IRRCi Research Report The Alignment Gap Between Say on Pay Voting and Creating Value . The analysis, opinions and perspectives herein are the sole responsibility of the authors. The copyright for this report is held by the IRRC Institute. The material in this report may be reproduced and distributed without advanced permission, but only if attributed. If reproduced substantially or entirely, it should include all copyright and trademark notices. © Copyright 2014, Investor Responsibility Research Center Institute (IRRCi) For more information, please contact: Jon Lukomnik, Executive Director Investor Responsibility Research Center Institute (IRRCi) 40 Wall Street, 28th Floor New York, New York, 10005, T: (+1) 646-512-5807 info@irrcinstitute.org www.irrcinstitute.org Report authors: Mark Van Clieaf, Partner Organizational Capital Partners 3001 North Rocky Point Dr. E, Suite 200 Tampa, Florida, 33607, United States of America T: (+1) 813-600-5259 mark_vanclieaf@orgcapitalpartners.com www.orgcapitalpartners.com The Alignment Gap Between Say on Pay Voting and Creating Value Karel Leeflang, Partner Organizational Capital Partners 14 Rue du Rhône 1204 Geneva, Switzerland (+41) 76 512-2980 karel_leeflang@orgcapitalpartners.com Twitter: @OC_Partners Page 2 .

Table of Contents Special acknowledgement ........................................................................................................................................................ 4 Introduction to the report ........................................................................................................................................................ 5 Executive Summary .................................................................................................................................................................. 6 An opportunity for institutional investors............................................................................................................................

7 Chapter 1: Return on invested capital, economic performance and Say-on-Pay alignment ................................................... 8 1.1. Relevant finance and value creation principles ............................................................................................................

8 1.2. Understanding enterprise value ................................................................................................................................... 9 1.3.

A lens to review longer-term value creation ............................................................................................................... 10 Chapter 2: Research methodology ......................................................................................................................................... 12 Chapter 3: Analysis of economic performance, return on invested capital and Say-on-Pay voting ......................................

14 3.1 Value Quadrant Four: Value destroying performance and Say-on-Pay Voting ........................................................... 14 3.2 Value Quadrant Two: Value creating performance and Say-on-Pay Voting ............................................................... 17 3.3 Value Quadrant One: Value creation potential and Say-on-Pay Voting ......................................................................

19 3.4 Value Quadrant Three: Hidden value and Say-on-Pay Voting ..................................................................................... 21 3.5. Value quadrant analysis – a summary .......................................................................................................................

24 Chapter 4: Conclusions ........................................................................................................................................................... 25 4.1 ROIC, economic profit and Say-on-Pay voting ............................................................................................................. 25 4.2 The opportunity for longer term investors...................................................................................................................

27 Appendix ................................................................................................................................................................................ 28 Asset Owner and Asset Manager List ..................................................................................................................................... 29 Glossary – Key terms ..............................................................................................................................................................

30 List of tables and figures......................................................................................................................................................... 32 The Alignment Gap Between Say on Pay Voting and Creating Value Page 3 . Special acknowledgement This is the second in a series of two reports on performance measurement, value creation, long-term incentive plan design and pay-for-performance. The first report focused on performance measurement, value creation, long-term incentive plan design, and pay for performance. This second report focuses on Say-on-Pay proxy voting. The research project was made possible by a research grant from the Investor Responsibility Research Center Institute (IRRCi). IRRCi Executive Director Jon Lukomnik played a critical in defining the project, offering feedback, and guiding the development of the work products. The analysis and the related two reports in this series are unique as it is the first time that multiple databases have been woven together to create integrated insights about: 1.

Economic performance and shareholder value (Data source: Organizational Capital Partners and Shareholder Value Advisors) 2. Pay-for-performance alignment and long-term incentive plan design (Data source: Incentive Lab and Shareholders Value Advisors) 3. Proxy voting for Say-on-Pay by institutional shareholders (Data source: FundVotes). The insights from this research and series of reports for IRRCi would not have been possible without the analytical input, insights, collaborative teamwork of Steve O'Byrne, Shareholder Value Advisors; Jack Zwingli, Incentive Lab; Jackie Cook, FundVotes; Tom Hillman, Credit Suisse HOLT; and members of the team at Organizational Capital Partners: Mark Van Clieaf, Karel Leeflang, Marg Soden, Roland Burgman, Kelly Boyden, Lori Mattes, Al Risdorfer.

We thank them all for their collaboration. The Alignment Gap Between Say on Pay Voting and Creating Value Page 4 . Introduction to the report Early in 2014 the Investor Responsibility Research Center Institute (IRRCi) asked Organizational Capital Partners to research the Standard & Poor’s 1500 companies relating to a question it had developed. This question was: “What is the relationship and level of alignment between company economic performance, shareholder return and executive compensation?” This seemingly simple question masked a highly complex piece of work to be performed. There are various studies looking at parts of the question, but none that undertake a comparative analysis to look at the level of alignment between: 1. Company performance (strategy development, strategy execution, intrinsic value creation) with a focus on economic profit and return on invested capital 2. Shareholder return performance 3. Executive compensation design and pay-for-performance alignment 4. “Say-on-Pay” voting by institutional investors relative to economic performance This research has required us to integrate the various databases that do exist in each of these three separate areas. This resulted in a highly complex data set with no obvious connection points.

We therefore had to introduce a number of measurement methods and analyses to contrast and compare, so as to create real insight about the level of alignment. To focus the analysis, the research has been divided into two reports. The first report focused on longer-term value creation fundamentals and whether or not economic value creation is aligned with executive compensation incentive design. The first report also focused on whether the existing metrics and design of executive compensation plans are fit for purpose as key inputs to value creation. This second report focuses on how and to what extent institutional investors and proxy advisory firms consider economic value creation in their analysis of executive compensation and pay-forperformance alignment testing for Say-on-Pay proxy voting. The enclosed analysis in this second report will be of most value to institutional investors (including chief investment officers, heads of corporate governance, equity analysts and proxy voting advisors) as an enhanced basis for investment decision-making, performance analysis, and pay-forperformance alignment testing as inputs to Say-on-Pay proxy voting. It may also be of use to corporate CFOs, investor relations officers, compensation committees and corporate secretaries.

Increasingly institutional investors provide feedback on company performance expectations to company management and Boards, and some do so through voting. Consequently, the Say-on-Pay vote is a source of insight as to how investors are evaluating a company’s strategy, business model and performance. By understanding Say-on-Pay voting patterns, and investor motivations and behavior better, companies may be able to better interpret and manage interactions with institutional investors. The Alignment Gap Between Say on Pay Voting and Creating Value Page 5 .

Executive Summary Investors, directors and executive management share common interests when it comes to company performance, shareholder return and economic value creation. The first report in this series identified that return on invested capital (ROIC) and economic profit are enhanced operating performance metrics with a high correlation to sustainable value creation and shareholder returns. In applying these metrics to the companies of the S&P 1500 a surprising finding emerges. Forty-three percent (43%) of companies, over ten years of observations (2003- 2012), had a ROIC less than their weighted average cost of capital and a cumulative economic loss over five-year rolling performance periods. Investors, analysts, directors and executive management of these companies should be concerned about these companies’ business strategy, financial and operating performance and prospective future returns. As noted in the first report, 75% of the larger companies in the S&P universe do not disclose balance sheet or capital efficiency metrics to measure executive management effectiveness in deploying invested capital or alignment to long-term incentive plan design, and so do not appear to have the tools to measure or manage creating economic profitability. In the United States, Say-on-Pay is an advisory vote by shareholders on the executive compensation design of named executive officers, including the CEO.

Institutional investors and proxy voting advisory services may consider a broad range of factors in their overall Say-on-Pay voting decision. This might include, for example, compensation policy, change in control provisions, internal pay equity, use of performance metrics, performance analysis and pay-for-performance alignment. Some institutional investors may also use the Say-on-Pay vote as a way to communicate their evaluation of the company’s strategy, business model and performance. This report looks at how more than 100 of the largest mutual fund families in the United States cast those votes.

