SCHEDULE 14A
(Rule 14a)
INFORMATION REQUIRED IN PROXY STATEMENT
SCHEDULE 14A INFORMATION
Proxy Statement Pursuant to Section 14(a) of the Securities
Exchange Act of 1934
(Amendment No.     )

 

Filed by the Registrant  x

 

Filed by a Party other than the Registrant  o

 

 

EATON CORPORATION

(Name of Registrant as Specified in its Charter)

 

XXXXXXXXXXXXXXXX

(Name of Person(s) Filing Proxy Statement, if other than the Registrant)

 

Payment of Filing Fee (Check the appropriate box):

o  Fee computed on table below per Exchange Act Rules 14a-6(i)(4) and 0-11.

 

(1)  Title of each class of securities to which transaction applies:  ­ ­

 

(2)  Aggregate number of securities to which transaction applies:  ­ ­

 

 

(4)  Proposed maximum aggregate value of transaction: ­ ­

 

(5)  Total fee paid:  ­ ­

 

o  Fee paid previously with preliminary materials.

 

 

(1)  Amount Previously Paid: ­ ­

 

(2)  Form, Schedule or Registration Statement No.: ­ ­

 

(3)  Filing Party: ­ ­

 

(4)  Date Filed: ­ ­

 

NOTICE OF MEETING

 

The 2010 annual meeting of Eaton Corporation shareholders will be held Wednesday, April 28, at 10:30 a.m. local time at Eaton Center, 1111 Superior Avenue, Cleveland, Ohio, for the purpose of:

 

 

These matters are more fully described in the following pages.

 

The record date for the meeting has been fixed by the Board of Directors as the close of business on March 1, 2010. Shareholders of record at that time are entitled to vote at the meeting.

 

By order of the Board of Directors

 

 

Thomas E. Moran

Senior Vice President and Secretary

 

March 19, 2010

 

 

 

 

Eaton Shareholders can now sign up for electronic delivery of the Proxy Statement and Annual Report to Shareholders, as well as online proxy voting. Use this link to register for online delivery of your future proxy materials: http://enroll.icsdelivery.com/etn

 

 

Important Notice Regarding the Availability of Proxy Materials for the Annual Meeting of Shareholders to be held on April 28, 2010: This proxy statement and the Company’s 2009 Annual Report to Shareholders are available on Eaton’s website at www.eaton.com/proxy and www.eaton.com/annualreport, respectively.

CONTENTS

 

PROXY STATEMENT

 

Eaton Corporation

1111 Superior Avenue

Cleveland, Ohio 44114-2584

216-523-5000

 

This proxy statement, the accompanying proxy form and Eaton’s annual report for the year ended December 31, 2009 are scheduled to be sent to shareholders on or about March 19, 2010.

 

 

Eaton’s Board of Directors solicits your proxy, in the form enclosed, for use at the 2010 annual meeting of shareholders and any adjournments thereof. The individuals named in the enclosed form of proxy have advised the Board of their intention to vote at the meeting in compliance with instructions on all forms of proxy tendered by shareholders and, where no contrary instruction is indicated on the proxy form, for the election of the individuals nominated to serve as directors and for ratification of the appointment of Ernst & Young LLP as independent auditor for 2010.

 

Any shareholder giving a proxy may revoke it by giving Eaton notice in writing or by fax, email or other verifiable communication before the meeting or by revoking it at the meeting. All properly executed or transmitted proxies not revoked will be voted at the meeting.

 

In addition to soliciting proxies through the mail, certain employees may solicit proxies in person or by telephone or fax. Eaton has retained The Proxy Advisory Group, LLC, 18  East 41^st Street, Suite 2000, New York, New York 10017, to assist in the solicitation of proxies, primarily from brokers, banks and other nominees, for a fee of $11,500, plus reasonable out-of-pocket expenses. Brokerage firms, nominees, custodians and fiduciaries may be asked to forward proxy soliciting material to the beneficial shareholders. All reasonable soliciting costs will be borne by Eaton.

 

Each Eaton shareholder of record at the close of business on March 1, 2010 is entitled to one vote for each share then held. On March 1, 166,541,151 Eaton common shares (par value, 50¢ each) were outstanding and entitled to vote.

 

At the 2010 annual meeting, the inspector of election appointed by the Board of Directors for the meeting will determine the presence of a quorum and tabulate the results of shareholder voting. As provided by Ohio law and Eaton’s Amended Regulations, Eaton shareholders present in person or by proxy at the meeting will constitute a quorum. The inspector of election intends to treat as “present” for these purposes shareholders who have submitted properly executed or transmitted proxies that are marked “abstain.” The inspector will also treat as “present” shares held in “street name” by brokers that are voted on at least one proposal to come before the meeting.

 

Director nominees receiving more “for” votes than “against” votes will be elected directors. Abstentions have no effect in determining whether the required affirmative majority votes have been obtained. Adoption of all other proposals to come before the meeting will require the affirmative vote of the holders of a majority of the outstanding Eaton common shares, consistent with the general vote requirement in Eaton’s Amended Articles of Incorporation. The practical effect of this vote requirement will be that abstentions and shares held in “street name” by brokers that are not voted in respect of those proposals will be treated the same as votes cast against those proposals.

As provided by Ohio law, each shareholder is entitled to cumulative voting rights in the election of directors if any shareholder gives written notice to the President or a Vice President or the Secretary of Eaton at least 48 hours before the time fixed for the meeting, requesting cumulative voting, and if an announcement of that notice is made at the beginning of the meeting by the Chairman or Secretary, or by or on behalf of the shareholder who gave the notice. If cumulative voting is in effect with respect to the election of directors, each shareholder has the right to cumulate his or her voting power by giving one nominee that number of votes which equals the number of directors to be elected multiplied by the number of the shareholder’s shares, or by distributing his or her votes on the same principle among two or more nominees, as the shareholder sees fit. If cumulative voting is in effect with respect to the election of directors, and if the shareholder has not given contrary voting instructions, the individuals named in the proxy will vote the shares cumulatively for those nominees that they may determine in their discretion.

 

Majority Voting in Director Elections — At the 2008 annual meeting, Eaton shareholders approved an amendment to the Amended Articles of Incorporation requiring a majority vote for the election of directors in uncontested elections. An affirmative majority of the total number of votes cast with respect to the election of a director nominee is required for election. Abstentions have no effect in determining whether the required affirmative majority votes have been obtained. For contested elections, plurality voting will be in effect.

 

The Board of Directors has adopted a policy requiring “holdover directors” to submit a written offer to resign from the Board promptly after the voting results are certified. A holdover director situation would occur if a director fails to receive an affirmative majority of votes cast in an election, and his or her successor has not yet been elected and qualified. With advice from the Governance Committee, the Board will decide, within 90 days after the voting results are certified, whether to accept the resignation offer, and we will promptly disclose the Board’s decision in a press release. If the Board decides to reject the resignation offer, the press release will indicate the reasons for that decision.

 

Our Board of Directors is presently composed of thirteen members. The terms of five directors will expire in April 2010 and those directors have been nominated for re-election. Four of those nominees were elected at the 2007 annual meeting. Todd M. Bluedorn, who was recommended to the Governance Committee by our Board search consultant, was elected by the Board of Directors on January 27, 2010 and is standing for re-election at the 2010 annual meeting, when his current term of office expires.

 

John R. Miller, a director since 1985, and Victor A. Pelson, a director since 1994, having attained normal retirement age, will resign as directors at the conclusion of the 2010 annual meeting of shareholders on April 28. Following the annual meeting, the Board of Directors will be composed of eleven directors.

 

If any of the nominees become unable or decline to serve, the individuals named as proxies in the enclosed proxy form will have the authority to appoint substitute nominees. However, we have no reason to believe that this will occur.

 

Biographical information for each nominee and the other directors, as well as information on their experience, qualifications and skills that support their service as a director of the Company, is set forth below.

Nominees for election to terms ending in April 2013 or when a successor is elected and has qualified:

 

Nominee for election to term ending in April 2011 or when a successor is elected and has qualified:

 

 

Directors whose present terms continue until April 2011:

 

Directors whose present terms continue until April 2012:

 

 

Director Nomination Process — The Governance Committee of the Board, comprised entirely of directors who meet the independence standards of the Board of Directors and the New York Stock Exchange, is responsible for overseeing the process of nominating individuals to stand for election as directors. The Governance Committee charter is available on our website at http://www.eaton.com/governance. Printed copies will also be provided free of charge upon request. Requests for printed copies should be directed to our Investor Relations Office, Eaton Corporation, 1111 Superior Avenue, Cleveland, Ohio 44114-2584.

