do
Consistent with “SEC Safe Harbor” rule
Expected life formula:
* [full term + avg. vesting]
Full term
Term / Expected Life
Comments
New Methodology
Old Methodology
Presenter's Name
Towers Perrin’s New Long-Term Incentive Methodology
Avg. Incremental Change in Value
Impact on Value
Nature of Change
Factor
-3%
Down
From Black-Scholes to binomial
Option
Model
-9%
Down
From spot to curve
Risk Free Rate
-5%
Down
From 3% to 5%
Employee Turnover
-20%
Down
From full term to “safe harbor” expected life
Expected Life*
Impact by change in assumption
Presenter's Name
Towers Perrin’s New Long-Term Incentive Methodology
Impact on overall long-term incentive values
Aggregate expected values down by about 20%
Depends on the type and mix of LTI vehicles and nature of performance features
-7%
Restricted share units
-5%
Performance plans
-25%
Stock options
Average Value Change
LTI Vehicle
Presenter's Name
Towers Perrin’s New Long-Term Incentive Methodology
0%
0%
0%
Dividend Yield (1 year historical)
106%
68%
56%
Volatility (3 yr historical)
Over 4 Years
(assumed)
Over 4 Years
(assumed)
Over 4 Years
Vesting
$
$
$
2004 Grant Price (Proxy Circular)
5 Years
10 Years
7 Years
Term
Years
Years
Years
Expected Life
Option Values
(Option Value As a Percent of Grant Price)
New Methodology (Binomial/Lattice)
Old Methodology (Black-Scholes)
$22 (-12%)
$8 (-20%)
$11 (-15%)
$25
$10
$13
Sierra Wireless
Spectrum Signal
ATI
Impact using specific tech company examples
Presenter's Name
Questions?
Fiona Macdonald
(604) 691 - 1008
@
Susan Gelinas
(604) 691 - 1053
@
Thank you for joining us today
Presenter's Name
Presentation Title