In the aggregate, those fund families control more than $11 trillion in global assets under management. In addition, the data set included 11 of the largest North American pension funds with close to $2 trillion in assets under management, as well as the voting recommendations of the two largest proxy advisory companies, Institutional Shareholder Services (ISS) and Glass Lewis. In theory, at least, these should be amongst the most resourced and sophisticated Say-on-Pay voters and advisors. Yet, the analysis in this report of Say-on-Pay votes for a S&P 1500 companies discovered no large Sayon-Pay voting differences (FOR vs.

AGAINST) for subsets of companies which created value versus those that destroyed value over five years. Performance was measured using ROIC minus weighted average cost of capital (economic profit) and relative TSR. The average Say-on-Pay support was 82% for 32 low-performing and 84% for 32 high-performing companies across a sample of 128 S&P companies.

Nor was there much difference in the median vote, at 90% for the low-performing and 96% for the high-performing companies. Neither was there a robust difference amongst the proxy advisor recommendations. ISS recommended for 84% of the pay plans at the value destroying companies and at 81% of the value creating companies.

Glass Lewis showed a slightly greater difference, recommending for at 72% of the value destroying companies and 81% of the value creating companies. The Alignment Gap Between Say on Pay Voting and Creating Value Page 6 . Those results suggest that creation of economic value is not currently a major factor in institutional investor Say-on-Pay voting or in the recommendations of the two largest proxy advisors. This finding is consistent with the findings of the first report, which suggested that competitive pay, rather than performance, was the dominant driver of executive compensation, and that TSR, which is a measure of alignment (co-movement of stock price [plus dividend] and executive compensation) rather than a measure of value creation, is the most common metric in long term incentive compensation plans. An opportunity for institutional investors The use of value-based performance metrics such as ROIC and or economic profit as part of Say-onPay voting analysis would shift the focus of compensation programs from short-term alignment with stock market movement to longer-term company economic performance. Furthermore, asking for disclosure of balance sheet or capital efficiency metrics in company performance reporting and inclusion of these measures in long term incentive plan design would provide better insight into a company’s value creation ability. Doing so would enable institutional investors and proxy voting advisors to enhance voting execution aligned to long-term value creation. A performance and pay-for-performance analytical model that incorporates fundamental finance precepts (i.e. ROIC greater than weighted average cost of capital) would also create a more direct line of sight alignment between operating performance and long-term sustainable shareholder returns at investee companies. The Alignment Gap Between Say on Pay Voting and Creating Value Page 7 .

Chapter 1: Return on invested capital, economic performance and Say-on-Pay alignment 1.1. Relevant finance and value creation principles The first IRRCi report in this series provided a set of principles and a framework for longer-term performance evaluation of a company and value creation for shareholders. As a point of departure, to create sustainable value requires that, over time, the value of the outputs of a company must exceed the total value of the inputs. Therefore, to determine financial value creation a number of principles are important: ï‚· The best measure of economic value creation is economic profit, i.e.

net operating profit minus a capital charge for invested capital. Economic profit, unlike conventional profit, subtracts all input costs (including capital) from output value to determine true value creation. Economic profit can also be converted to return on invested capital (ROIC) as a measure of capital productivity and fundamental value creation from operations for investors; ï‚· Economic profit is only positive when the return on invested capital is greater than the weighted average cost of capital; thus executive management, board and investors need to measure and monitor both ROIC and cost of capital to enable longer-term value creation for shareholders; ï‚· Sound business strategy choices sometimes call for sacrificing current economic profit in order to increase future economic profit by an even greater amount.

In evaluating business strategy and management performance, directors have to evaluate whether the required future increase in economic profit is reasonably likely to occur; ï‚· Meaningful financial value creation is ideally measured over the longer term. For the purposes of this report, we define this to mean a period of at least five years; ï‚· The market enterprise value of a public company has two components: the current value of capital and economic profit and future value, i.e., the value of expected economic profit improvement; ï‚· Understanding the current and future value components of total shareholder return can help executive management and directors understand the requirements of, and threats to, sustainable value creation, and thereby, do a better job evaluating business strategy and performance. Mathematically, the key formulas are: ï‚· Economic profit = Net Operating Profit After Tax (NOPAT) minus Capital Charge ï‚· Net Operating Profit After Tax = EBIT minus Cash Taxes Paid ï‚· Capital charge = Invested Capital times Weighted Average Cost of Capital (WACC) ï‚· Current value = Invested Capital plus the Present Value of Current Economic Profit ï‚· Future value = Market Enterprise Value minus Current Value = the Present Value of Future Economic Profit Improvement The Alignment Gap Between Say on Pay Voting and Creating Value Page 8 . These financial formulas jointly provide the building blocks to compare operating performance between companies and to determine whether economic value is created and if this value creation is sustainable. For a full discussion of economic value creation and the implications of it, please see the first IRRCi report, available at www.irrcinstitute.org. Economic value creation analysis provides insight into real company performance over longer time periods, and allows us to determine its alignment with both shareholder value creation (through share price development), total compensation and long term incentive plan design for the most senior executives. This, then, provides a further framework against which to test to what extent Say-on-Pay proxy voting results are in alignment with foundational business strategy, finance and longer-term value creation practices. Note that these fundamentals of value creation are independent of traditional metrics of alignment with short-term stock price movement. Most companies use capital market and operating measures of performance for both performance measurement and compensation incentive plan design purposes. The most common measures of market performance are total shareholder return (TSR) and relative TSR.

Other common measures of operating performance are earnings and earnings per share (EPS) growth. TSR is significantly affected by market and industry factors, and hence, is not a great measure of management performance or business strategy success. While relative TSR provides a better measure of management performance and business strategy success in that some exogenous factors should affect peers as well as the specific company, it does not provide much insight about the requirements for, and threats to, sustainable value creation. In addition, relative TSR, as conventionally calculated, also assumes re-investment of all dividends, and hence, doesn’t properly capture those situations where value is created by decreasing the level of invested capital in the business. Earnings and EPS do not take into account the level of invested capital, cost of capital or future value built into enterprise valuation.

So, for example, a company could boost higher earnings and higher earnings per share following a value-destroying acquisition, if that acquisition were paid for with debt that did not come due during the measurement period. Yet TSR is the dominant performance metric for corporate LTIPs and well may be the dominant or sole performance metric used by institutional investors and proxy advisory services in analyzing Say-on-Pay voting and pay-for-performance alignment analysis. 1.2. Understanding enterprise value The premise that enterprise value is a discounted cash flow valuation has important implications for effective Say-on-Pay voting: ï‚· Enterprise value can be expressed as the sum of invested capital and the present value of future economic profit. Economic profit is profit after a charge for all capital including equity capital. ï‚· Enterprise value is the sum of current value and future value.

Current value is the sum of invested capital and the present value of current economic profit. For this report, we assume that the present value of current economic profit is its perpetuity value, i.e., current economic profit divided by weighted average cost of capital. Future value is the difference between market enterprise value and current value.

It is also equal to the present value of expected future economic profit improvement. Future value as a percentage of enterprise value for a ten-year The Alignment Gap Between Say on Pay Voting and Creating Value Page 9 . period (2003 – 2012) for the S&P 1500 is 33% of EV at the median and 65% of EV at the 80th percentile for the S&P 1500. ï‚· Investors can achieve a positive return on market value even when economic profit declines. This doesn’t mean that positive economic profit and or return on invested capital is unimportant; it just means that it is possible – and sometimes desirable – to sacrifice current economic profit and return on capital for expectations of even greater economic profit improvement and return on capital in the future. ï‚· A sustainable and viable business model must eventually provide consistent positive economic profit and a Return on Invested Capital great than its cost of capital. Without a reasonable expectation of positive economic profit, and a positive ROIC greater than WACC then no amount of sales or earnings growth will create sustainable longer-term shareholder value. In general, when a business model has a consistently negative performance spread (ROIC minus WACC) over five years or longer, it signals that there is a potential business strategy, economic model and/or strategic leadership problem. Conversely, a longer-term positive performance spread indicates to a board and executive management team that it is providing effective stewardship of invested capital which in return is driving the creation of sustainable value. Value creation principles dictate that investors, directors and executive management should be very concerned about a firm’s business strategy, financial and operating performance and prospective return when that firm has a five-year cumulative economic loss which also means a net negative ROIC (ROIC minus WACC) and/or a five-year economic profit decline over the performance period. Future value is a significant contributor to enterprise and company valuation, yet is rarely isolated in performance measurement design and executive compensation plan design. As a consequence it is unlikely that the drivers of future value are being explicitly managed. This means a material contributor of the expected value of the firm is about the future strategy, innovation and growth beyond the next two to three years, but there is no direct alignment to disclosed value-building metrics or executive incentive plan design for 85% of listed companies. Consequently, this lack of (disclosed) performance metrics alignment (company valuation, performance measurement design and long-term incentive design) creates a material risk for boards and investors. 1.3.

