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									   2009 World at Work
Total Rewards Conference

           Real-World Performance:
Getting Results from Long-Term Incentive Plans
                                    June 2, 2009

 Melissa L. Means                 Virginia Leonard                  Alice V. Johannen
    Managing Director           Director, HR Shared Services      Director, Global Compensation
     Pearl Meyer & Partners             Cabot Corporation             Charles River Laboratories
 132 Turnpike Road, Suite 300           157 Concord Road                251 Ballardvale Street
   Southborough, MA 01772               Billerica, MA 01460             Wilmington, MA 01887
         (508) 630-1487                    (978) 670-6225                   (781) 222-6291
melissa.means@pearlmeyer.com    virginia_leonard@cabot-corp.com        alice.johannen@crl.com

The Changing Landscape of Long-Term Incentives (LTI)

The Charles River Laboratories International Story

The Cabot Corporation Story

Issues to Consider


The Changing Landscape

Times they are a-changin’.
Competitive practices prior to the Fall 2008.
 • Companies continuing to evaluate and rebalance mix of long-term
   incentive (LTI) instruments - using multiple instruments to deliver
   LTI awards
 • Stock options still on the decline in the past few years
 • Use of restricted stock (RS) continues to increase; continued
   investor pressure to tie stock awards to performance
Companies continue to implement / investigate use of
performance metrics in LTI plan; more in line with
shareholder and institutional expectations
44% of the Fortune 1000 and 62% of the S&P 500 have 3-
year performance-based LTI plans
64% of respondents offered performance-based plans in
2007, up from 30% in 2004 (2007 NASPP Domestic Stock
Plan Design & Administration Survey)

Market Drivers of Change

 Financial Crisis - Economic recession, limited liquidity,
 bankruptcies, highly volatile markets
 Declining confidence - Unemployment rates, lost retirement
 fund values, large bonus payouts on Wall Street…
 High profile fraud – Ponzi schemes
 Democratic control - Executive and legislative
 Government bailouts – EESA, TARP, CPP, DP, AP, RAA,
 Shareholder activism – Say on pay, poor pay practices, burn
 rate and dilution limits
 Pending legislation - Say on pay, 162(m)…
 Optics – shareholders, employees, press, government
As a result, LTI remains in the forefront of public interest and companies
       continue to re-evaluate existing programs & instrument mix

The Changing Landscape

Rethinking LTI again to address the following for 2009:
 •   Managing awards in a declining market
 •   How much LTI value to deliver and what instruments to use
 •   Impact of awards on burn rates and pool of available shares
 •   How to set performance metrics in an unpredictable economy
 •   What to do with underwater stock options

What is everyone considering or implementing now:
 •   Changing the mix of instruments used
 •   Using cash to settle awards
 •   Reducing plan participation
 •   Granting lower award values
 •   Implementing longer holding restrictions
 •   Modifying the timing of the annual award cycle
 •   Exchanging underwater stock options

Six Steps to Implementing Performance Metrics

The following outlines six key design considerations
for implementing a performance-based LTI plan:

 • Metric Selection

 • Performance Measurement Period

 • Absolute vs. Relative Performance

 • Cumulative vs. Point-in-Time Metrics

 • Consecutive vs. Overlapping Performance Cycles

 • Set Performance/Payout Scale

Charles River Laboratories International

                Alice Johannen
        Director, Global Compensation

Charles River Laboratories International

 US (Headquarters)   Ireland           China
 Canada              UK                India
                     France            Japan
                     Germany           So. Korea

History of the Company
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                                                                                         O        ul ble
                             1                                                                  M ou

    7                 7


                                                                                   20 9

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1          19



    Charles River provides essential                                    CURRENT STATE
    products and services to help                                        $1.3B Revenue
    pharmaceutical and biotechnology                                    8,500 Employees
    companies, government agencies and                                     13 Countries
    leading academic institutions around                               CEO: James Foster
    the globe accelerate their research                                  (founder’s son)
    and drug development efforts.
LTI in 2001: Annual Only