 

Any director candidates recommended by our shareholders are given consideration by the Governance Committee, consistent with the process used for all candidates. Shareholders may submit recommendations in the manner described on this page under the heading “Shareholder Recommendations of Director Candidates.”

 

All potential director candidates are reviewed by the Governance Committee in consultation with the Chairman and Chief Executive Officer, typically with the assistance of a professional search firm retained by the Committee. During 2009, the search firm assisted the Committee with the identification and background checks on director candidates. The Committee decides whether to recommend one or more candidates to the Board of Directors for nomination. Candidates who are ultimately nominated by the Board stand for election by the shareholders at the annual meeting. Between annual meetings, nominees may also be elected by the Board itself.

 

Director Qualifications and Board Diversity — In order to be recommended by the Governance Committee, a candidate must have the following minimum qualifications, as described in the Board of Directors Governance Policies: personal ability, integrity, intelligence, relevant business background, independence, expertise in areas of importance to our objectives, and a sensitivity to our corporate responsibilities. In addition, the Governance Committee looks for individuals with specific qualifications so that the Board as a whole has diversity in experience, international perspective, background, expertise, skills, age, gender, and ethnicity. These specific qualifications may vary from one year to another, depending upon the composition of the Board at that time. The Governance Committee is responsible for ensuring that minimum director qualifications are met and Board diversity objectives are considered during its review of director candidates. The Governance Committee evaluates the extent to which these goals are satisfied annually as part of its assessment of the skills and experience of each of the current directors using a director skills matrix and a director evaluation process. The director evaluation process includes self evaluation, peer evaluation and input from the chairs of each of the Board committees. Upon completion of the skills matrix and the evaluation process, the Governance Committee identifies areas of director knowledge and experience that may benefit the Board and us in the future, and uses that information as part of the director search and nomination effort.

 

The Board of Directors Governance Policies are included in this proxy statement as Appendix A and are available on our website at http://www.eaton.com/governance. Printed copies will also be provided free of charge upon request. Requests for printed copies should be directed to our Investor Relations Office, Eaton Corporation, 1111 Superior Avenue, Cleveland, Ohio 44114-2584.

 

Shareholder Recommendations of Director Candidates — The Governance Committee will consider individuals for nomination to stand for election as directors who are recommended to it in writing by any Eaton shareholder. Any shareholder wishing to recommend an individual as a nominee for election at the annual meeting of shareholders to be held in 2011 should send a signed letter of recommendation to the following address: Eaton Corporation, 1111 Superior Avenue, Cleveland, Ohio 44114-2584, attention Corporate Secretary. Recommendation letters must be received before November 5, 2010, and must state the reasons for the recommendation and contain the full name and address of each proposed nominee as well as a brief biographical history setting forth past and present directorships, employments, occupations and civic activities. Any such recommendation should be accompanied by a written statement from the proposed nominee consenting to be nominated and, if nominated and elected, consenting to serve as a director.

Director Independence — The Board of Directors Governance Policies provide that all of our outside directors should be independent. These Policies are attached as Appendix A to this proxy statement and are available on our website at http://www.eaton.com/governance. Printed copies will also be provided free of charge upon request. Requests for printed copies should be directed to our Investor Relations Office, Eaton Corporation, 1111 Superior Avenue, Cleveland, Ohio 44114-2584. The listing standards of the New York Stock Exchange state that no director can qualify as independent unless the Board of Directors affirmatively determines that the director has no material relationship with us. Additional, and more stringent, standards of independence are required of Audit Committee members. Our annual proxy statement discloses the Board’s determination as to the independence of the Audit Committee members as well as its determination as to all outside directors.

 

As permitted by the New York Stock Exchange listing standards, the Board of Directors has determined that certain relationships between an outside director and us will be treated as categorically immaterial for purposes of determining a director’s independence. These categorical standards are included in the Board of Directors’ independence criteria. The independence criteria for outside directors and members of the Audit Committee are available on our website at http://www.eaton.com/governance. Printed copies will also be provided free of charge upon request. Requests for printed copies should be directed to our Investor Relations Office, Eaton Corporation, 1111 Superior Avenue, Cleveland, Ohio 44114-2584.

 

Since directors’ independence might be influenced by their use of Company aircraft and other Company-paid transportation, the Board has adopted a policy on this subject. This policy is available on our website at http://www.eaton.com/governance.

 

In their review of director independence, the Board of Directors and its Governance Committee have considered the following circumstances:

 

 

After reviewing the circumstances described above (which are the only relevant circumstances known to the Board of Directors), the Board has affirmatively determined that none of our outside directors has a material relationship with us other than in their capacities as directors and that each of the following directors qualifies as independent under the Board’s independence criteria and the New York Stock Exchange standards: T. M. Bluedorn, C. M. Connor, M. J. Critelli, C. E. Golden, E. Green, A. E. Johnson, N. C. Lautenbach, D. L. McCoy, J. R. Miller, G. R. Page, V. A. Pelson and G. L. Tooker. All members of the Audit, Compensation and Organization, Finance and Governance Committees qualify as independent under the standards described above.

 

The Board has also affirmatively determined that each member of the Audit Committee, that is, C. E. Golden, E. Green, A. E. Johnson, N. C. Lautenbach, V. A. Pelson and G. L. Tooker, meets the special standards of independence required of them under the criteria of the New York Stock Exchange, the Sarbanes-Oxley Act of 2002 and rules adopted thereunder by the Securities and Exchange Commission, and our Board of Directors.

Review of Related Person Transactions — Our Board of Directors has adopted a written policy to identify and evaluate “related person transactions,” that is, transactions between us and any of our executive officers, directors, director nominees, 5%-plus security-holders or members of their “immediate families,” or organizations where they or their family members serve as officers or employees. The Board policy calls for the disinterested members of the Board’s Governance Committee to conduct an annual review of all such transactions. At the Committee’s direction, a survey is made annually of all transactions involving related persons, and the results are reviewed by the Committee in January of each year. As to any such transaction, the Committee is responsible to determine whether (i) it poses a significant risk of impairing, or appearing to impair, the judgment or objectivity of the individuals involved; (ii) it poses a significant risk of impairing, or appearing to impair, the independence of an outside director or director nominee; or (iii) its terms are less favorable to us than those generally available in the marketplace. Depending upon the Committee’s assessment of these risks, the Committee will respond appropriately. In addition, as required by the rules of the Securities and Exchange Commission, any transactions that are determined to be material to us or a related person are disclosed in our proxy statement.

 

In January 2010, the Governance Committee conducted an annual survey and found that since the beginning of 2009 the only related person transactions were those described in paragraphs numbered 1 and 2 under the heading “Director Independence” beginning on page 9 and that none of our executive officers engaged in any such transactions. The Committee also concluded that none of the related person transactions posed risks to us in any of the areas described in items (i), (ii) or (iii) above.

 

Board Committees — The Board of Directors has the following standing committees: Audit, Compensation and Organization, Executive, Finance and Governance.

 

Audit Committee. The functions of the Audit Committee include assisting the Board in overseeing the integrity of our financial statements and its systems of internal accounting and financial controls; the independence, qualifications and performance of our independent auditor; the performance of the internal auditors; and our compliance with legal and regulatory requirements. The Audit Committee exercises sole authority to appoint, compensate and terminate the independent auditor and pre-approves all auditing services and permitted non-audit services to be performed for us by the independent auditor. Among its other responsibilities, the Committee meets regularly with our independent auditor, Vice Chairman and Chief Financial Officer, Senior Vice President-Internal Audit, Executive Vice President and General Counsel, and Vice President-Global Ethics and Compliance in separate executive sessions; approves the Committee’s report to be included in our annual proxy statement; assures that performance evaluations of the Audit Committee are conducted annually; and establishes procedures for the proper handling of complaints concerning accounting or auditing matters. Each Committee member meets the independence requirements, and all Committee members collectively meet the other requirements, of the New York Stock Exchange, the Sarbanes-Oxley Act of 2002 and rules adopted thereunder by the Securities and Exchange Commission. Further, Committee members are prohibited from serving on more than two other public company audit committees. The Board of Directors has determined that each member of the Audit Committee is financially literate and that C. E. Golden qualifies as an audit committee financial expert (as defined in Securities and Exchange Commission rules) and that all members of the Audit Committee have accounting or related financial management expertise. The Audit Committee held eleven meetings in 2009. Present members are Messrs. Golden (Chair), Green, Johnson, Lautenbach, Pelson and Tooker.