A lens to review longer-term value creation Investors, directors, and executive management would enable enhanced value creation and shareholder alignment if they applied business value-based performance measurement fundamentals in company performance management and planning, as well as in executive reward structures. While there are numerous ways to interpret the changes in these metrics over time, one interpretation would suggest that there are four key stages that align to this lifecycle (figure 1). The value quadrant model is a simple way for analyzing and segmenting company performance based on two performance metrics for evaluating value creation: 1.

Relative TSR (as a proxy for the change in future value) 2. Economic profit (or performance spread = ROIC minus WACC) The Alignment Gap Between Say on Pay Voting and Creating Value Page 10 . Figure 1: Value creation life cycle and value quadrant performance metrics Sustainability of longer-term value creation is all about the company’s ability to achieve economic profit growth and positive return on invested capital over time. Overlaying capital returns on the corresponding life cycle with future value changes and growth in ROIC, results in the following performance cycle and value quadrants as seen in figure 2. Figure 2: Value creation life cycle Directors and executive management can enhance shareholder alignment by questioning the desirability of continuing to invest in businesses that fail to earn their cost of capital, and develop a plan to improve returns or exit the business. Directors and investors in creating this alignment would insist on performance measures that: ï‚· Measure capital efficiency and economic value creation over time ï‚· Measure changes in future value ï‚· Measure value based on actual, not hypothetical, re-investment in the business The Alignment Gap Between Say on Pay Voting and Creating Value Page 11 . Chapter 2: Research methodology We screened the S&P 500 and S&P 400 companies for the 150 largest value creating and 150 largest value-destroying companies, based on five-year cumulative economic profit (2008-2012) and fiveyear relative TSR (positive versus negative). Figure 3 below outlines the measurement framework applied in the analysis. This group of high- and low-performance companies were further screened to best represent companies across multiple industry sectors (using four-digit GICS codes) to identify a sample 128 companies with 32 companies in each of the four value quadrants outlined. Figure 3: Value quadrant performance metrics Value Quadrant Performance Metrics 1 Positive Relative TSR and Negative Economic Profit (ROIC lower than WACC) 2 Positive Relative TSR and Positive Economic Profit (ROIC exceeds WACC) 3 Negative Relative TSR and Positive Economic Profit (ROIC exceeds WACC) 4 Negative Relative TSR and Negative Economic Profit (ROIC lower than WACC) (This is the same value quadrant framework, and same set of companies, outlined in the first IRRCi report) Each of the selected 128 companies was compared to the FundVotes proxy voting database for institutional investors and their Say-on-Pay proxy voting results. This database includes more than 100 of the largest mutual fund families representing over $11 trillion in global assets under management.

The data set also included 11 of the larger North American pension funds with close to $2 trillion in assets under management. A list of these funds is in the appendix. Organizational Capital Partners also obtained the voting recommendations from ISS and Glass Lewis, the two largest proxy advisory firms, and added those voting recommendations to the analysis. Please note that the FundVotes analysis and effective average Say-on-Pay support vote “For” is not the same as the aggregate total Say-on-Pay vote from all shareholders.

The aggregate vote total includes votes from multiple types of shareholders, including both those sampled by FundVotes (mutual funds and large pension funds) and those not included in the FundVotes database (e.g. individuals, hedge funds, corporate insiders). In some cases there may not be a high correlation between the FundVotes effective Say-on-Pay outcome and the actual outcome from all shareholders, for idiosyncratic reasons. For example, in the case of Viacom, that company has multiple share classes, and only “class A” shares are allowed to vote.

That share class is the less liquid, and most funds choose to invest in the more liquid non-voting shares. As a result, only two funds in the FundVotes database invested in the company and executed a Say-on-Pay vote with a combined average support of 0% as both funds voted “against”. The Alignment Gap Between Say on Pay Voting and Creating Value Page 12 . In other cases, the institutional shareholders in the FundVotes database may make up a significant portion of the shareholder base of a specific company. And, as these are amongst the largest institutional investors, in theory, at least, these should be amongst the most resourced and sophisticated Say-on-Pay voters. Overall, this group of larger mutual funds and pension funds provides a relevant sample of how major institutional investors with fiduciary obligations, analyzed the performance, compensation plans, pay for performance alignment and voted their proxies for Say-on-Pay. The Alignment Gap Between Say on Pay Voting and Creating Value Page 13 . Chapter 3: Analysis of economic performance, return on invested capital and Say-on-Pay voting A detailed review of the 128 companies (divided into the four quadrants with 32 companies each) that resulted from the screening process outlined in chapter two results in a surprising finding when they are analyzed for economic performance, shareholder return, long term incentive plan design and Say-on-Pay voting results.1 Simply put, there does not seem to be a material correlation between economic performance and Say-on-Pay voting results. 3.1 Value Quadrant Four: Value destroying performance and Say-on-Pay Voting The 32 value destroying companies in value quadrant four were all identified as having a negative return on invested capital over the last five years (2008-2012) when compared to their respective industry sector cost of capital and were analyzed as generating some of the larger five-year cumulative economic losses in the S&P 500 and 400. They also had negative relative TSR over five years. The performance statistics for the 32 sample companies includes: ï‚· Median return on invested capital of 5% (below cost of capital); ï‚· Cumulative five-year economic loss of over $502 billion; ï‚· 24 of a sample of 32 companies collectively generated a greater economic loss ($62 billion) in 2012 than in 2008; their economic performance worsened over five years; ï‚· Five-year relative total TSR of negative 52%, at the median for the group; ï‚· 84% of these companies (27 of 32) had no disclosed capital-efficiency or balance-sheet performance metrics from which to measure, monitor, reward executive management performance in creating positive economic value and return on invested capital for shareholders; ï‚· Average longest accountable performance period for named executive officers was three years. Despite all those factors, when the Say-on-Pay voting results2 for these 32 value-destroying companies were analyzed: ï‚· Voting support for current disclosed performance, performance metrics, pay-for-performance and incentive design was an average 82% “FOR” from institutional investors ï‚· ISS recommended support at 27 of the 32 (84%) companies. ï‚· Glass Lewis recommended support at 23 of the 32 (72%) companies. ï‚· 3 of 32 (9%) companies received a Say-on-Pay support of less than 50%. The average support at those three companies was 32.7% 1 The financial data for analysis is provided by subscription data feeds and may be subject to error for some companies. 2 In general, voting results for all companies were the 2012 proxy season.