•   Types         Annual (time-based) only
•   Eligibility   Director level & above; top technical staff
•   Vehicles      100% Options
•   Vesting       3-year vesting, 10-year term
•   Non-US        < 5 recipients (RSUs)
•   Amounts       Based on 3 subjective “performance levels”
•   Other         Restricted stock very rare
                  “Special” annual awards for hi-potential
                  lower levels

2001-2004 Changing Landscape

• Heightened interest in tying executive rewards to
  long-term corporate performance and strategic

2004: Mid-Term Incentive
 • Comp Committee institutes MTI Plan
   – Bridge gap between STI & LTI
   – “Add on” to existing STI & LTI
   – Based on cumulative revenue & operating income
     (OI) vs. 3-year plan
   – Overlapping – intended to have new plan cycle each
   – “Performance Units” (stock) – target levels set, with
     payout grid based on % achievement in OI and

MTI Payout Grid

MTI Plan Challenges
• Problems:
   – Executive resistance
   – Difficult to communicate clearly
   – Entrepreneurial, high-growth company

       • “Acquisition mode” meant the OI and Revenue landscape
         was constantly changing; goals were “consciously
   – 2005 acquisition immediately changed the game

• Result:
   – No new award cycles in 2nd or 3rd year – plan failed
   – No payout for anyone
2005/6: Landscape
• Charles River acquires Inveresk
   – Large non-US employee population with many stock-eligible staff

• Institutional investors much more concerned about
  overhang and burn rate levels
   – Need to control rate at which stock is used

• Options expensing changed efficiency of equity vehicles

• Holding requirements instituted

• New Comp Committee Chairman -- rekindled interest in
  tying LTI more closely to corporate performance

2006: Actions
• Stopped awarding “special” grants to non-eligibles
• Switched to Options + Restricted Stock model:
   – 50% of value delivered through options, 50% through RS
   – Lengthened vesting; shortened term (control expense)
• Challenge: CEO had to overcome the notion that R.S.
  was “extremely special”
• Result:
   – Lowered rate at which stock was being utilized.
   – Expense held fairly steady
   – Receipt of R.S. well-received by newer executives trying to gain
     ground on their holding requirements
• But . . . still time-based only, not tied to corporate strategy

2007: Landscape
• External:
   – Increasing emphasis on performance-based LTI

• Internal:
   – Desire to better differentiate employees in annual
     award process
   – Comp Committee serious about tying executive LTI to
     corporate strategy

2007: Year of Tweaking
 • Annual LTI Awards
   – Doubled number of “performance” levels
   – Above average performance receives rich reward;
     subpar performance “feels the pain”
 • New performance LTI – “Performance Awards”
   –   Carved out of annual LTI award
   –   Executives only
   –   Challenge: De facto reduction in LTI?
   –   Solution: Used a higher market percentile for total
       target LTI

LTI Now: Annual + Performance
• ANNUAL:           75% of total Exec LTI, 100% Dir & Tech
  –   Eligibility   Director level & above; top technical staff
  –   Vehicles      50% Options, 50% Restricted
  –   Vesting       4-year (7-year term for options)
  –   Non-US        ~100 (RSUs)
  –   Amounts       Based on 8 subjective “performance levels”

• PERFORMANCE:      25% of total Exec LTI
  –   Eligibility   Senior Executives Only
  –   Vehicles      Stock/restricted stock settled
  –   Vesting       50% immediately once earned; 50% 1-year
  –   Non-US        3 recipients
  –   Amounts       0-150% of target
                    based on personal achievement of goals
Performance Awards (“stretch goals”)

• Period        1-year performance period
• Eligibility   Top executives only
• Vehicles      Stock / Restricted Shares
                50% vest immediately; 50% 1-year vest
• Metrics       Achievement of personal goals
                tied to 3-yr strategic plan
• Payouts       0%, 25%         150% max
• Other         Consecutive cycles (one after another)
                Absolute, point-in-time goals set in January
                BOD evaluates at year-end
Stretch Goal Challenges
• Lack of executive buy-in
  – Very long-term, stable executive group
  – Previous failed plans
  – “Goldilocks Goals”
     • Some too easy
     • Some too difficult