 

Compensation and Organization Committee. The functions of the Compensation and Organization Committee include reviewing proposed organization or responsibility changes at the senior officer level; evaluating the performance of the Chief Executive Officer with input from all outside directors and reviewing the performance evaluations of the other senior officers; reviewing succession planning for key officer positions including the position of Chairman and Chief Executive Officer; and reviewing our practices for the recruitment and development of a diverse talent pool. The Committee is also responsible for annually determining the salary and long-term incentive opportunities for each of our senior officers; establishing performance objectives under our short- and long-term incentive compensation plans and determining the attainment of such performance objectives; annually determining the aggregate amount of

awards to be made under our short-term incentive compensation plans and adjusting those amounts as the Committee deems appropriate within the terms of those plans; annually determining the awards to be made to our senior officers under our short-and long-term incentive compensation plans; administering stock plans; reviewing compensation practices as they relate to key employees to confirm that those plans remain equitable and competitive; reviewing significant new employee benefit plans or significant changes in such plans or changes with a disproportionate effect on our officers or primarily benefiting key employees; and preparing an annual report for our proxy statement regarding executive compensation. Additional information on the Committee’s processes and procedures is contained in the Compensation Discussion and Analysis beginning on page 17. The Compensation and Organization Committee held seven meetings in 2009. Present members are Ms. McCoy (Chair) and Messrs. Bluedorn, Connor, Critelli, Miller and Page.

 

Executive Committee. The functions of the Executive Committee include all of the functions of the Board of Directors other than the filling of vacancies in the Board of Directors or in any of its committees. The Executive Committee acts upon matters requiring Board action during the intervals between Board meetings. The Executive Committee met once during 2009. Mr. Cutler is a member of the Committee for the full twelve-month term and serves as Committee Chair. Each of the non-employee directors serves a four-month term.

 

Finance Committee. The functions of the Finance Committee include the periodic review of our financial condition and the recommendation of financial policies to the Board; analyzing Company policy regarding its debt-to-equity relationship; reviewing and making recommendations to the Board regarding our dividend policy; reviewing our cash flow, proposals for long-and short-term debt financing and the risk management program; meeting with and reviewing the performance of the management pension committees and any other fiduciaries appointed by the Board for pension and profit-sharing retirement plans; and reviewing the key assumptions used to calculate annual pension expense. The Finance Committee held three meetings in 2009. Present members are Ms. McCoy and Messrs. Critelli, Golden, Green and Page (Chair).

 

Governance Committee. The responsibilities of the Governance Committee include recommending to the Board improvements in our corporate governance processes and any changes in the Board Governance Policies; advising the Board on changes in the size and composition of the Board; making recommendations to the Board regarding the structure and responsibilities of Board committees; and annually submitting to the Board candidates for members and chairs of each standing Board committee. The Governance Committee, in consultation with the Chief Executive Officer, identifies and recommends to the Board candidates for Board membership, reviews and recommends to the Board the nomination of directors for re-election; oversees the orientation of new directors and the ongoing education of the Board; recommends to the Board compensation of non-employee directors; administers the Board’s policy on director retirements and resignations; administers the directors’ stock ownership guidelines; and establishes guidelines and procedures to be used by the directors to evaluate the Board’s performance. The responsibilities of the Governance Committee also include providing oversight regarding significant public policy issues with respect to our relationships with shareholders, employees, customers, competitors, suppliers and the communities in which we operate, including such areas as ethics compliance, environmental, health and safety issues, community relations, government relations, charitable contributions and shareholder relations. The Governance Committee held five meetings in 2009. Present members are Messrs. Bluedorn, Connor, Johnson, Lautenbach (Chair), Miller, Pelson and Tooker.

 

Committee Charters and Policies — The Board committee charters are available on our website at http://www.eaton.com/governance. Printed copies will also be provided free of charge upon request. Requests for printed copies should be directed to our Investor Relations Office, Eaton Corporation, 1111 Superior Avenue, Cleveland, Ohio 44114-2584.

 

In addition to the Board of Directors Governance Policies, certain other policies relating to corporate governance matters are adopted from time to time by Board Committees, or by the Board itself upon the Committees’ recommendation.

The Board of Directors held nine meetings in 2009. Each of the directors attended at least 89% of the meetings of the Board and the Committees on which he or she served. The average rate of attendance for all directors was 96%.

 

Audit Committee Report — The Audit Committee of the Board of Directors is responsible to assist the Board in overseeing (1) the integrity of the Company’s consolidated financial statements and its systems of internal accounting and financial controls; (2) the independence, qualifications and performance of the Company’s independent auditor; (3) the performance of the Company’s internal auditors and (4) the Company’s compliance with legal and regulatory requirements. The Committee’s specific responsibilities, as described in its charter, include the sole authority to appoint, terminate and compensate the Company’s independent auditor, and to pre-approve all audit services and other services to be provided to the Company by the independent auditor. The Committee is comprised of six directors, all of whom are independent under the Sarbanes-Oxley Act of 2002, the rules of the Securities and Exchange Commission and the Board of Directors’ own independence criteria.

 

The Board of Directors amended the Committee’s charter most recently on October 22, 2008. A copy of the charter is available on our website at http://www.eaton.com/governance.

 

In carrying out its responsibilities, the Audit Committee has reviewed, and has discussed with the Company’s management and independent auditor, Ernst & Young LLP, the Company’s 2009 audited consolidated financial statements and the assessment of the Company’s internal control over financial reporting.

 

The Committee has also discussed with Ernst & Young the matters required to be discussed by applicable auditing standards.

 

The Committee has received the written disclosures from Ernst & Young regarding their independence from the Company that are required pursuant to Rule 3526 of the Public Company Accounting Oversight Board (“Communication with Audit Committees Concerning Independence”), has discussed with Ernst & Young their independence and has considered whether their provision of non-audit services to the Company is compatible with their independence.

 

For 2008 and 2009, Ernst & Young’s fees to the Company were as follows:

 

 

The Audit Committee did not approve any of the services shown in the above three categories through the use of the “de minimis” exception permitted by Securities and Exchange Commission rules.

 

The Audit Committee has adopted the following procedure for pre-approving audit services and other services to be provided by the Company independent auditor: specific services are preapproved from time to time by the Committee or by the Committee Chair on its behalf. As to any services approved by the Committee Chair, the approval is made in writing and is reported to the Committee at the following meeting of the Committee.

Based upon the Committee’s reviews and discussions referred to above, and in reliance upon them, the Committee has recommended to the Board of Directors that the Company’s audited consolidated financial statements for 2009 be included in the Company’s Annual Report on Form 10-K, and the Board has approved their inclusion.

 

Respectfully submitted to the Company’s shareholders by the Audit Committee of the Board of Directors.

 

Charles E. Golden, Chair

Ernie Green

Arthur E. Johnson

Ned C. Lautenbach

Victor A. Pelson

Gary L. Tooker

 

Board of Directors Governance Policies — The Board of Directors revised the Governance Policies most recently in January 2010, as recommended by the Governance Committee of the Board. The revised Governance Policies are included in this proxy statement as Appendix A and are available on our website at http://www.eaton.com/governance. Printed copies will also be provided free of charge upon request. Requests for printed copies should be directed to our Investor Relations Office, Eaton Corporation, 1111 Superior Avenue, Cleveland, Ohio 44114-2584.

 

Executive Sessions of the Non-Employee Directors — The policy of the Board of Directors is that the non-employee directors, who qualify as “independent” under the criteria of the Board of Directors and the New York Stock Exchange, meet in Executive Session at each regular Board meeting, without the Chairman and Chief Executive Officer or other members of management present, to discuss whatever topics they may deem appropriate. At the present time, all non-employee directors meet these criteria. As described more fully in the section below entitled “Leadership Structure,” the Lead Director chairs the Executive Sessions of the Board of Directors.