In any situation where the company did not hold a say-on-pay vote (some companies have bi-annual or tri-annual cycles), the most recent vote was substituted. The Alignment Gap Between Say on Pay Voting and Creating Value Page 14 . In summary, this group of 32 value destroying companies, while generating a five-year cumulative $502 billion estimated economic loss; five-year relative TSR of negative 52% at the median; and failing in 84% of cases to disclose capital efficiency metrics in their LTIP design, still received an 82% Say-on-Pay approval “FOR” from institutional investors. The gap between the level of five-year cumulative economic loss, low return on invested capital, negative relative TSR of these 32 sample companies and their high Say-on-Pay support suggests that return on invested capital and or economic profit type capital efficiency performance metrics are not a material part of the current processes for evaluating enterprise performance, business strategy, economic viability, pay-for-performance alignment as part of Say-on-Pay voting. The Alignment Gap Between Say on Pay Voting and Creating Value Page 15 . Figure 4: Value quadrant four – 32 sample companies with detailed performance metrics VQ Sums VQ Performance Statistics LTIP & Say-on-Pay Voting Company Total Five yr. Capital Economic Five yr. Efficiency Profit Cumulative Five yr. /Balance Growth, Ecn Profit Total Median Total Total Sheet yr. Ending (2008Five yr. ROIC% Five yr. Five yr. Perf 2012, 2012) Revenue with Relative Absolute Metric in Ticker $millions $millions Growth% Goodwill TSR% TSR% LTIP Instnl Investors Say-onPay Average of Percent Support ISS REC SAYONPAY HESS CORP HES ($722) ($276) 19% 7% -27% -16% No 82% Against For MANPOWERGROUP MAN ($180) ($322) 1% 6% -23% 10% No 81% For Against HEWLETT-PACKARD CO HPQ ($10,234) ($718) 15% 12% -75% -60% No 62% For Against BARNES & NOBLE INC BKS ($381) ($873) 26% -2% -73% -36% No 73% Against For AVNET INC AVT $108 ($879) 64% 8% -48% -27% Yes 100% For For INGRAM MICRO INC IM $146 ($1,007) 8% 6% -17% 24% Yes 81% For Against SEALED AIR CORP SEE ($997) ($1,094) 64% 8% -6% 9% No 95% For For JABIL CIRCUIT INC JBL $184 ($1,273) 40% 5% -7% 26% No 94% For For CARNIVAL CORP/PLC (USA) CCL ($1,401) ($1,619) 18% 7% -31% 3% No 90% For For METLIFE INC MET ($6,240) ($1,680) 29% 16% -36% -29% No 90% For For NABORS INDUSTRIES LTD NBR ($649) ($1,904) 42% 3% -58% -52% No 10% TEXTRON INC TXT $305 ($2,056) -7% 6% -53% -44% No 93% For For PENNEY (J C) CO JCP ($2,093) ($2,705) -35% 6% -80% -57% No 72% For Against NEWFIELD EXPLORATION CO NFX ($1,451) ($2,805) 44% -7% -63% -58% No 91% For For FREEPORT-MCMORAN FCX ($2,144) ($2,807) 6% 20% -34% -23% Yes 53% ELECTRONIC ARTS INC EA VALERO ENERGY CORP VLO E TRADE FINANCIAL CORP ETFC XEROX CORP PFIZER INC Glass Lewis REC SAYONPAY Against Against Against Against ($295) ($3,329) 4% -3% -68% -48% No 45% For ($2,372) ($3,568) 46% 6% -10% 2% No 98% For For $2,230 ($3,872) -2% -1% -75% -72% No 82% For Against XRX ($8) ($4,270) 30% 5% -62% -36% No 98% For For PFE ($486) ($6,321) 22% 7% 0% 75% No 96% For For SEARS HOLDINGS CORP SHLD ($622) ($6,467) -21% 3% -72% -41% No 97% For For BANK OF NEW YORK MELLON BK ($2,452) ($6,694) 2% 7% -33% -26% No 95% For For DOW CHEMICAL DOW ($2,928) ($7,328) 6% 5% -10% 5% Yes 95% For For AMERICAN AIRLINES GROUP AAL ($753) ($7,719) 9% -5% -71% -54% No 83% For For ADVANCED MICRO DEVICES AMD $2,060 ($8,250) -10% -4% -62% -57% No 73% For Against MORGAN STANLEY MS ($1,195) ($9,535) -62% 0% -48% -44% Yes 70% For Against DEVON ENERGY CORP DVN ($2,090) ($9,800) -16% 5% -51% -43% No 43% Against For ALCOA INC AA ($2,225) ($10,441) -23% 3% -78% -74% No 96% For For BANK OF AMERICA CORP BAC ($23,785) ($60,970) -16% 3% -60% -65% No 92% For For CITIGROUP INC C $4,562 ($97,189) -38% 4% -74% -78% No 92% For For GENERAL ELECTRIC CO GE ($9,753) ($97,678) -15% 4% -45% -23% No 93% For For AMERICAN INTNATL GROUP AIG $3,649 ($137,246) -40% -7% -95% -94% No 96% For For SUM ($62,214) ($502,694) % For % For 84% 72% 80th $139 ($1,130) Median ($738) ($3,449) 20th ($2,343) ($9,278) % No 84% 30% 7% -24% 6% 5% -52% -38% -1% -73% 82% 3% -16% Average% For -57% The Alignment Gap Between Say on Pay Voting and Creating Value Page 16 .

3.2 Value Quadrant Two: Value creating performance and Say-on-Pay Voting The 32 value creating companies in value quadrant two over the last five years (2008-2012) were all identified as having a positive return on invested capital when compared to their respective industry sector cost of capital and generated some of the larger five-year cumulative economic profits in the S&P 500 and 400. They also created significant above median relative TSR. The performance statistics on these 32 high performance companies includes: ï‚· Median return on invested capital of 16% (well above cost of capital) and 4 times greater than the median of value quadrant 4 companies; ï‚· Cumulative five-year economic profit for these 32 companies of over $605 billion; ï‚· Economic profit growth of $88 billion from 2008 to 2012; they were generating $88 billion more economic profit than five years earlier (almost 15% year-on-year improvement); ï‚· Five-year relative total TSR of 24%, at the median; ï‚· 72% of these companies had no disclosed capital-efficiency or balance sheet performance metrics from which to measure, monitor, and reward executive management performance in creating positive economic value for shareholders. This group had 28% of companies using capital efficiency metrics in LTIP design as compared to only 16% in the value destroyer group in value quadrant 4: ï‚· Average longest accountable performance period for named executive officers is 3 years. However, when the Say-on-Pay voting results for these 32 high performance companies was analyzed: ï‚· The most recent Say-on-Pay voting support for current disclosed performance, performance metrics, pay-for-performance and incentive design was an average 84% “FOR” from institutional investors, not materially different from the 82% for the value destroying companies. ï‚· Both ISS and Glass Lewis recommended support at 26 of the 32 (81%) companies (though they differed on some of the specific companies). ï‚· 6 of 32 (19%) companies received a Say-on-Pay support of less than 50%, though it is worth noting that the average vote at those six companies was 42.3%, suggesting that a switch of just a few funds might have flipped the vote to majority support. In summary, this group of 32 high-performance and value-creating companies generated a $605 billion estimated five-year cumulative economic profit, a five-year relative TSR of 24% at the median, along with an increased use of capital efficiency metrics in their LTIP design and received close to the same level of Say-on-Pay approval from institutional investors versus the 32 larger value destroying companies in value quadrant four (84% and 82%, respectively). There is no material difference in Say-on-Pay voting support between the groups of high and low economic performance companies, despite the significant (positive versus negative) performance contrast between the companies when measured on return on invested capital, cumulative economic profit and relative total shareholder return over five years. The Alignment Gap Between Say on Pay Voting and Creating Value Page 17 .