  – Disagreement with goals

• No “change of course” plan in place

More Challenges
• Legal implications of nomenclature
  – “Performance awards” vs. “performance shares”

• Goals as written were not S.M.A.R.T.
• Administration
  – Updates: No forethought on how often and in what
    format to provide updates throughout the year
  – Accruals: Difficult to know whether the BOD would be
    “tough graders” or “easy graders” as most
    measurements were subjective

Looking Back – Performance Shares
 • 2007:
   – Slow start getting executives to focus on their goals
   – Problematic for administrative function execs
   – Partial achievement was rewarded; no 0%
 • 2008:
   –   Executives more engaged from the beginning
   –   Refined participants to top 5 + operational execs only
   –   Acquisition “changed the game” for one executive
   –   Partial achievement rewarded; still no 0%
 • Successful?
   – Compared to previous failed plans, yes, somewhat, but with
     room for improvement
   – No 0% dilutes the program?
Looking Back – Annual Awards
 • Annual Award Rating Scale:
    – New scale helped differentiate awards, but …
    – Execs insisted on using “half” steps between ratings in ’07 and
      ‘08, creating essentially a 12-point scale
    – Ratings still clustering right around middle
 • Successful?
    – Better than 3-point scale
    – Burn rate reduction through options/RS split now gone
        • RS is now required to be counted as 2.2 or 2.3 per
          share (fungible share counting)
    – RS awards helped new executives with holding requirements
      (until the economy debacle)

Responding to the Current “Situation”
 • Annual Awards:
   – Almost all shares are underwater
   – Options exchange? Too early to know
   – Decided to grant generously this year because 3-year
     burn rate not a problem … yet
   – Sticking with 50/50 split of options & RS
 • Performance Shares/Stretch Goals
   – On hold for 2009
   – No stretch goals given for ’09
   – Current year’s business environment is considered
     enough of a “stretch”

Future Considerations
 • Annual Awards
   – Monitor burn rate/overhang
   – Use performance management rating for awards?
   – Add performance element?
 • Performance Shares/Stretch Goals
   – Assuming this program re-starts in 2010:
      • Must improve S.M.A.R.T.ness of goals
      • Must ensure strong tie to strategic initiatives
      • Include relative measures (performance vs. peers)?

Lessons Learned
• Ensure executives/BOD are disciplined in setting
  S.M.A.R.T. goals
   – Specific      - Attainable    - Time-Based
   – Measurable    - Relevant
• Ensure there’s a way to handle mid-year business events
  that impact goals
• Ensure everyone knows how payouts are to be
• Ensure the program has enough weight to warrant
  executive attention
• Avoid “Goldilocks” goals (too easy / too hard) so execs
  take it seriously
• Ensure administration of the program is well thought out
  and defined before implementation
Cabot Corporation

Virginia Leonard
Director, HR Shared Services
  About Cabot

• Performance Materials

• 125 Year History; public since 1968

• $3.2 Billion in Sales (2008)

• 4,000 Employees

• 39 Plants in 20 Countries

• Focus on Core and New Businesses

• Significant employee and family ownership
     Cabot Businesses and Products

Carbon Black                         Metal Oxides
rubber blacks, performance           fumed silica,
products, inkjet colorants,          aerogel
elastomer composites

Supermetals                            Fluids
Tantalum, niobium,                     cesium formate
printable electronic
displays (PEDs)

Cabot Global Footprint

     2005 Review of LTI Plan
•   Culture             •   Entrepreneurial, valued managerial
                            judgment and debate, share ownership
                            deep in organization

•   Strategy            •   Long-term growth of new businesses

•   Stock price         •   Stable, low volatility

•   Global              •   Consistent approach to support global
    Philosophy              enterprise
                        •   Long-term, subjective measures
•   Performance
•   Shareholders        •   High burn rate compared to peers
                            (RiskMetrics Group (RMG) Burn Rate