 

At each meeting of the Audit, Compensation and Organization, Finance and Governance Committees, an Executive Session is held at which only the Committee members (all of whom qualify as independent) are in attendance, without any members of our management present, to discuss whatever topics they may deem appropriate.

 

Leadership Structure — Our governance structure follows a successful leadership model under which our Chief Executive Officer also serves as Chairman of the Board. Recognizing that different leadership models may work well for other companies at different times depending upon individual circumstances, we believe that our Company has been well-served by the combined Chief Executive Officer and Chairman leadership structure, and that this approach will continue to be highly effective with the addition of a Lead Director. We believe we have greatly benefited from having a single person setting the tone and direction for us and having primary responsibility for managing our operations, while allowing the Board to carry out its oversight responsibilities with the equal involvement of each independent director.

 

Our Board is comprised exclusively of independent directors, except for our Chairman. Of our twelve independent directors, six are currently serving or have served as a chief executive officer of a publicly-traded company. Each committee of the Board is chaired by an independent director. Our Chairman and Chief Executive Officer has benefited from the extensive leadership experience of our Board of Directors.

 

Annually, the Board evaluates the leadership structure and it will continue to do so as circumstances change, including when a new Chief Executive Officer is elected. In its January 2010 annual evaluation, the Board concluded that the current leadership structure — under which our Chief Executive Officer serves as Chairman of the Board, our Board committees are chaired by independent directors, and a Lead Director assumes specified responsibilities on behalf of the independent

directors — remains the optimal board leadership structure for our Company and our shareholders at the present time.

 

Lead Director — Recently, our Board created the position of Lead Director, and Ned C. Lautenbach, who has served on our Board since 1997, was elected Lead Director by our independent directors. The Lead Director has specific responsibilities, including chairing Executive Sessions of the Board, coordinating the agenda for Board meetings with the Chairman on behalf of the independent directors, ensuring the quality and timeliness of information sent to the Board, and serving as a Board focal point for communications with shareholders and other Company stakeholders. The Lead Director has the authority to call meetings of the independent directors, and to retain outside advisors who report directly to the Board of Directors.

 

Oversight of Risk Management

 

Management continually monitors the material risks facing the Company, including strategic risk, financial risk, operational risk, and legal and compliance risk. The Board of Directors has chosen to retain overall responsibility for risk assessment and oversight at the Board level in light of the interrelated nature of the elements of risk, rather than delegating this responsibility to a Board committee. The Board has responsibility for overseeing the strategic planning process and reviewing and monitoring management’s execution of the corporate and business plan. As described below, the Board receives assistance from certain of its committees for the identification and monitoring of those risks that are related to the committees’ areas of focus as described in each committee charter. The Board and its committees exercise their risk oversight function by carefully evaluating the reports they receive from management and by making inquiries of management with respect to areas of particular interest to the Board.

 

The Audit Committee considers risks related to internal controls, disclosure, financial reporting and legal and compliance activity. Among other processes, the Audit Committee meets regularly in closed-door sessions with our internal and external auditors, senior members of the Finance function, the Executive Vice President and General Counsel and the Vice President-Global Ethics and Compliance. As described more fully below in the section entitled “Relationship Between Compensation Plans and Risk,” the Compensation and Organization Committee reviews risks associated with the Company’s compensation programs, to ensure that incentive compensation arrangements for senior executives do not encourage inappropriate risk taking. The Governance Committee considers risks related to corporate governance, such as director independence and related person transactions, and risks associated with the environment, health and safety.

 

Shareholder Communications to the Board — The Board of Directors provides the following process for shareholders and other interested parties to send communications to the Board, individual directors, or the non-management directors as a group:

 

Shareholders and other interested parties may send such communications by mail or courier delivery addressed as follows:

 

Corporate Secretary

Eaton Corporation

1111 Superior Avenue

Cleveland, Ohio 44114-2584

 

In general, the Corporate Secretary forwards all such communications to the Chair of the Governance Committee. The Governance Committee Chair in turn determines whether the communications should be forwarded to other members of the Board and, if so, forwards them accordingly. However, for communications addressed to a particular member of the Board, the Chair of a particular Board Committee or the non-management directors as a group, the Corporate Secretary forwards those communications directly to those individuals.

However, the directors have requested that communications that do not directly relate to their duties and responsibilities as our directors be excluded from distribution and deleted from email that they access directly. Such excluded items include “spam,” advertisements, mass mailings, form letters and email campaigns that involve unduly large numbers of similar communications, solicitations for goods, services, employment or contributions, surveys and individual product inquiries or complaints. Additionally, communications that appear to be unduly hostile, intimidating, threatening, illegal or similarly inappropriate will be screened for omission. Any omitted or deleted communications will be made available to any director upon request.

 

Director Attendance at Annual Meetings — The policy of the Board of Directors is that all directors should attend annual meetings. At our 2009 annual meeting held April 22, 2009, all members of the Board were in attendance.

 

Code of Ethics — We have a Code of Ethics that was approved by the Board of Directors. We provide training globally for all employees on our Code of Ethics. We require that all directors, officers and employees of the Company, our subsidiaries and affiliates, abide by our Code of Ethics, which is available on our website at http://www.eaton.com/governance. Printed copies will be provided free of charge upon request. Requests for printed copies should be directed to our Investor Relations Office, Eaton Corporation, 1111 Superior Avenue, Cleveland, Ohio 44114-2584.

 

 

Table of Contents

 

 

 

The Compensation and Organization Committee of the Board of Directors (the “Committee”) determines the compensation for our executive officers and reviews, approves and oversees the administration of all of our executive compensation plans and programs. The Committee consists of six independent non-employee directors and is supported by our Human Resources Department as well as one or more independent executive compensation consultants chosen, retained and directed by the Committee. The Compensation and Organization Committee’s charter and key responsibilities are available on our website at http://www.eaton.com/governance. Please note that the use of the terms “we”, “us” or “our” throughout this Compensation Discussion and Analysis refers to the Company or its management.

 

The dramatic collapse of the global economy, which began in the second half of 2008 and continued to spread into 2009, had a far ranging negative impact on all of our business sectors. In the face of this environment, our management responded with significant, company-wide actions aimed at re-sizing operations, adjusting staff levels and driving cost savings appropriate to the new business conditions. These actions included:

 

 

The deep global economic recession also had a substantial impact on our executive compensation programs. In February 2009, the Committee set executive compensation performance objectives for our short- and long-term incentive plans. As the first quarter of the year came to a close and economic conditions continued to deteriorate, it became apparent that the global recession and market conditions were going to hit much deeper lows and would be more prolonged than we initially projected in February when we established our performance objectives. In the face of these rapidly deteriorating economic conditions, the Committee determined that it would more frequently assess our executive compensation programs during 2009. In addition, it became apparent that the recession would impact compensation for several years beyond 2009.

 

The following is a summary of the 2009 compensation elements affected by economic conditions:

 

 

 

 

 

Although the following pages discuss our 2009 compensation programs with respect to the total compensation of Mr. Cutler and the other Named Executive Officers, it should be noted that the items listed above also impacted all other officers and executives who participated in our short- and long-term incentive plans in 2009. Additional details about these items are provided throughout this analysis.

 

Our executive compensation program reflects the belief that executive compensation must, to a significant extent, be at risk where the amounts earned depend on achieving rigorous Company, business unit and individual performance objectives that are intended to enhance shareholder value. Furthermore, our incentive compensation plans and programs are designed to pay larger amounts when we achieve superior performance and smaller amounts, if any, when we do not achieve target performance. This is demonstrated in the following tables which summarize Mr. Cutler’s 2009 target and actual realized compensation as well as our performance. “Fixed” compensation, as illustrated in the following charts, includes elements of pay that are not performance-based such as base salary and the items reported as “other compensation” in footnote (4) of the Summary Compensation Table.

 

On average, the mix between fixed compensation and the amount of pay that is tied to performance has remained constant over the last three years for Mr. Cutler and the other Named Executive Officers. Over the last three years, 84% of Mr. Cutler’s total compensation opportunity at target has been contingent on achieving company performance objectives. In looking at the actual realized compensation over the last three years, on average, 90% of Mr. Cutler’s pay has been performance based.