Figure 5: Value quadrant two – 32 sample companies with detailed performance metrics VQ Sums Company Ticker VQ Performance Statistics LTIP & Say-on-Pay Voting Total Five yr. Capital Economic Five yr. Efficiency Profit Cumulative Five yr. /Balance Growth, Ecn Profit Total Median Total Total Sheet yr. Ending (2008Five yr. ROIC% Five yr. Five yr. Perf 2012, 2012) Revenue with Relative Absolute Metric in $millions $millions Growth% Goodwill TSR% TSR% LTIP Instnl Investors Say-onPay Average of Percent Support ISS REC SAYONPAY Glass Lewis REC SAYONPAY EXXON MOBIL CORP XOM ($207) $129,551 17% 20% 8% 20% No 45% Against For APPLE INC AAPL $40,744 $103,056 552% 101% 204% 171% No 47% Against For CHEVRON CORP CVX $6,060 $66,714 9% 18% 53% 65% No 94% For For INTL BUSINESS MACHINES IBM $9,405 $53,810 6% 22% 28% 103% No 94% For For WAL-MART STORES INC WMT $5,557 $49,511 24% 15% 23% 50% Yes 94% For For INTEL CORP INTC $8,814 $26,164 39% 21% 11% 22% No 45% Against For AMERICAN EXPRESS CO AXP $1,291 $18,989 7% 41% 61% 70% Yes 78% For Against MCDONALD'S CORP MCD $2,511 $17,138 21% 21% 54% 109% No 96% For For ABBOTT LABORATORIES ABT $2,641 $17,079 54% 14% 6% 52% Yes 79% For Against WELLS FARGO & CO WFC $2,666 $16,423 70% 14% 109% 44% Yes 97% For For QUALCOMM INC QCOM $1,639 $12,752 116% 20% 34% 70% No 89% For For ALTRIA GROUP INC MO ($756) $10,141 -54% 15% 23% 112% No 97% For For COLGATE-PALMOLIVE CO CL CATERPILLAR INC CAT WELLPOINT INC UNION PACIFIC CORP $318 $9,718 24% 29% 22% 72% No 94% For For $1,061 $8,459 47% 10% 6% 27% Yes 95% For For WLP $455 $7,897 1% 17% 8% 56% No 98% For For UNP $2,282 $6,886 29% 10% 75% 150% Yes 95% For For EBAY INC EBAY $1,067 $6,488 83% 18% 11% 82% Yes 38% DU PONT (E I) DE NEMOURS DD $709 $4,999 15% 9% 14% 30% No 95% DISCOVER FINANCIAL SVCS INC DFS Against Against For For For For $1,969 $4,445 40% 22% 170% 170% No 95% MCKESSON CORP MCK $236 $4,385 20% 15% 40% 115% Yes 43% DEERE & CO DE $418 $4,384 51% 10% 4% 20% Yes 93% For For GAP INC GPS $646 $3,954 -1% 28% 8% 126% No 96% For For CVS CAREMARK CORP CVS ($199) $3,818 61% 8% 7% 44% Yes 98% For For ILLINOIS TOOL WORKS ITW ($286) $3,377 11% 13% 21% 46% Yes 98% For For ROCKWELL AUTOMATION ROK $720 $3,229 25% 31% 36% 39% No 95% For For MOODY'S CORP MCO $8 $3,088 21% -82% 53% 66% No 98% For For PNC FINANCIAL SVCS GROUP PNC ($685) $2,226 65% 12% 48% 14% Yes 79% For Against INTUITIVE SURGICAL INC ISRG $401 $2,082 263% 40% 5% 51% No 94% For For SIMON PROPERTY GROUP INC SPG $607 $2,042 36% 18% 39% 106% No 36% ALLERGAN INC AGN $756 $860 47% 8% 15% 101% No 90% For For MARATHON OIL CORP MRO ($2,531) $828 -74% 6% 24% 41% No 95% For For RAYMOND JAMES FINANCIAL RJF $33 $175 26% 12% 60% 29% No 95% For For SUM $88,350 $604,666 80th $2,615 $18,619 60% 22% 54% 109% Median $715 $6,687 25% 16% 24% 60% 20th $13 $3,116 9% 10% 8% 32% % No 72% The Alignment Gap Between Say on Pay Voting and Creating Value Against Against Against Against Average% % For 84% 81% % For 81% Page 18 .

3.3 Value Quadrant One: Value creation potential and Say-on-Pay Voting The 32 sample companies in value quadrant one illustrate companies with an expectation for growth (positive relative TSR) but with business models that are not currently creating positive economic value. The performance statistics on these 32 companies are: ï‚· Median five-year return on invested capital of 4% (below cost of capital); ï‚· Cumulative five-year economic loss for these 32 companies of over $147 billion; ï‚· Cumulative economic profit growth of $3 billion from 2008 to 2012 showing signs of positive value creation trending; the challenge is 12 of 32 companies are generating a greater economic loss in 2012 than in 2008 even though they had a positive increase in relative and absolute TSR. For those 12 companies, stock price is up but the underlying economics are still value destroying and getting worse after five years; ï‚· Five year total relative TSR of 31%, at the median for the group; ï‚· Incentive Lab database identified that 72% of these companies had no disclosed capital-efficiency or balance-sheet performance metrics from which to measure, monitor, and reward executive management performance in creating positive economic value for shareholders; ï‚· Average Longest Accountable performance period for named officers is 3 years. When the Say-on-Pay voting results for these 32 turnaround companies was analyzed: ï‚· The most recent Say-on-Pay voting support for current disclosed performance, performance metrics, pay-for-performance and incentive design was an average 87% “FOR” from institutional investors; ï‚· ISS recommended support at 29 of the 32 (91%) companies; ï‚· Glass Lewis recommended support at 24 of the 32 (75%) companies; ï‚· 3 of 32 companies (10%) received a Say-on-Pay support of less than 50%. The average support at those three companies was 33%. In summary, this group of 32 turnaround companies with a $147 billion estimated cumulative economic loss over five years, five-year positive relative TSR of 31% at the median, and 72% with no capital-efficiency metrics received a slightly higher Say-on-Pay support than the value-creating companies in value quadrant two (87% vs. 84%).

Yet, 38% of these companies are destroying more value (economic loss) in 2012 than in 2008, which suggests their turn-around strategies are not yet working even though TSR is positive over the same performance period. Companies where economic profit growth is positive as compared to companies whose economic profit growth is negative, and getting worse, would not appear to be effectively differentiated in the current pay-for-performance alignment testing as part of Say-on-Pay proxy voting. These companies are, however, above median in relative TSR. The high level of Say-on-Pay support may have been impacted by a dominant use of TSR or relative TSR as key performance metrics used by institutional investors in their Say-on-Pay voting analysis processes. The Alignment Gap Between Say on Pay Voting and Creating Value Page 19 .

Figure 6: Value quadrant one – 32 sample companies with detailed performance metrics VQ Sums VQ Perfm Statistics Company Total Five yr. Economic Five yr. Profit Cumulative Five yr. Growth, Ecn Profit Total Median Total Total yr. Ending (2008Five yr. ROIC% Five yr. Five yr. 2012, 2012) Revenue with Relative Absolute Ticker $millions $millions Growth% Goodwill TSR% TSR% ITT CORP ITT SLM CORP SLM TECH DATA CORP LTIP & Say-on-Pay Voting Capital Efficiency /Balance Sheet Perf Metric in LTIP Instnl Investors Say-onPay Average of Percent Support ISS REC SAYONPAY Glass Lewis REC SAYONPAY $27 ($116) -75% 10% 13% 36% No 100% For For $2,234 ($137) -37% 7% 31% 42% No 97% For For TECD $214 ($215) 8% 8% 3% 39% No 95% For For LEGGETT & PLATT INC LEG $255 ($356) -14% 7% 55% 186% No 97% For For GATX CORP GMT ($76) ($499) -1% 5% 31% 58% Yes 100% For For KEMPER CORP/DE KMPR ($17) ($707) -15% 5% 11% 17% Yes 93% For For FAIRCHILD SEMICONDUCTOR INTL FCS $20 ($713) -16% 0% 4% 19% No 100% For For OMNICARE INC OCR $27 ($919) -1% 4% 60% 131% No 72% For Against VERTEX PHARMACEUTICALS INC VRTX For Against $485 ($934) 667% -38% 31% 130% No 72% CYPRESS SEMICONDUCTOR CORP CY $177 ($958) -52% 0% 76% 101% No 41% CINCINNATI FINANCIAL CORP CINF ($18) ($975) -3% 7% 54% 62% No 97% For For NISOURCE INC NI $336 ($1,128) -37% 4% 65% 123% No 99% For For INTL PAPER CO IP $425 ($1,181) 27% 7% 79% 104% Yes 99% For For UNITED RENTALS INC URI $113 ($1,182) 10% 1% 143% 192% No 99% For For SANDISK CORP SNDK ($71) ($1,285) 30% 10% 64% 144% No 96% For For CONSTELLATION BRANDS -CL A STZ $266 ($1,428) -26% 4% 40% 149% No 91% For For TENET HEALTHCARE CORP THC $1,442 ($1,823) 3% 4% 45% 110% Yes 100% For For CHEMTURA CORP CHMT $135 ($2,585) -30% -8% 158% 198% No 100% For For MASCO CORP MAS ($393) ($3,041) -34% -1% 1% 22% Yes 95% For For JPMORGAN CHASE & CO JPM $878 ($3,812) -8% 11% 79% 23% No 88% For For MONDELEZ INTERNATIONAL INC MDLZ ($2,175) ($4,119) -6% 6% 6% 84% No 75% For Against HUNTINGTON BANCSHARES HBAN ($428) ($4,325) -12% -1% 0% -22% Yes 96% For For $441 ($4,441) 16% 1% 8% 25% No 97% For For For RESOLUTE FOREST PRODUCTS INC RFP Against Against ALLSTATE CORP ALL ($1,145) ($5,586) -10% 6% 13% 19% Yes 98% For CIT GROUP INC CIT $1,446 ($6,011) -49% 1% 400% 289% No 97% For For ANADARKO PETROLEUM CORP APC ($1,631) ($6,027) 18% 6% 26% 43% No 84% For Against COMCAST CORP CMCSA $4,888 ($6,063) 103% 6% 15% 137% No 73% For Against XL GROUP PLC XL ($82) ($6,361) -19% -3% 17% 23% Yes 96% For For COCA-COLA ENTERPRISES INC CCE ($179) ($9,004) -61% -4% 36% 137% No 92% For For MOTOROLA SOLUTIONS INC MSI $293 ($16,728) -76% -5% 19% 77% No 45% Against For CBS CORP CBS $5,576 ($23,503) 0% -4% 16% 141% No 13% Against Against COP ($10,281) ($31,765) -66% 3% 12% 26% $3,185 ($147,926) CONOCOPHILLIPS SUM Yes % No 72% th 80 $477 ($754) 10% 7% 65% Median $124 ($1,625) 20th ($159) ($6,024) 4% 31% -1% 11% 87% Against % For 91% 81% -37% For 140% -11% 78% Average% % For 23% The Alignment Gap Between Say on Pay Voting and Creating Value Page 20 75% .

