How to Compete With a dot.comHow to Compete With a dot.com
Jeffrey M. Kanter
Erin Bass-Goldberg
Frederic W. Cook & Co., Inc.
May 11, 2000
Wall Street Compensation and Benefits Association
2
Today’s ObjectivesToday’s Objectives
Examine dot.com pay practices
Approaches to make you competitive
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Who’s a dot.com?Who’s a dot.com?
Line is blurring between old and new economy companies
Bricks & Mortar Bricks & Clicks
Chase Chase.com
DLJ DLJdirect
BankOne Wingspanbank.com
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dot.com Employee Mentalitydot.com Employee Mentality
Harsh generalization:
Therefore:
Little loyalty; lots of
greed
5
dot.com Employee Mentality (cont’d)dot.com Employee Mentality (cont’d)
Originally a different culture
Existing pay structures/guidelines were irrelevant
– Moving too fast
– Bureaucracy is a dirty word
Get rich quick
– Vs. career and security
– Don’t care about old “rules of thumb”
High risk: high reward
Typical pay programs may not work
But seeing shift to old economy structures
– Best of both worlds
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dot.com Company Mentalitydot.com Company Mentality
Downplay cash; up play stock
Would like structures
And to create retention
But fighting high turnover rates and lack of available talent at all levels
With market downturn and continued talent flight, more cash and more options required
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Recruiting Can Be ExpensiveRecruiting Can Be Expensive
In the money option values:
– 18 internet companies
$0
$50
$100
$150
$200
$250
1999 2000(est.)
1999 2000(est.)
1999 2000(est.)
1999 2000(est.)
Vested Unvested
Option Gains ($000,000)
CEO COO CFO Top Sales
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Different Pay PackagesDifferent Pay Packages
Joseph Galli example:
From To
Company Black & Decker Amazon
Position Head of Power ToolBusiness
President & COO
Compensation (Latest year) $1.1Mannual cash + $460KLTI + 75K options +rich pension/SERP
$200K salary +3.9M options with$20M guarantee +$5M cash signingbonus
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Generic Job ComparisonsGeneric Job Comparisons
$0
$500
$1,000
$1,500
$2,000
$2,500
Salary Bonus Long-Term
CEO CFO Top Sales General Counsel
GI
GIGI
GI
Internet
Internet
Internet
Internet
($000)
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Run Rate ComparisonsRun Rate Comparisons
1.1%
5.0% - 7.0%
2.1%
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
Old Economy New Economy
1989 1999
An
nu
al G
ran
ts a
s a
% o
f O
uts
tan
din
g S
har
es
91% Growth
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Dilution ComparisonsDilution Comparisons
6.9%
13.7%
20.0% - 25.0%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
Old Economy New Economy
1989 1999
Pot
enti
al D
ilu
tion
as
a %
of
Ou
tsta
nd
ing
Sh
ares
99% Growth
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Stock Option ProvisionsStock Option Provisions
Relative comparison:
EstablishedCompanies Emerging Companies
Participation Exclusive Inclusive
Grant Timing Annual grants basedon competitiveguidelines
Front-loadedhiring/promotion grants;“refresher” grants forongoing unvested shares Old economy
practices may return
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Stock Option Provisions (cont’d)Stock Option Provisions (cont’d)
Relative comparison (cont’d):
EstablishedCompanies Emerging Companies
IndividualGrants
Uniform by job level Differentiated for technical andcritical-skills employees Tech premium
-- 20% tech vs. non-tech-- 35% tech vs. sales
Vesting 3-4 years annualinstallments
Immediate with repurchaseright or over 3 years, monthly
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Response of Old Economy CompaniesResponse of Old Economy Companies
Many old economy companies are developing and implementing their own internet- and technology-based strategies
– This approach is complementary to their traditional business
Wal-Mart , Barnes & Noble, Toys R Us, GM, Ford, Sears
Others are attempting to convert to a “new economy” focus
– Kodak, AT&T
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Response of Old Economy Companies (cont’d)Response of Old Economy Companies (cont’d)
The critical success factor is human capital and the ability to attract and retain “hot skills“ employees
The primary objectives include:
1. Compete with greater upside of new economy Need a “great stock”
2. Address loss in incentive and retention value associated with share price depreciation
Need to leverage upside and/or decrease perceived riskiness of current employment situation
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Innovative ApproachesInnovative Approaches
Tracking stock
Subsidiary stock (external market)
Subsidiary stock (internal market)
Venture capital funds
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Tracking StockTracking Stock
Tracking stock is a separate class of publicly-traded parent company stock whose market value relates to the financial results of a particular business
– Not a direct ownership interest
– No formal separation of assets
– No legal separation of the company
– No separate board of directors
Separate P&L statements are prepared for each tracking stock business
– But only one annual report and proxy statement
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Tracking Stock (cont’d)Tracking Stock (cont’d)
Examples:
Parent Company Tracker
AT&T
Disney
Donaldson, Lufkin, Jenrette
Lucent Technologies
Perkin-Elmer
Staples
Liberty Media (cable)/AT&T WirelessGroup (wireless)
Go.com (internet entertainment)
DLJdirect (internet brokerage)
PBX Systimax (proposed)
PE Biosystems (bio-tech)
Staples.com (internet retail; proposed)
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Tracking Stock (cont’d)Tracking Stock (cont’d)