 

The mix between the elements of our Chairman and Chief Executive Officer’s compensation package is heavily weighted toward long-term incentive compensation. This strategic approach also extends to the other Named Executive Officers and is intended to focus executives’ attention on external factors, such as shareholder returns, and internal performance measures as well as foster retention. The

following chart illustrates the mix of compensation elements, at target, established for Mr. Cutler in 2009 as well as the mix of actual realized compensation delivered to Mr. Cutler in 2009.

 

The following tables summarize Mr. Cutler’s 2009 realized pay and performance over the period in which the elements of compensation were earned. The information in these tables is intended to supplement the information contained in the Summary Compensation Table on page 40. The tables differ substantially from the 2009 Summary Compensation Table required by the SEC and are not a substitute for that table. The equity grants reported in the following tables reflect the gross compensation value prior to the deduction of applicable taxes to Mr. Cutler upon exercise of stock options and vesting of restricted share awards in 2009, irrespective of when the awards were granted, versus the grant date fair value of equity awards that were granted in 2009 as shown in the Summary Compensation Table. In addition, the Summary Compensation Table includes compensation based upon the change in pension value and nonqualified deferred compensation earnings, which is not shown in the following tables. The Committee monitors these amounts as part of the Tally Sheet review (discussed on page 26) and considers these programs in the context of a competitive overall benefit design and not as an element of its annual compensation decisions. Therefore, the change in pension values and above market earnings on non-qualified deferred compensation are excluded from the tables in this Executive Summary.

 

The following table further demonstrates that our incentive plans and programs are structured to deliver greater rewards for strong performance, smaller rewards if we do not achieve target performance, and no reward if we do not meet threshold performance levels by illustrating the decline in Mr. Cutler’s compensation that has occurred over the last three years. This reduction in realized

compensation is attributable to the impact that the economic environment has had on (a) our ability to achieve our Earnings Per Share (“EPS”) and Cash Flow Return on Gross Capital (“CFR”) goals under the annual and long-term incentive plans and (b) on our share price as it relates to the realized value from stock option exercises and vested restricted share awards.

 

 

 

 

The following table illustrates the annualized and cumulative returns on our common shares from the grant dates to the exercise dates for the realized values reported for Mr. Cutler in the previous tables:

 

 

In summary, our compensation programs for Mr. Cutler and the other Named Executive Officers are heavily weighted on performance. We place an emphasis on long-term performance and delivering a balanced portfolio of cash and equity compensation as further described in the following narrative.

 

Overview of Our Executive Compensation Philosophy — Under our executive compensation philosophy, which is reviewed and updated by the Committee annually, typically in January, we design our executive compensation plans and programs to help us attract, motivate, reward and retain highly qualified executives capable of creating long-term and sustained value for our shareholders. A major goal is to implement compensation programs that are aligned with the interest of our shareholders and endorse compensation actions that fairly reflect, in the judgment of the Committee, our performance and the responsibilities and personal performance of individual executives.

 

Pay for Performance — Our executive compensation program reflects the belief that the amount earned by our executives must, to a significant extent, depend on achieving rigorous Company, business unit and individual performance objectives designed to enhance shareholder value. As noted in the Executive Summary and as shown in the Summary Compensation Table on page 40, the decline in value of the annual and long-term cash incentive awards paid to our Named Executive Officers from 2007 through 2009 are evidence of this belief and the link between pay and performance. Our executive incentive compensation programs are intended to deliver target awards when our performance aligns with the peer group median performance and awards that exceed 150% of target when our performance is at or above the 75th percentile of the peer group.

 

Market Competitiveness — Under our executive compensation program, we target total compensation to be within the median range of compensation paid by similarly-sized industrial companies. For this purpose, total compensation includes base salary, a target annual cash incentive opportunity, a target long-term cash incentive opportunity, and equity-based incentives. We also continuously monitor and assess the competitive retention and recruiting pressures for executive talent in applicable industries and markets. To ensure that these pressures do not jeopardize our ability to retain our key executives, the Committee retains and has periodically exercised its discretion to set target compensation levels as necessary and appropriate to address these risks. As noted in the section on page 17 summarizing its compensation actions, in 2009 the Committee exercised its discretion to address compensation issues and executive retention risks in order to respond to the effects of the global recession.

 

Use of Compensation Consultants — We employ a variety of outside compensation, benefit and actuarial consultants to support various types of technical and administrative work in these disciplines. Typically, this includes data analysis, broad-based employee compensation and benefit benchmarking and design, actuarial work, drafting selected employee communications, business processes and administrative recordkeeping services, and assistance with acquisition and divestiture due diligence. We choose firms for individual consulting and service assignments based upon their specific project capabilities and the proposed price for their work.

 

To support our market analysis of professional, managerial, operating and senior executive positions, we participate in and use the annual surveys sponsored by three separate national compensation consulting firms: Hewitt Associates, Towers Watson and Hay Associates. Each survey provides comprehensive compensation data covering hundreds of companies across a range of industries. In the analysis that we prepare for the Committee, we focus on the median and mean data reported in the surveys for “similarly-sized” industrial companies, which the Committee currently defines as companies with annual sales of $5 billion to $30 billion.

 

The Committee also selects and retains the services of an independent executive compensation consultant when it deems it appropriate to support its oversight and management of our executive compensation programs. The Committee validates our executive compensation plans and programs through periodic comprehensive studies conducted with the assistance of its consultant. For several years, and again in 2009, the Committee retained Peter Egan, a senior consultant with Hewitt Associates, as its primary advisor to assist the Committee in its review of our executive compensation

policies, programs and processes. In 2009, Mr. Egan performed the following assignments for the Committee:

 

 

To ensure the Committee’s continued access to qualified independent advice on executive compensation and governance matters, the Committee has adopted a formal policy that requires us to first obtain its review and approval prior to awarding any material consulting assignment to any firm that has already been engaged by the Committee. In 2009, the only work performed by Hewitt Associates was advice and recommendations on executive and director compensation provided to the Committee. Therefore, the Committee determined that its senior consultant is well positioned to provide independent advice.

 

Chairman and Chief Executive Officer Annual Appraisal — The Committee thoroughly assesses the performance of our Chairman and Chief Executive Officer annually. The Committee selected and retained Dr. David Hofrichter, an independent consultant from Hewitt Associates, to support this process in 2009. After reviewing a comprehensive annual goal report and self-evaluation prepared by our Chairman and Chief Executive Officer, each director confidentially provided Dr. Hofrichter with his or her independent ratings recommendations, comments and suggestions for performance improvement. The items that were addressed in this review included:

 

 

Each director’s feedback on these performance areas, along with any narrative commentary, was compiled anonymously and independent of management by Dr. Hofrichter. Dr Hofrichter prepared a draft consensus evaluation for review and approval by Ms. McCoy, as Chair of the Committee. This evaluation was also reviewed in an Executive Session of the Board of Directors and shared with our Chairman and Chief Executive Officer prior to a performance evaluation discussion with Ms. McCoy. The Committee used this appraisal as one of several factors in determining Mr. Cutler’s payouts under our short- and long-term incentive plans. In addition, the results of the annual appraisal are considered when determining any adjustments to Mr. Cutler’s base salary or his short- and long-term incentive targets and equity awards.

Competitive Analysis and Benchmarking Processes — To support the Committee in overseeing our executive compensation plans and programs, we employ three primary analytical processes, which follow separate, but complementary, approaches. The first analysis is our “Total Compensation Analysis and Planning Process,” the second is our “Peer Group Pay and Performance Analysis Process,” and the third is our “Peer Group Pay Targeting and Performance Hurdle Analysis.” These processes are summarized in the table below and described in more detail immediately following the table.

 

Total Compensation Analysis and Planning Process — Each year, we provide the Committee with an analysis of the total compensation provided to each executive officer. For purposes of this analysis, total compensation includes base salary, annual and long-term incentive compensation (including both cash and equity-based elements). We analyze the median and mean data for each compensation element for each executive officer’s position. We prepare a planning worksheet for the Committee which sets forth the average of the median values reported in the Hewitt, Towers Watson and Hay surveys for comparable positions in “similarly-sized” industrial companies. If the surveys do not report reasonably equivalent data for a specific executive officer’s position, each compensation element for that position is extrapolated from the available survey data. The Committee uses these worksheets as it assesses each executive’s total compensation and in establishing an updated annual total compensation plan for each officer. Consequently, as the Committee establishes base salary levels, target cash incentive opportunities, and equity-based incentive awards for the next fiscal year, it is able to base these decisions on an accurate and up-to-date understanding of how each executive officer’s resulting total compensation plan will

compare to current market practices by similarly-sized industrial companies. The worksheet also is provided to the Committee’s compensation consultant, who reviews our results and methodology.