3.4 Value Quadrant Three: Hidden value and Say-on-Pay Voting The 32 sample companies in value quadrant three illustrate mature growth companies where the expectation for growth is lower (negative relative TSR) but where the business model generates significant current value (five-year cumulative positive economic profit and ROIC > WACC). The performance statistics on these 32 mature companies suggest there is hidden value in these companies: ï‚· Median five-year return on invested capital of 15% (well above cost of capital); ï‚· Cumulative five-year economic profit for these 32 companies of over $281 billion; ï‚· Cumulative economic profit growth of only $777 million from 2008 to 2012 showing the signs of mature growth; the challenge is 19 of 32 are generating a smaller economic profit in 2012 than in 2008 although still positive. On the flip side, 13 of 32 companies generated more economic profit in 2012 than in 2008. Relative TSR is negative over five years for each company. Nevertheless, the underlying business economics are value creating.

This clearly demonstrates that TSR and relative TSR are incomplete measures of longer-term performance and value creation; ï‚· Five-year total relative TSR of negative 19%, at the median, which reflects the slowing growth and value creation relative to their industry peers; ï‚· 66% of these companies had no disclosed capital-efficiency or balance-sheet performance metrics from which to measure, monitor, and reward executive management performance in creating positive economic value for shareholders. The good news is as a mature group of companies, 44% do use some type of balance sheet performance metric in incentive design. This is the highest of the four value quadrants reflecting the maturity and sophistication of these companies; ï‚· Average Longest Accountable performance period for named executive officers is 3 years. When the Say-on-Pay voting results for these 32 mature companies was analyzed: ï‚· The most recent Say-on-Pay voting support for current disclosed performance, performance metrics, pay-for-performance and incentive design was an average 77% “FOR” from institutional investors; ï‚· ISS recommended support at 26 of the 32 (81%) companies; ï‚· Glass Lewis recommended support at 21 of the 32 (66%) companies; ï‚· 6 of 32 (19%) companies received a Say-on-Pay support of less than 50%.

The average vote at those six companies was 25.2%. However, that includes a zero level of support amongst the represented funds on the Viacom Say-on-Pay vote. Viacom features multiple classes of stock, and only “class A” shares are eligible to vote.

In general, “class B” shares are more liquid and held by more institutions. Only two funds held “class A” shares, which partially explains the zero vote. The average level of support at the five other companies which received less than 50% (excluding Viacom) was 30.2%. The Alignment Gap Between Say on Pay Voting and Creating Value Page 21 . In summary, this group of 32 mature companies with $281 billion in estimated cumulative economic profit over five years, five-year relative TSR of negative 19% at the median, and 44% with disclosed capital efficiency performance metrics had Say-on-Pay approval from institutional shareholders slightly lower than the high performance group of companies in value quadrant two (77% vs. 84%). 59% of these companies are generating a smaller positive economic profit in 2012 than in 2008, which suggests many are challenged to innovate and grow as mature companies. This economic profit deceleration may have contributed to the five-year negative relative TSR and thus slightly lower Say-on-Pay approval compared to value quadrant two. The Alignment Gap Between Say on Pay Voting and Creating Value Page 22 . Figure 7: Value quadrant three – 32 sample companies with detailed performance metrics VQ Sums VQ Performance Statistics LTIP & Say-on-Pay Voting Company Total Five yr. Economic Five yr. Capital Profit Cumulative Five yr. Efficiency Growth, Ecn Profit Total Median Total Total /Balance yr. Ending (2008Five yr. ROIC% Five yr. Five yr. Sheet 2012, 2012) Revenue with Relative Absolute Perf Metric Ticker $millions $millions Growth% Goodwill TSR% TSR% in LTIP MICROSOFT CORP MSFT $7,793 $82,975 44% 46% -21% 13% No 95% For For COCA-COLA CO KO $3,577 $31,776 66% 21% -15% 54% Yes 44% Against For PEPSICO INC PEP ($1,018) $23,463 66% 24% -31% 27% No 95% For For PROCTER & GAMBLE CO PG ($2,103) $20,605 9% 10% -24% 14% No 94% For For SCHLUMBERGER LTD SLB ($924) $13,653 81% 16% -20% -8% No 93% For For LILLY (ELI) & CO LLY ($2,339) $10,777 21% 11% -20% 42% No 97% For For AT&T INC T $3,118 $10,268 7% 8% -12% 28% Yes 95% For For LOCKHEED MARTIN CORP LMT ($51) $10,209 13% 15% -3% 17% Yes 80% For Against RAYTHEON CO RTN $1,409 $7,906 15% 17% -13% 5% Yes 99% For For GOLDMAN SACHS GROUP INC GS ($5,458) $7,672 -53% 13% -14% -8% Yes 76% For Against HALLIBURTON CO HAL $728 $7,402 87% 18% -4% 9% Yes 91% For For DISNEY (WALT) CO DIS $2,199 $7,366 19% 10% -4% 65% No 30% Against Against MEDTRONIC INC MDT ($402) $6,728 23% 11% -27% 18% Yes 80% For For AFLAC INC AFL $975 $5,014 65% 21% -13% -8% No 99% For For SCHWAB (CHARLES) CORP SCHW $219 $4,513 -11% 25% -7% 1% Yes 84% For Against OMNICOM GROUP OMC KELLOGG CO K COACH INC UNITED PARCEL SERVICE INC Instnl Investors Say-onPay Average of Percent Support ISS REC Glass SAYLewis ON- REC SAYPAY ON-PAY $162 $3,822 12% 20% -30% 48% No 95% For For ($181) $3,800 21% 16% -19% 43% No 94% For For COH $375 $3,748 82% 73% -6% 24% No 79% For For UPS ($4,111) $3,598 9% 12% -16% 37% Yes 86% For For ($1,209) $3,480 102% 12% -43% -9% No 93% For For $1,175 $3,235 3% 11% -24% 41% No 0% Against For $260 $3,176 27% 19% -13% 34% No 97% For For Against ARCHER-DANIELS-MIDLAND ADM VIACOM INC VIAB AGILENT TECHNOLOGIES INC A ADOBE SYSTEMS INC ADBE ($162) $2,106 39% 14% -29% 17% No 76% For DUN & BRADSTREET CORP DNB ($64) $1,575 4% 48% -21% 13% No 97% For For AVON PRODUCTS AVP ($621) $1,381 8% 17% -58% -38% No 23% Against Against UDR INC UDR $78 $406 44% 20% -12% 33% No 97% For For NORTHERN TRUST CORP NTRS ($321) $401 -22% 10% -16% -8% Yes 76% For Against SPX CORP SPW ($527) $385 6% 12% -32% -18% No 79% For Against NUCOR CORP NUE ($1,364) $215 17% 7% -30% -19% Yes 77% For Against SL GREEN REALTY CORP SLG ($150) $108 34% 8% -22% 18% No 36% Against Against ($23) $103 19% 12% -5% 45% No 93% For For ($262) $92 20% 8% -65% -27% No 18% Against Against $777 $281,960 % For % For 81% 66% CORRECTIONS CORP AMER CXW ABERCROMBIE & FITCH ANF SUM % No 66% 80th $925 $10,256 61% 21% -12% ($107) $3,811 20% 15% -19% 17% 20th ($999) $601 7% 10% -30% 77% 40% Median Average% -8% The Alignment Gap Between Say on Pay Voting and Creating Value Page 23 .

