Many companies move some or all of their equity compensation grants to performance-based shares, often at the urging of shareholder advisory groups. However, in hindsight, some are now questioning their effectiveness. This presentation to at the Midwest GEO conference provides insight into what is and is not working... and why that is happening.

1. Performance Share Plans
Perspectives from the Morning After
2015 GEO Awards, London UK

2. 2
Trends in Equity Compensation

3. Equity Compensation
3
During the 1990’s, achieving equilibrium was easy,
with little or no concerns about:
• Run rates
• Overhang
• Expense
• Allocation
• Motivation

4. Life was good!
4
• Stock Options were King!
– Everyone got them
– They always went up
– They were easy to explain
– They were easy to administer
– They were unique ~ the only vehicle that allows the
participant to time the grant
– And with APB 25, everyone came out a winner!

5. Things were not as easy in the next decade
5
Things were more difficult in the 2001-2002 recession:
• Economic pressure drove
increased diversification in the
use of equity plans
• Changes felt across many
participation levels and
geographies
• For a long time, the solutions
were simple…

6. Now, there were two kings!
6
By the early 2000’s, the most
common practice was to grant
50% stock options and 50%
restricted shares…
… as companies began to
trade off flexibility for
efficiency

7. But No One Expected…
7
The 2008-2009 recession was unprecedented in:
• The depth of its decline
• The duration of its decline
• Its global economic impact
And had a profound impact on
equity compensation programs

8. Now there was a new player…
8

9. And a new trend …
Today, most companies use a portfolio
approach that includes performance shares

10. But, was this really a new player…
10
Performance Share Plan
Example: Participant is awarded 20,000 shares, earned out over a three year performance period
Actual
Shares Earned out over 3 Year Period Award
Maximum 150% 30,000
20,000 Target 100% 20,000
Threshold 50% 10,000
If performance is below Threshold, no shares are earned.
Actual award of shares is pro rated, e.g., at 125% performance, 25,000 shares are earned
• Performance Share Plans Have been around since the early days of equity
compensation
• But they were not popular/practical until FAS123R changed the accounting

11. Performance Share Plans are unique …
11
0%
50%
100%
150%
200%
250%
300%
70% 80% 90% 100% 110% 120% 130%
% of Goal Achieved
%ofTargetPaymentReceived
0%
50%
100%
150%
200%
250%
300%
70% 80% 90% 100% 110% 120% 130%
% of Goal Achieved
%ofTargetPaymentReceived
Performance Share Plan• They provide
rewards at two
levels: the number of
shares earned and
the value of the
shares at vesting
• Metrics can be set to
maximize line-of-
sight
• Leverage can be
adjusted to fit
risk/reward profile

12. They seemed perfect!
12

13. What is driving this change?
• Concerns about stock options and risk
• Memories of underwater options
• Concerns about share efficiency: dilution and
run rate
• Concerns about time-based awards and pay
for performance
• Pay for Performance vs. Cause and Effect
13

14. And, of course…
…Pressure from SEC, Institutional
Shareholder Services, Glass Lewis,
Shareholder Activists, etc.
14

15. How should we measure performance?
15
40%
18%
16%
15%
9%
0%
0% 5% 10% 15% 20% 25% 30% 35% 40% 45%
TSR
Return On Capital
Operating Income
Free Cash Flow
Other (Primerily EPS)
Sales
What is the Best Measure of Company Performance?

16. So, no surprise in plan design
Total Shareholder Return (“TSR”) is by far the most
popular metric
– Almost always a measure of relative performance
– About 60% of the companies used a custom peer group while
40% used an established index
It is less common to use a financial metric, sometimes in
conjunction with TSR.
– This financial metric is usually a measure of absolute
performance relative to the company’s key business goals.
– The most common financial metrics are operating income/
EBITDA, EPS, ROCE, ROIC and sales/revenue growth.
16

17. Market Prevalence…
17
• Trend continues to be granting the majority of value in
performance-based restricted stock
• Data suggests a decrease in the targeted value for the first
time, with a shift toward time-based restricted stock
32% 37% 41% 45% 43%
30%
31%
33% 31% 34%
37%
33% 27% 24% 23%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2010/2011 2011/2012 2012/2013 2013/2014 2014/2015
Performance-Based Restricted Stock Time-Based Restricted Stock Stock Options

18. Market Prevalence…
18

19. Market Prevalence…
19

20. Market Prevalence…
20

21. How is it working?
21

22. How is it working?
22
Shareholder
dissatisfaction
is still high
Concerns about
risk, dilution, and
ownership have
fueled broad-
ranging governance
initiatives
Employer
dissatisfaction
is still high
Fueled by costs of
administration,
financial reporting,
compliance, and
disclosure
For employees,
the motivational
value is low
Motivational values
are clearly tied to
line of sight… i.e.,
the ability of
participants to
impact the outcome
Shareholder
dissatisfaction
is still high
Concerns about
risk, dilution, and
ownership have
fueled broad-
ranging governance
initiatives
Employer
dissatisfaction
is still high
Fueled by costs of
administration,
financial reporting,
compliance, and
disclosure
For employees,
the motivational
value is low
Motivational values
are clearly tied to
line of sight… i.e.,
the ability of
participants to
impact the outcome