 

As a key part of this process, each year Mr. Cutler prepares a proposed total compensation plan (usually consisting of base salary, the target annual cash incentive opportunity, the target long-term cash incentive opportunity and equity-based incentive awards, which can consist of stock options, restricted shares or restricted share units) for each executive officer. With the exception of Mr. Cutler’s recommendation to reduce his base salary for 2009, no member of management makes recommendations to the Committee with respect to his or her own compensation opportunity. Initially, Mr. Cutler meets individually with his senior management team to discuss the performance assessment for each of their respective executive officer direct reports and to formulate initial recommendations for an appropriate total compensation plan for each executive. After considering this input, and following a subsequent review with the Executive Vice President-Chief Human Resources Officer, Mr. Cutler submits to the Committee a proposed total compensation plan for each executive officer. He then meets with the Committee to discuss the performance of each executive officer and highlights the rationale for his recommendations with a special focus on any compensation element for any executive officer that is significantly higher or lower than the reported survey median (if available) for the executive’s position.

 

Following this discussion, the Committee establishes a total compensation plan for each executive officer. The Committee also meets in Executive Session with its independent consultant (but with no members of our management in attendance) to review the same comprehensive market data for Mr. Cutler’s position and to establish a total compensation plan for him. In 2009, the Committee again reviewed and discussed the proposed total compensation plans for Mr. Cutler and our executive officers with its independent compensation consultant prior to finalizing these plans.

 

Peer Group Pay and Performance Analysis and Peer Group Pay Targeting and Performance Hurdle Analysis— These processes encompass a comprehensive annual analysis comparing our data to the publicly-available financial results and executive compensation data for a group of publicly-held diversified industrial peer companies (the “Peer Group”). In 2008, the Board of Directors reviewed the composition of our Peer Group and determined that it would make a slight change to the makeup of the Peer Group in order to strengthen the overall aggregate long-term profile that we use for competitive performance comparisons. Effective for 2009, Crane and Thermo Electron were removed from the Peer Group and ABB Ltd., Siemens AG and 3M were added. We rank at approximately the median of this new Peer Group in terms of revenue. The Peer Group companies that we review in these analyses are the same group used by our Board of Directors in reviewing our 2009 Strategic Plan and Annual Profit Plan and in setting short- and long-term incentive plan performance goals. For these processes in 2009, this peer group consisted of the following organizations (shown in alphabetical order):

 

 

 

 

Use of Tally Sheets — In February of each year, we provide the Committee with a comprehensive tally sheet for each Named Executive Officer. The tally sheet, which is reviewed prior to making decisions about the compensation of the Named Executive Officers, sets forth the amount of all components of each executive’s current compensation including base salary, annual incentive compensation, long-term cash and equity incentive compensation, retirement and savings programs, health and welfare programs and the cost of personal executive benefits. In reviewing these tally sheets, the Committee also reviews potential compensation payments to Mr. Cutler and the other Named Executive Officers under various termination of employment scenarios, including in the event of a change of control of the Company. This process includes a review of potential severance payments that we would typically expect to make, the potential values of vested and unvested restricted share awards and restricted share units and stock options, and accumulated balances and projected payment obligations in connection with our retirement and savings programs, including our deferred compensation and limited service supplement and restoration retirement income plans. Based upon this review in 2009, the Committee determined that total compensation in the aggregate (including the total payments of accrued benefits and severance payments that would typically be made under the various termination scenarios) for Mr. Cutler and the other Named Executive Officers is appropriate. This analysis did not suggest the need for any material changes to our executive compensation program or its administration and it did not prompt the Committee to make any substantive changes to any compensation elements for any of the Named Executive Officers, except for the promotion-based increases for Messrs. Gross and Arnold, discussed below.

Components of Executive Compensation and Benefits

 

We use the components described below to achieve our objectives related to hiring, motivating, retaining and rewarding our executive officers.

 

Base Salary — We pay a competitive base salary to our executive officers in recognition of their day-to-day job responsibilities. In setting executive officer salaries each year, the Committee first reviews each executive’s current base salary compared to the median salary as determined under the annual Total Compensation Analysis and Planning Process. In general, the Committee sets base salaries at approximately the median of market practice, although the Committee at times may establish a base salary level in excess of the reported market median. In making salary adjustments, the Committee considers such factors as individual performance against business plans, initiative and leadership, time in position, experience, knowledge and success in building organizational capability. Consistently effective individual performance is a threshold requirement for any base salary increase. In Executive Session, the Committee uses this same process to establish a base salary for Mr. Cutler.

 

2009 Base Salary Actions:

 

 

Short-Term Incentives — We establish a competitive annual cash incentive compensation opportunity for our executives, who participate in either our Senior Executive Incentive Compensation Plan (the “Senior EIC Plan”) or our Executive Incentive Compensation Plan (the “EIC Plan”). Those executives who participate in one plan do not participate in the other plan. Senior EIC participants include Mr. Cutler and each officer reporting directly to him.

 

For 2009, the Committee established a bonus pool under the Senior EIC Plan equal to two percent (2%) of our Annual Net Income (as defined under the Plan). The Committee also assigned a percentage share of the Net Income Incentive pool to each participant in the Senior EIC Plan, thus setting the maximum amount that the participant could receive under the Plan for 2009. These percentages ranged from 12% to 30% of the Annual Net Income Incentive Pool for the Named Executive Officers. Under the Senior EIC Plan, no participant may be assigned a percentage share that is worth more than $7,500,000.

 

Although the initial incentive payout for each participant in the Senior EIC Plan is formula driven, the Committee exercises its discretion, after considering a variety of quantitative and qualitative factors, to reduce the size of these initial amounts to the final payouts. For purposes of making its determinations for 2009 awards, the Committee established performance goals which were tied to our EIC Plan objectives. These performance goals were based on our operating earnings per share (“EPS”) (which excludes acquisition integration charges) and cash flow return on gross capital employed in the business (“CFR”), weighted equally, in addition to a number of quantitative and qualitative individual and business unit performance objectives. The Committee selected the EPS and CFR goals because, over time, they bear a statistical correlation to the market trading price of our

shares. Based on its review of market analyses, our annual profit plan as approved by the Board of Directors, and external research reports and comparative analyses of our Peer Group, the Committee believed that the target levels that it established for the EPS and CFR goals were demanding, relative to the goals established in prior years, but attainable with sustained effort.

 

Although the Committee typically gives weight to our actual performance relative to these EPS and CFR goals when making award determinations, it also takes into consideration each participant’s performance against his or her individual and/or business unit objectives. These individual goals include, but are not limited to: success in achieving the annual financial plan for the executive’s business unit; success in achieving growth goals; success in building organizational capacity which includes objectives that reinforce our ethical standards; environmental health and safety-related goals; ability to think and act strategically, and ability to demonstrate an effective leadership style. Ultimately, the Committee applies its own business judgment and experience to assess actual performance against these goals and objectives and determine the incentive payouts, if any, for the participants in the Senior EIC and EIC Plans. Although the Committee may use these performance results as one factor in making its determinations, this information is not the Committee’s sole basis for deciding whether to pay incentive awards and, if so, their amounts.

 

2009 Short-Term Incentive Decisions:

 

No annual incentive awards were paid to any elected officers for 2009. At the time that the Committee established the EPS and CFR performance objectives for the EIC Plan in February 2009, its intent was to enable reasonable incentive awards to be earned if management could successfully generate results that created ongoing value for shareholders in a very difficult operating environment. The Committee recognized at that time, however, that global market conditions were continuing to erode and that the recession would likely be deeper than expected. By the second quarter, conditions had eroded to a point where it became clear that we would not be able to reach the EPS or CFR performance thresholds needed to earn a payment for 2009. Therefore, no payments were awarded under the EIC Plan or the Senior EIC Plan.