3.5. Value quadrant analysis – a summary Figure 8: Value quadrant summary 32 companies – performance, LTIP design, Say-on-Pay voting Five Year Capital Institutional Economic Five yr. Five yr. Efficiency / Investors ISS Profit Cumulative Median Balance Say-on-Pay REC Growth Ecn Profit ROIC% Five yr. Five yr. Sheet Average of SAYending (2008- 2012) with Relative Absolute Performance Percent ON2012 $millions Goodwill TSR TSR Metric in LTIP Support PAY Glass Lewis REC SAYONPAY Value Quadrant 1 – 32 companies SUM $3,185 ($147,926) % For 91% 75% Average% % For % For 72% 84% 81% 81% % No Average% % For % For 66% 77% 81% 66% % No Average% % For % For 84% 31% % For 87% % No 4% Average% 72% Median % No 82% 84% 72% 81% Value Quadrant 2 – 32 companies SUM $88,350 $604,666 Median 16% 24% 60% Value Quadrant 3 – 32 companies SUM $777 $281,960 Median 15% -19% 17% Value Quadrant 4 – 32 companies SUM Median ($62,214) ($502,694) 5% -52% The Alignment Gap Between Say on Pay Voting and Creating Value -38% Page 24 . Chapter 4: Conclusions 4.1 ROIC, economic profit and Say-on-Pay voting Economic value creation fundamentals such as ROIC and/or economic profit for performance measurement either are not used in current processes for Say-on-Pay advisory voting by institutional shareholders and in the analysis by the major proxy voting agencies, or they are outweighed by other considerations, such as TSR alignment. If economic value creation factors were primary considerations, there would be greater differentiation in Say-on-Pay voting results, based on economic profit performance and return on invested capital. Do fundamental business strategy and finance using return on invested capital and economic profit as key performance metrics appear to impact current performance analysis and pay-for-performance alignment testing and the resulting Say-on-Pay voting results? The simple answer appears to be no. This conclusion is best illustrated when comparing companies in value quadrant four as compared to value quadrant two: ï‚· Value quadrant four includes 32 value-destroying companies:  Five year median ROIC of 4% (below cost of capital);  Generated a cumulative five year economic loss of $502 billion;  Five year relative total TSR of negative 52%, at the median;  Received an average 82% Say-on-Pay approval from institutional investors; Received five negative recommendations from ISS and nine negative recommendations from Glass Lewis;  3 of 32 companies (13%) received a Say on Pay support of less than 50%, with those companies receiving an average “for” vote of 32.7%. ï‚· Value quadrant two include 32 value-creating companies:  Five year median ROIC of 16% (well above the cost of capital);  Generated a cumulative five year economic profit of $604 billion;  Five year relative total TSR of positive 24%, at the median;  Received an average 84% Say-on-Pay approval from institutional investors;  Received six negative recommendations from both ISS and Glass Lewis;  6 of 32 companies (19%) received a Say-on-Pay support of less than 50% (though the average “for” vote at those companies was 42.3%). While a there is a material negative versus positive performance and value creation difference in relative TSR and economic profit over five years, between the sample companies in each of these two value quadrants, both groups received similar Say-on-Pay support in the 82% to 84% average range.3 3 For those value-creating companies in value quadrant two that received less than a 50% Say-on-Pay support, one possible explanation for the lack of support may not be about overall level of performance but the level of premium The Alignment Gap Between Say on Pay Voting and Creating Value Page 25 . Say-on-Pay voting results were similar across all four quadrants ranging from 77% to 87% average support by quadrant, with an average overall support of 82% (see the summary table, Figure 8). As was outlined in the first IRRCI report, 48% of the S&P 1500 generated a cumulative economic loss and thus an average ROIC less than their cost of capital (Figure 9). These companies failed to create economic value over five years or longer and thus may require strategic governance focus including enhanced performance measurement and LTIP design for named officers. Yet the 128 companies illustrated by the sample Say-on-Pay analysis do not appear to be differentiated as value creating versus value destroying based on their level of consistent institutional investor Say-on-Pay support in the 77% to 87% range. Figure 9: S&P 1500 five-year cumulative economic profit versus five-year relative TSR (period: 2008 – 2012) compensation at some companies relative to their peer group. Premium compensation analysis was beyond the scope of this report, which focused on economic performance. The Alignment Gap Between Say on Pay Voting and Creating Value Page 26 .

4.2 The opportunity for longer term investors The use of ROIC and/or economic profit type performance metrics in Say-on-Pay voting would enhance the longer-term value creation alignment of the Say-on-Pay process for investors. The first IRRCi report in this series outlined the higher correlation between positive ROIC, economic profit growth and shareholder returns as compared to just net income or net income growth. The use of such metrics as ROIC and or economic profit would allow institutional investors enhanced voting execution aligned to long-term value creation. It would create an ability to go beyond relying on a sub-optimal use of TSR and or earnings as dominant metrics for performance analysis and pay-forperformance alignment testing. Institutional investors and proxy advisory firms could consider incorporating key business strategy, finance and value creation alignment principles into their Say-on-Pay voting processes by: ï‚· Applying value-based performance metrics such as ROIC relative to weighted average cost of capital (WACC) and or economic profit in their Say-on-Pay processes in evaluating business strategy and business model viability, performance measurement, value creation and pay-forperformance alignment; ï‚· Adding future value improvement metrics (innovation, customer loyalty, employee engagement, environment) to their Say-on-Pay decision process from which to evaluate longer term pay-forperformance and value creation alignment at investee companies; ï‚· Giving credit to companies that extend the longest accountable performance-period for named executive officers beyond 3 years, ideally to the use of five-year rolling performance period as being advocated by some institutional investors. The Alignment Gap Between Say on Pay Voting and Creating Value Page 27 .

Appendix Data providers and sources Databases and data analytics have been woven together to create integrated insights about: 1. Economic performance and shareholder value a. Organizational Capital Partners i. S&P 1500 with data feed from S&P Compustat and Hoovers and calculations for economic profit, adjusted ROIC and Future Value b.

Shareholder Value Advisors i. S&P 1500 with data feed from S&P Compustat and calculations for economic profit, adjusted ROIC and Future Value 2. Pay-for-performance alignment and long-term incentive plan design a.

Incentive Lab – with over 1200 companies across the S&P 500, 400 and 600 and their incentive design details including pay mix, short-term vs. long term, performance based vs. time based, performance metrics, performance periods for named officers b.

Shareholders Value Advisors i. Perfect Pay-for-performance model and analytics using the complete S&P 1500 and a broad range of economic profit and relative TSR performance metrics and S&P ExecuComp database ii. Model and analytics for Pay-for-performance Alignment, Pay Leverage and Excess Pay relative average peer group performance 3.

Proxy voting for Say-on-Pay by institutional shareholders (mutual funds and pension funds) a. FundVotes i. A database covering mutual fund voting for over 100 mutual fund families representing over $11 trillion in global assets under management.