               LTI Program in place since 1992 –
               Was it still the right plan for Cabot?
2005 LTI Program Design Overview

 • All participants can select their awards
   as a choice between:
   – Purchased Restricted Stock with 70%


   – Non-Qualified Stock Options

Purchase Restricted Stock

 – Purchase Restricted Stock (RS):
    • 30% Purchase Price based on Fair Market
      Value on grant date
    • Cabot financing available for purchase (except
      for Section 16 Officers) - interest only on loan
      until vesting
    • Vests 100% after 3 years (cliff)
    • Receive benefits of share ownership -
      dividends and proxy voting rights
    • Variations for tax rules in different countries
       – Intent was to have the same impact globally

 – 90% of participants elected RS
 Non-Qualified Stock Options

– Non-Qualified Stock Options:
  • 2:1 ratio vs. Purchase Restricted Stock

  • Vests 100% after 3 years

  • 5 year life

– 10% of participants elect options

2005 Review and Shareholder Vote

•   External consultants (PM&P) worked with
    Compensation Committee to review Cabot’s LTI
    plan design

       Conclusion: the plan was effectively
      supporting Cabot’s business strategy

•   Plan did not receive RMG support – passed all
    tests except Burn Rate

•   CEO met with key shareholders to request

          Shareholders approved new plan

       2008 Leadership Transition
Strategy/4 Levers/4 Elements for Success

             “Deliver earnings growth through
                leadership in Performance

                                 Capacity and
                  Margin        Emerging Market
                Improvement       Expansion

                 Portfolio       New Product
                Management       Development



        2008 Review of LTI Plan

•   Culture            •   Accountability, financial metrics,
                           transparency and alignment

•   Strategy           •   Balance Core and New Business growth
•   Stock price        •   Increased volatility
•   Global             •   Locally competitive and meaningful
•   Performance        •   Balance short- and long-term with focus on
                           objective measures

•   Shareholders       •   High burn rate compared to peers (RMG
                           Burn Rate Test)

              New LTI program part of change in
                 compensation philosophy
      Compensation Philosophy
•   Culture
    – Leverage our strengths in teamwork, innovation and
      entrepreneurial spirit
    – Increase focus on financial performance and accountability
    – Recognize and adapt practices to broad global footprint
    – Maintain long-term, strategic perspective
•   Alignment
    – Support the business vision with focus on sustainable increase in
    – Focus the organization on key objectives, across the business /
      region / function matrix
    – Aligned with shareholder interests
•   Transparency
    – Strengthen link between business and individual results and pay
    – Establish and communicate clear metrics, targets and market-
      based process for compensation

     Compensation Principles
• Differentiate compensation programs between
  executives and non-executives in recognition of
  the difference in impact and accountability
• Cash compensation (base and STI) positioned at
  50th percentile on average across Cabot (currently
  below 40th percentile)
• LTI positioned between 50th and 65th percentile
  (currently above 75th percentile)
• Recognize local competitive practices

     Attract and retain the people who will help
          deliver superior business results
   LTI Instruments and Rationale
• Options
   – Drive focus on stock price performance
   – Shareholder alignment
   – Available for Executives only

• Performance-Based Restricted Stock Units
   –   Achievement of three year performance targets
   –   Shareholder alignment
   –   Units more tax effective in many countries outside US
   –   Units settled in cash for China to address securities

• Time-Based Restricted Stock Units
   – Eases transition
   – Retention
   – Same rationale as above for units
      LTI Metrics - Approach

• Performance Based RSUs

  – Long-term objectives aligned with
    messages to shareholders and business
    • EPS and ROIC – progressive annual
      scorekeeping or banking to maintain line of
      sight (absolute metrics)