 

Long-Term Incentives — Our long-standing practice has been to provide long-term incentive compensation to executive officers in two components: equity and a four-year performance-based cash incentive compensation opportunity. We continue to believe that this “portfolio approach” to structuring long-term incentives provides an appropriate balance that focuses executives on both an external measure of our success (via equity awards) and on internal performance metrics (via the four-year cash incentive plan). This strategic approach is reviewed annually by the Committee with the assistance of its independent compensation consultant. The goal of the strategy is to continue to drive executive performance, while being sensitive to executive retention risks. The independent compensation consultant has confirmed that this approach is appropriate to achieve the stated goal.

 

Equity Grants: The Committee (which is composed entirely of independent directors) has authority (which it has delegated in one limited situation, as discussed below) to fix the date and all terms and conditions of equity grants to executive officers and other executives or key employees under our various stock plans, all of which have been approved by our shareholders.

 

The Committee strictly adheres to the following grant practices:

 

 

 

Long-Term Cash Incentive Plan:  Each year, the Committee creates a new long-term cash incentive opportunity under the Executive Strategic Incentive Plan (“ESIP”) and establishes objectives for the four-year award period. We base awards under ESIP on our success in achieving aggressive growth in four-year EPS and CFR goals which have historically been weighted equally.

 

The Committee establishes ESIP performance goals at the beginning of each four-year award period. These goals are based on a comprehensive analysis prepared by us that analyzes publicly-available peer group data that is used both by the Committee in establishing objectives and also by the Board of Directors in reviewing our Strategic and Profit Plans. The analyses include: (a) a comparison of our past performance across a range of performance metrics to that reported for our Peer Group, (b) our estimated financial results and those for each of our Peer Group companies as projected by financial analysts who follow these companies (generally covering two or three year periods into the future) and (c) a review of our strategic objectives and annual business plans for the four-year performance period. In the past, these analyses have allowed us to develop strategies to be “ahead of recessions” and size our businesses in anticipation of economic declines. The Committee sets performance hurdles for each four-year award period such that: (a) payment at approximately 100% of the target incentive opportunity would be made if our performance over the four-year period is at or above the projected median of the performance of our Peer Group and (b) payment at or above 150% of the target incentive opportunity would be made if our performance over the four-year period is at or above the projected 75th percentile of the performance of our Peer Group.

 

Individual award opportunities under ESIP have been expressed in the form of cash or contingent share units, depending on the award period, and are paid in cash unless deferred by the executive under one of our non-qualified deferred compensation plans. Contingent share units align the interests of the executives with those of the shareholders because the units reflect appreciation or depreciation and earnings on our common shares during the performance period. Prior to the 2005-2008 award period we expressed ESIP award opportunities in the form of

contingent share units. Beginning with the 2005-2008 award period, the Committee amended the plan to provide that incentive opportunities would be expressed in cash. The Committee made this change because it believed at that time that the executive compensation portfolio had become somewhat over-weighted in favor of equity-based compensation. The Committee annually reviews this design element of ESIP to ensure that it aligns well with competitive practice and provides an effective long-term incentive and retention structure. As a result of this review in late 2007, the Committee determined that the ESIP plan design should again return to the use of contingent share units in order to rebalance the long-term incentive portfolio. This contingent share design feature was included in the shareholder approved amended ESIP, discussed above.

 

Executive officers may defer receipt of some or all of their ESIP award payouts under a plan described in more detail in the narrative accompanying the Nonqualified Deferred Compensation Table beginning on page 48.

 

Decisions Affecting Long-Term Compensation Established Prior to 2009:

 

For the payout of the ESIP awards under the 2006-2009 award period, each Named Executive Officer’s target award opportunity was multiplied by 25% to reflect the fact that our actual EPS performance did not meet the threshold for a payout, but that our CFR performance did meet the threshold goal established by the Committee at the start of this four-year period. The Committee used its judgment to determine each executive’s actual award by applying an individual performance rating to the initial formulaic award. The Committee generally determines the individual performance ratings for the four-year award period by taking the average of the four annual performance ratings that were assigned to each executive for purposes of determining his or her Senior EIC or EIC awards, whichever is applicable, for each of the years in the ESIP award period. Individual performance ratings under the short-term plans are affected by various quantitative and qualitative objectives as described under Short-Term Incentives on page 27. Actual individual ratings for the Named Executive Officers ranged from 105% to 128%. When combined with the 25% adjustment related to our EPS and CFR performance, the final adjusted cash awards delivered to the Named Executive Officers ranged from 26% to 32% of the executives’ original target ESIP opportunities.

 

Decisions Affecting Long-Term Compensation Established in 2009:

 

For 2009, the Committee approved a shift in the type of equity from stock options to restricted share units (“RSUs”). The Committee chose to award RSUs rather than stock options in order to ensure a sufficient number of shares would be available in the stock plan to allow for meaningful equity grants to all eligible participants in 2009.

 

In addition, the Committee approved a change in the mix of the long-term incentive opportunity for each executive who participated in ESIP such that the target opportunity under the 2009-2012 ESIP award period comprised 75% of the total long-term incentive target and the remaining 25% of the long-term incentive opportunity was delivered in RSUs. Employees who were eligible for long-term incentives but did not participate in ESIP received 100% of their long-term incentive opportunity in RSUs.

 

In 2009, the Committee also approved stock option grants for a small number of lower level executives residing in countries with regulatory limitations that made the use of RSUs impractical or unlawful.

 

In 2009, the Committee had to deal with the impact of the collapse of the global economy on our various long-term incentive plans and equity grants. In a matter of a few months, the effects of the deep recession drove our share values to new lows, placing most of our existing stock option grants underwater and significantly reducing the value of previously granted restricted shares. It also quickly became clear that participants in all existing ESIP open award periods (which reward performance against goals established for overlapping four-year incentive periods) would now only be able to earn, at most, a minimum award because stretch performance objectives for

these open award periods were set by the Committee prior to the collapse in the global markets. As a result, we and the Committee were concerned with the elevated executive retention risks that we faced in light of the combined impact of:

 

 

Given these concerns, and in response to continuing uncertainty in global market conditions, the Committee determined that it would need to exercise its judgment to adjust some of its traditional long-term incentive practices in order to create some meaningful incentive opportunities and improve our ability to retain executive talent.

 

During the first five months of the year, the Committee made the regular grants under our long-term incentive plans and then later adjusted the grants in order to respond to the rapidly changing operating environment’s impact on our compensation plans and programs.

 

In February 2009, the Committee considered whether to set EPS and CFR performance goals for the 2009-2012 ESIP award period under the amended ESIP (which meets the requirements of Internal Revenue Code Section 162(m)). The Committee determined that attempting to set performance goals for a four-year period during a time of such a major market disruption was not realistic. Instead, the Committee granted participants a four-year incentive opportunity under our 2009 ESIP, which does not meet the requirements of Internal Revenue Code Section 162(m).

 

Using the 2009 ESIP, the Committee set EPS and CFR performance objectives for 2009 and decided that it would set additional performance objectives for each of 2010, 2011 and 2012 at the beginning of each of these subsequent years. For 2009, the EPS and CFR goals mirrored the goals that were established for 2009 under our annual EIC Plan.

 

In addition to establishing performance objectives for the first year of the four-year ESIP award period, the Committee approved 2009-2012 ESIP award period opportunities expressed in the form of contingent share units for Messrs. Cutler, Fearon, Arnold, Gross, Palchak, Carson and Sweetnam as noted below. The Committee discussed and approved Mr. Cutler’s award opportunity in Executive Session with only its independent compensation consultant in attendance.

 

 

The Committee approved 2009 RSU grants to Mr. Cutler, the other Named Executive Officers and the remaining executives and key employees who were proposed by management to receive grants. RSUs comprised 25% of the target total long-term incentive opportunity for ESIP participants, including the Named Executive Officers. Other executives who do not participate in

ESIP receive 100% of their long-term incentive opportunity in RSUs. The RSU grants awarded to each Named Executive Officer are noted below:

 

 

Mr. Cutler’s grant was approved by the Committee in Executive Session with only its independent compensation consultant in attendance. Mr. Carson was not approved for a 2009 annual equity grant in light of his planned retirement. These RSU grants will vest in equal, annual installments over the next four years, subject to the executive’s continued employment with us. Dividends are not accrued or paid on these RSUs during the restricted period.