The top 30 mutual fund groups include $9.4 trillion in global assets under management and $3.8 trillion in US domestic equities. ii. This analysis also covers 11 of the larger North American pension funds with close to $2 trillion in global assets under management The Alignment Gap Between Say on Pay Voting and Creating Value Page 28 . Asset Owner and Asset Manager List The following is a list of 144 mutual and pension funds in the FundVotes database that were analyzed for Say-On-Pay voting. Their combined assets under management is over $ 13 trillion dollars. Asset Manager Asset Owner ADVISORS FMI OAKMARK AFSCME AGF FRANKLIN TEMPLETON OCEANROCK/MERITAS AIMCO ALGER GABELLI OPPENHEIMER BCIMC ALLIANCEBERNSTEIN GE PARNASSUS CALPERS ALLIANZ GMO PAX CALSTERS AMERICAN GOLDMAN SACHS PH&N CPPIB AMERICAN BEACON GREEN CENTURY PIMCO OMERS AMERICAN CENTURY GUIDESTONE PIONEER OTPP AMERITAS HARBOR PORTFOLIO 21 SBAFLA ARIEL HARTFORD PRIMECAP ODYSSEY SWIB ARTISAN HSBC PRINCIPAL TIAA-CREF ASTON IA CLARINGTON PRUDENTIAL AXA ING PUTNAM BARON INHANCE QUAKER BERKSHIRE INTEGRITY RBC BLACKROCK INVESCO ROYCE BMO INVESTORS RS BNY MELLON JANUS RUSSELL BOSTON COMMON JOHN HANCOCK SCHRODER BOSTON TRUST & WALDEN FUNDS JP MORGAN SCHWAB BRIDGEWAY LAZARD SCOTIABANK CALAMOS LEGG MASON SCOUT CALVERT LIBERTY SEI CAPSTONE LONGLEAF STANDARD LIFE CI LORD ABBETT STATE STREET CIBC MACKENZIE STEWARD COHEN & STEERS MAINSTAY SUNAMERICA COLUMBIA MANAGERS T ROWE CREDIT SUISSE MANULIFE TCW DAVIS MASSMUTUAL TD DELAWARE MCLEAN BUDDEN TEMPLETON DESJARDINS MD FUNDS THORNBURG DIMENSIONAL METROPOLITAN THRIVENT DODGE & COX MFS TRANSAMERICA DOMINI MMA PRAXIS TRILLIUM DREYFUS MORGAN STANLEY UBS DWS MUNDER UNITED DYNAMIC NATIONWIDE USAA EATON VANCE NATIXIS VALIC F&C NBIM VANGUARD FEDERATED NEI VICTORY FIDELITY NEUBERGER BERMAN VIRTUS FIFTH THIRD NORTHERN WADDELL & REED FIRST EAGLE NUVEEN WELLS FARGO WILLIAM BLAIR The Alignment Gap Between Say on Pay Voting and Creating Value Page 29 . Glossary – Key terms Term Capital charge Cash flow return on investment (CFROI) Company wealth index Current value (CV) Discounted Cash flow valuation (DCF) Earnings per share (EPS) Economic profit (EP) Enterprise value (EV) Enterprise value divided by NOPAT multiple Excess cash Excess shareholder returns relative to weighted average cost of capital Future value (FV) Generally Accepted Accounting Principles (GAAP) Definition Capital charge in dollars = beginning invested capital times weighted average cost of capital. The cash flow return on investment (CFROI) measures a company's cash return on invested assets. It is calculated as the internal rate of return assuming the maintenance of the current gross cash flow for the life of the asset base. Transaction CFROI includes goodwill from acquisitions (Credit Suisse HOLT) The company wealth index is a cumulative measure of shareholder wealth per share calculated from monthly total returns. The sum of invested capital plus the present value of the current economic profit level. Economic Profit divided WACC plus Invested Capital Discounted cash flow (DCF) valuation is a method of valuing an asset using the time value of money. DCF value is the present value of expected future cash flows discounted at the cost of capital.

It can also be expressed as the sum of book capital plus the present value of expected economic profit. Net Income available to common shareholders divided by the weighted average number of shares outstanding. Economic profit is a non-GAAP measure of true economic profitability and is a measure of profit after minimum return for both invested equity and debt capital. NOPAT minus capital charge equals economic profit. Market value of equity plus the market value of debt minus excess cash. We assume that the market value of debt is equal to its book value. Enterprise value is also made up of two components, which are the current value (CV) and the future value (FV) of the enterprise.

Enterprise value can also be calculated as = present value of current economic profit plus current invested capital plus present value of economic profit improvement. Enterprise value divided by net operating profit after tax. This valuation multiple includes the total value of the company (debt plus equity minus excess cash) versus only the market value of equity in a P/E multiple. This multiple provides a comparison free of capital structure differences of the operating-cash generating capacity of the company; some investment banks find this multiple has a higher correlation with TSR than other valuation multiples; a high enterprise value divided by NOPAT multiple means a high expectation for future growth Cash, cash equivalents and short-term investments beyond 2% of revenues that are not required to operate the business. The dollar difference between actual shareholder wealth and shareholder wealth assuming a cost of capital return.

The excess return can expressed as the sum of the future value of capitalized excess economic profit improvement and the dollar change in future value Enterprise value minus current value equals future value. If the current economic profit level is fully sustainable, one can show mathematically that future value is equal to the present value of future economic profit improvement. Generally accepted accounting principles (GAAP) refer to the standard framework of guidelines for financial accounting used in any given jurisdiction; generally known as accounting standards or standard accounting practice. These include the standards, conventions, and rules that accountants follow in recording and summarizing and in the preparation of financial statements. The Alignment Gap Between Say on Pay Voting and Creating Value Page 30 .

Term Invested capital Net Equity Profit After Tax (NEPAT) Net Operating Profit After Tax (NOPAT) Non-interest-bearing current liabilities Performance-based equity compensation Performance spread Price divided by earnings multiple (P/E multiple or ratio) Relative total shareholder return Return on equity (ROE) Return on invested capital (ROIC) Time-based equity compensation Total shareholder return (TSR) Weighted Average Cost of Capital (WACC) Definition Total asset (including goodwill) minus non-interest bearing current liabilities minus capitalized special items (including discontinued operations) minus excess cash plus capitalized R&D. Positive special items (gains) reduce capital, while negative special items (losses) increase capital Earnings before taxes on the income statement (EBT), adjusted for special items and R&D, minus cash taxes paid from the cash flow statement. Special items (including discontinued operations) and R&D expense are capitalized and amortized over a five-year period. Earnings before interest and taxes (EBIT) on the income statement, adjusted for special items and R&D, minus cash taxes paid from the cash flow statement and minus the tax savings from interest expense, calculated at the corporate marginal rate. Special items (including discontinued operations) and R&D expense are capitalized and amortized over a five-year period. Non-interest bearing current liabilities including accounts payable and taxes payable. Awards with market and/or performance conditions. Return on invested capital (ROIC) minus the cost of capital (WACC).

A positive performance spread is where ROIC exceeds WACC and results in value creation for shareholders. A negative performance spread is where ROIC is lower than WACC and results in value destruction for shareholders. Market value of equity divided by the net income for the period. This is usually calculated on a yearly or trailing twelve-month time period.

This may be converted to stock price per share divided by earnings per share; the higher the P/E multiple is, the higher is the investors expectation of future growth and innovation from the company relative to current earnings. Conversely, a stock with a low P/E multiple suggests that investors have more modest expectations for its future growth compared to the market as a whole. The company’s shareholder return relative to that of a specific comparator group, i.e., [(1 + TSR)/(1 + peer group TSR)] – 1. For this report, we use each company’s GICS industry group (four digit GICS) as its peer group. Net Income divided by beginning shareholders’ equity. A non-GAAP measure of capital productivity and balance-sheet efficiency measured as net operating profit after tax divided by beginning invested capital; a measure of the competitive advantage of a company in creating value for shareholders. Awards dependent on a defined time period. The point-to-point measurement of the percentage gain or loss to shareholders, i.e., (share price end of period minus share price beginning of period) plus dividends divided by share price beginning of period.

TSR for periods longer than one month is calculated by compounding monthly TSR. A calculation of a firm's cost of capital in which each category of capital is proportionately weighted. All capital sources (i.e. common stock, preferred stock, bonds and any other long-term debt) are included in a WACC calculation.

The median WACC for all S&P 1500 companies for the last 5 and 10 years is 8%. The Alignment Gap Between Say on Pay Voting and Creating Value Page 31 . List of tables and figures Figure 1: Value creation life cycle and value quadrant performance metrics........................................................................ 11 Figure 2: Value creation life cycle........................................................................................................................................... 11 Figure 3: Value quadrant performance metrics ..................................................................................................................... 12 Figure 4: Value quadrant four – 32 sample companies with detailed performance metrics .................................................

16 Figure 5: Value quadrant two – 32 sample companies with detailed performance metrics ................................................. 18 Figure 6: Value quadrant one – 32 sample companies with detailed performance metrics ................................................. 20 Figure 7: Value quadrant three – 32 sample companies with detailed performance metrics ...............................................

23 Figure 8: Value quadrant summary 32 companies – performance, LTIP design, Say-on-Pay voting ..................................... 24 Figure 9: S&P 1500 five-year cumulative economic profit versus five-year relative TSR (period: 2008 – 2012) ................... 26 The Alignment Gap Between Say on Pay Voting and Creating Value Page 32 .