23. What is the problem?
• The accounting can be tricky
• Administration can be complex
• There are trade-offs between
governance and line-of-sight
23

24. Accounting
• For a share price-based “market condition”, e.g.
Total Shareholder Return, the “fair value” may be
determined using a Monte Carlo simulation or a
binomial model, but generally not Black-Scholes.
• The performance shares’ grant date “fair value”
is then amortized over the performance period.
• Whether or not the market condition goals have
been achieved, any recognized compensation
cost may not be reversed after the service
period has ended.
24

25. Accounting
• For a “performance condition”, the “fair value” is equal to
the number of shares expected to be earned (or actually
earned) multiplied by the grant date share price.
• Each reporting period, the number of performance shares
expected to vest is predetermined and the “fair value” of
these performance shares is amortized over the remaining
period less amounts previously recognized.
• At the end, compensation cost is trued up to equal the
“fair value” of the shares that actually vest.
• Previously recognized compensation cost for performance
shares that did not vest would be reversed.
25

26. Accounting
26
Expense Recognition for Peformance Plans
Dependent Goals
Year 1 Year 2 Year 3 Year 4
Tranche 1 Note: The Grant Date and the Service
Inception Date for each vesting tranche
Tranche 2 occurs on Year 1.
Tranche 3
Tranche 4
Total 52.08% 27.08% 14.58% 6.25%
Independent Goals
Year 1 Year 2 Year 3 Year 4
Note: The Service Inception Tranche 1
Date does not start
until the beginning of Tranche 2
that year
Tranche 3
Tranche 4
Total 25.00% 25.00% 25.00% 25.00%

27. Metrics
• A majority of companies report using performance-based
equity grants with TSR as the most common metric
• This is often attributed to the desire to align investor and
management interests
• However, most companies acknowledge the strong
influence of outside advisory firms in their decision to use TSR
• TSR has also been “favored” by the SEC
• However, few companies perceive that a TSR metric has a
significant positive impact on financial performance or on
shareholder return itself
• In fact, a number perceive that a TSR metric can have no or
a negative impact
27

28. Metrics… the disconnect
28
26%
19% 21%
28%
7%
0%
51%
18%
13%
7%
10%
0%
0%
10%
20%
30%
40%
50%
60%
TSR Return On Capital Operating Income Free Cash Flow Other (Primerily
EPS)
Sales
Perception of Performance Metreics
CEOs Directors

29. The disconnect lies in perception…
29
• Metrics like TRS measure value that has been created, but there
may be no link between cause and effect
• Cause and Effect requires using metrics that serve as value drivers
IncreasingComprehensiveness,
TechnicalAccuracy
Increasing Complexity
Growth
• Free Cash Flow
• EPS Growth
• EBIT Growth
• Revenue Growth
Return
• ROIC
• RONA/ROCE
• ROE
Return, Growth and
Cost of Capital
• CVA
• EVA
• RORAC
Return, Growth, Cost
of Capital and Free
Cash Flow
• CEROI
• TBR
Value
Based
Metrics
Value
Drivers

30. The disconnect lies in perception…
30
 A director’s perception is that value is measured by value (gain)
returned to shareholders
 But, a CEO sees that market valuation is driven on expectations of
cash flows discounted by the cost of capital, both in terms of projected
annual cash flows and a judgment about the likely continuing value
Market Value Continuing
Assets Liabilities Value
Current Assets
Current
Liabilities Annual Free Cash Flows
"Working"
Capital Long-Term Debt > = <
Fixed Assets Share- holder
Other Equity
Assets
Company X Book Value
Present Value of Time
Company X
Capitalization

31. The disconnect lies in perception…
31
 It has been proven that the stock market, over time, reacts to the free
cash flow patterns created by companies
 A positive trend caused by a mix of operational results and strategic
investment, is the basis for value creation.
 Economic rather than accounting methodologies provide a more
direct linkage to shareholder value creation.
The Stock Market Reacts to Expected Free Cash Flows …
Trend
… in Effect a “Cash-in/Cash-out" View of Investment Payoff

32. Parting question…
In the rush to satisfy optics, are we
sacrificing equity effectiveness?
32

33. Equity Effectiveness
33
• The effectiveness of any
equity plan, whether time
or performance-based
must look at the interests
of all stakeholders:
- Shareholders
- Company
- Participants
• Equity effectiveness is optimized when efficiency of the
plan is aligned with its motivational value

34. Questions
Jim Sillery
Principal and Executive Compensation Leader
312-215-2815
952-806-6114
James.sillery@xerox.com