Tracking stock objectives include:
1. Creation of a “pure play” Allows investors to focus on specific business segments Provides “currency” for acquisitions
2. Enhance overall market valuation (i.e., eliminate “conglomerate discount”)
Encourages more specific analyst review
3. Provide real equity incentives for business unit employees
Employees in each business receive equity incentives on real shares of their individual businesses
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Tracking Stock (cont’d)Tracking Stock (cont’d)
Advantages
– Provides a direct “line of sight incentive”
– Can be used in all the same ways as parent company stock
– Taxation and accounting treatment are identical to parent company stock
– Does not result in loss of control by parent company (like a spin-off would)
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Tracking Stock (cont’d)Tracking Stock (cont’d)
Disadvantages
– Presents challenging corporate governance issues Potentially creates “self dealing” opportunities among
senior management and Board members
» Can be offset by establishing a proper balance of incentives and ownership among different equity classes
Creates divergence of interests among each distinct group of stockholders
Raises the possibility of lawsuits
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Tracking Stock (cont’d)Tracking Stock (cont’d)
Disadvantages (cont’d)
– Requires complete recapitalization of company Is expensive and time consuming to establish Would be difficult to unwind
– Unlikely to completely capture “full” market valuation No “take-over” premium
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Subsidiary Stock (External Market)Subsidiary Stock (External Market)
A public market for a free-standing subsidiary is created by selling a small portion (e.g., 15%) through an IPO
– Objectives are similar to those of a tracking stock structure, except requires real separation of assets and full disclosure
Advantages
– Same as tracking stock
Disadvantages
– Same as tracking stock, except: Reduced corporate governance issues More difficult to unwind
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Subsidiary Stock (Internal Market)Subsidiary Stock (Internal Market)
This approach solely supports compensation objectives
Similar to phantom stock, but uses real shares of a freestanding business unit
– Shares are valued by third-party appraisal and are traded within an internal market
– Employees may be given a “put option” back to Company to provide liquidity
– The employer has a “right of first refusal” or “call option” to prevent loss of control over stock
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Subsidiary Stock (cont’d)Subsidiary Stock (cont’d)
Advantages
– Provides a direct “line of sight” incentive
– Can be used in all the same ways as parent company stock
– Insulates employees from the vagaries of the financial markets
– Can obtain favorable fixed plan accounting under APB Opinion 25 if:
Stock price based on fair market value Employees hold shares for a minimum of 6 months
before sale to the company
– Does not result in loss of control by parent company
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Subsidiary Stock (cont’d)Subsidiary Stock (cont’d)
Disadvantages
– Requires independent appraisal or complex valuation formula
– Administration is complex
– Six month holding requirement requires employee capital outlay and increased risk
Capital outlay could be addressed with company-sponsored loan or special dividend
No effective solution for stock price risk
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Venture Capital FundsVenture Capital Funds
Opportunity to “coinvest” in a company-sponsored venture capital fund
– Or, could be just a “carried-interest” program
– Fund set up as a wholly-owned management company
– Investments are generally targeted to those with strategic value to company; could simply be outside investments
– Realized returns are split between company and executives
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Venture Capital Funds (cont’d)Venture Capital Funds (cont’d)
Advantages
– Provides attractive investment diversification opportunity not available to executives on their own
– Can help recreate the partnership and entrepreneurial culture of private ownership
Disadvantages
– Can be administratively complex
– May be viewed by shareholders as inappropriate use of corporate assets
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Company ProfileCompany Profile
Frederic W. Cook & Co., Inc. provides management compensation consulting services to business clients.Formed in 1973, our firm has served over 1,000 corporations in a wide variety of industries from our offices in NewYork, Chicago, and Los Angeles. Our primary focus is on performance-based compensation programs which helpcompanies attract and retain key employees, motivate and reward them for improved performance, and align theirinterests with shareholders. Our range of consulting services encompasses the following areas:
Total Compensation Reviews Incentive Grant Guidelines Performance Measurement Strategic Incentives Executive Ownership Programs Globalization Specific Plan Reviews All-Employee Plans Privatization Restructuring Services Directors’ Compensation Compensation Committee Advisor Competitive Comparisons Equity Instruments Stock Option Enhancements
Our offices are located:
New York Chicago Los Angeles90 Park Avenue35th floor
19 South LaSalle StreetSuite 400
2029 Century Park EastSuite 1130
New York, New York 10016 Chicago, Illinois 60603 Los Angeles, California 90067212-986-6330 phone 312-332-0910 phone 310-277-5070 phone212-986-3836 fax 312-332-0647 fax 310-277-5068 fax
Web site address:www.fredericwcook.com