  – Overlapping three-year performance

Overview of the LTI Plan
  • LTI participants (other than the Executive Committee) receive
    awards in two forms of stock units
     – Time-Based Stock Units (TSUs) 50% of award
     – Performance-Based Stock Units (PSUs) 50% of award
  • Executive Committee receive awards as Time-Based Stock Units
    (30%), Performance-Based Stock Units (35%), and Options
  • A stock unit is a promise, denominated in shares, to deliver
    actual shares or equivalent cash upon the satisfaction of
  • No purchase requirement for stock units
  • A stock unit has no voting rights
  • Dividend equivalents are paid on TSUs only
  • Value changes with value of Cabot common stock
How PSUs Change Over Time

 • Each year, one-third of the PSUs granted are “at risk”
   and may increase or decrease depending upon
   performance against certain targets (see next slide).

 • Based on actual results compared to the target, an
   amount between 0 and 150% of the “at-risk” units will
    – Target performance will result in 100% of the units being
      “banked” (point-in-time )

 • “Banked” units vest upon the third anniversary of the
   original grant

LTI Plan Example

 1. Determining the number of stock units (for non-executives)
    (Grant value ÷ stock price)   =   Stock units granted (50% TSUs + 50% PSUs)

          $54,000 ÷ $30           =         1,800 (900 TSUs + 900 PSUs)

 2. Calculate the number of PSUs subject to performance metrics annually

          900 PSUs ÷ 3            =                   300 PSUs

   Calculate the weighting for each metric by multiplying the number of
   PSUs by .65 for EPS metric and .35 for ROIC metric
            EPS metric            =            300 PSUs x .65 = 195 PSUs
           ROIC metric            =            300 PSUs x .35 = 105 PSUs

LTI Plan Example
 3. Assessing performance against goals
                                    2009                2010                2011
                              EPS      ROIC       EPS      ROIC       EPS      ROIC
  Performance Goal            $2.25        9%    $2.65         10%   $3.00         11%
  Actual Performance          $2.00    8.1%      $2.90     10.0%     $3.30     11.6%
  Pro-rata Performance (A)    85%          85%   115%      100%      115%      115%
  PSUs “at risk” (B)          195          105    195          105    195          105
  Banked PSUs (A x B)        165.75    89.25     224.25    105.00    224.25    120.75

 4. Determining your payout
  Original Grant   Total Units Converted to        Vested Grant Value
  Value            Cabot Common stock
  $54,000          929 + 900                       $91,450
                   Banked PSUs (sum of             $50 Assumed Stock Price x
                   banked PSUs above) + TSUs       1829 Units

             Results – Phase 1
• Communication to employees November / December 2008
  (contingent on shareholder approval)

• Philosophy and principles favorably received by employees

• Shareholder approval March 2009 (without RMG support)

• 70% stock price depreciation since initial design

• Clear by end of Q1 that metrics will not be achieved for year

• At current stock price unable to manage burn rate and
  available shares with program as designed

• Options used for an interim grant to transition to new plan
  and manage burn rate; may need to consider cash in the

             Lessons Learned
• Ownership and support from the top is key to success

• Recognize global footprint – don’t try to export a US

• Identify transition accounting issues early

• Partnership with finance, legal, treasury, strategic
  planning, tax, and business groups is critical

• Consider how measurement period coincides with plan
  cycle and adjust as needed

• Recognize potential for significant economic changes in
  design and communications – both positive and negative

Additional Considerations

Additional Considerations

What are you trying to achieve and what behaviors are you
trying to drive?

Balance LTI with other elements of pay

Ensure line of sight

Adjusting/revising goals during performance period

Impact of converting to International Financial Reporting
Standards (IFRS) in the future

Foreign country awards

Keep some discretion

Other tax and accounting considerations



Keys to designing an effective performance-based LTI
 • Keep them as simple as possible
 • Limit initial plan eligibility, consider expansion once successful
 • Consider appropriate measurement periods
 • Select appropriate performance metric(s)
 • Ensure the plan aligns with the company’s business strategy
 • Develop an appropriate performance/payout scale
 • Understand impact of such awards in foreign countries
 • Understand the overall financial implications of such a plan
 • Discuss how to address unexpected financial circumstances



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