 

In addition to these annual equity grants, the Committee reviewed and approved a retention-based restricted share grant of 5,000 shares for Mr. Fearon, 30% of which will vest at the end of 24 months and another 30% will vest at the end of 36 months. The remaining 40% of the shares vest at the end of 48 months, subject to his continued employment with us.

 

Mr. Cutler also recommended, and the Committee approved, special restricted share grants (“Gap Grants”) for the Named Executive Officers and all other executives who participated in the 2007-2010 ESIP award period. The Committee approved this additional grant of restricted shares to partially address what the Committee felt was a “gap” in total compensation related to this earlier ESIP grant which was identified while reviewing the 2008 Peer Group Pay and Performance Analysis. This analysis showed that, despite the fact that the competitive position of our total compensation for key executives was at or near the median of market practices as reported for similarly-sized industrial companies in the Hewitt Associates, Towers Watson and Hay Associates surveys, our executives’ total compensation was below the median total compensation reported for our Peer Group. The Committee approved the following gap grants:

 

 

These additional “gap” grant restricted shares vest at the end of 24 months, provided that the executive remains employed with us throughout that period. The Committee did not approve a “gap” grant for Mr. Cutler in 2009.

 

Additional details of the equity grants to Mr. Cutler and the other Named Executive Officers described above may be found in the Summary Compensation Table, Grants of Plan Based Awards Table and Outstanding Equity Awards at Fiscal Year-End Table and corresponding footnotes.

 

In the February 2009 Committee meeting, Mr. Cutler and the Committee also discussed their shared concerns about the open four-year ESIP award periods (2006-2009, 2007-2010 and

2008-2011). Due to the impact of the economic collapse on our 2008 and 2009 operating results, the original EPS and CFR performance objectives established by the Committee for these open award periods will be largely unachievable. Projections indicated that, at best, we expect participants to earn 25% of the target incentive opportunity for these award periods. The Committee concluded that a significantly reduced, or possibly no, long-term incentive opportunity over such a prolonged period was not an effective incentive practice and that it would raise executive retention risks for us.

 

Instead of attempting to retroactively adjust performance objectives where permitted, the Committee approved Extension Grants from our Supplemental Plan. The Committee made the grants to our active employees, including the Named Executive Officers, who participate in the 2006-2009, 2007-2010 and 2008-2011 open ESIP award periods. Under the Extension Grants, a target award opportunity equal in value to the ESIP target for each open ESIP award period was established for each participant. The target amount of each Extension Grant was converted to contingent share units by dividing each executive’s target value by the average closing price of our common shares for the first 20 trading days of 2009, which was $48.09 and rounding up the results to the nearest 50 whole units. The target award value and contingent share units awarded to each Named Executive Officer are shown below and reported in the Grants of Plan Based Awards Table. Earned Extension Grants, if any, will be paid in cash on or before March 15^th of 2010, 2011 and 2012.

 

The Committee then approved Extension Grant performance goals for 2009, which mirrored the 2009 EIC objectives. The Committee intends to establish goals in 2010 and 2011 for the Extension Grants that cover the remainder of the 2007-2010 and 2008-2011 ESIP award periods.

 

The Committee intended for these Extension Grants to provide executives with an opportunity to earn some portion of the long-term incentive opportunity that had become unattainable. For each of the open award periods, the aggregate awards for each executive would consist of the payout (if any) from the original ESIP grant plus the payout (if any) from the Extension Grant subject to a cap on the aggregate awards in each open award period. For the 2006-2009 award period, the combined ESIP and Extension Grant opportunities were capped at 90% of the combined target opportunity with a maximum allowable payout under the Extension Grant at 65% of target. As previously stated, the underlying goals were not achieved and no payments were made to any executives in conjunction with the 2006-2009 Extension Grants.

 

For the 2007-2010 award period, the combined awards are capped at 125% of the combined target opportunity with a maximum allowable award under the Extension Grant capped at 100%. For the 2008-2011 award period, the combined awards are capped at 150% with a maximum opportunity under the Extension Grant capped at 125% of target.

 

As noted in the introductory remarks to this analysis, by early in the second quarter of 2009, the Committee had become concerned about executive retention risks due to the cumulative effects of the deepening global recession on our business operations and the 2009 annual and long-term incentive compensation opportunities granted to executives and key employees. In May 2009 the

Committee convened a special meeting to discuss these risks and to consider taking steps to mitigate them. The Committee noted that the severe effects of the recession had resulted in only a minimal discretionary payment under the 2008 annual incentive plan and that it was now clear that payouts under the 2009 annual incentive plans were no longer possible because the 2009 EPS and CFR goals had become unachievable. Furthermore, because these same goals underlie the Extension Grants and the 2009 ESIP, payouts under those programs were also compromised. The Committee also noted that the majority of outstanding employee stock option awards were underwater. The Committee discussed issues related to the prospect of no or only minimal short- and long-term incentive payouts in the next few years and the need for executive and leadership engagement and retention during a period that offers little or no incentive opportunity. Following its review and after considering alternatives, the Committee approved several actions intended to help mitigate the rising level of executive and key employee retention risks.

 

The Committee first cancelled the 2009 ESIP award period grants and then approved additional RSU grants for all employees who participated in the 2009 ESIP, including Mr. Cutler and the other Named Executive Officers. Each participant’s grant was equal to five times the number of RSUs granted in the regular annual equity grant approved on February 24, 2009. The grant date value of the original February RSU grant plus the grant date value of the supplemental RSU grant was approximately equal to the total targeted long-term incentive opportunity that was established for each participant in February 2009 during the total compensation planning process. The supplemental RSU grants cliff vest on the third anniversary of the date of the grant and are subject to a requirement of continued employment with us. No dividends are accrued or paid during the restricted period with respect to these RSUs. In order to align the supplemental RSU grant with the opportunity that would have been provided via the 2009 ESIP opportunity and to guard against any unintended windfall, the Committee established a “cap” on the total value of the supplemental RSUs that could be delivered to any executive. If the fair market value of the RSUs at the time of full or partial vesting exceeds 200% of the fair market value of an equal number of our common shares on the date of grant, only the number of RSUs with a fair market value equal to the cap will vest and the balance of the RSUs will be forfeited.

 

Canceling the 2009 ESIP grants and making this supplemental grant would, in the Committee’s opinion:

 

 

The following table contains information with respect to the cancelled 2009 ESIP award opportunity and supplemental RSU grant made to each Named Executive Officer in May 2009:

The grant date fair value of the supplemental RSU grant awarded on May 8, 2009 was equal to the closing price of our common shares on the date of grant ($47.69 per share). The somewhat elevated replacement values for Messrs. Arnold, Gross, Fearon, Palchak and Sweetnam reflected the fact that each received regular 2009 RSU grants that were slightly higher than the standard targets and that Messrs. Fearon, Arnold and Gross had been elevated to Vice Chairmen positions as part of our reorganization in 2009. Mr. Carson did not receive a supplemental grant in light of his planned retirement.

 

The Committee views the cancellation of the 2009 ESIP award period and individual award opportunities and awarding the supplemental RSU grants as a short-term response to the unprecedented operating and market environment caused by the economic crisis. The Committee expressed its intent to return to the traditional “balanced portfolio” as soon as economic conditions stabilize to a point where the Committee may realistically consider setting long-term performance objectives.

 

Share Ownership Guidelines — We expect all of our executive officers and, depending on their level in the Company, certain other key executives to hold a number of our common shares with a value equal to a pre-determined multiple of their base salary. These multiples range from one times base salary in the case of our General Managers and key non-officer staff executives to six times base salary for our Chairman and Chief Executive Officer. In 2009, the ownership guidelines for the Chairman and Chief Executive Officer increased from three times base salary to six times base salary. Likewise, the ownership guideline for the Vice Chairmen increased from two times base salary to four times base salary. These multiples are consistent with trends we have seen in the competitive market.

 

In 2009, we also implemented a requirement that each executive hold a minimum of 20% of his or her ownership guideline in shares that can be voted. The Committee annually reviews the progress of the individual executive officers toward these ownership levels and our Chairman and Chief Executive Officer annually reviews the progress of other non-officer executives. On December 31, 2009, our Chairman and Chief Executive Officer and the other Named Executive Officers owned our common shares with values in excess of their individual ownership requirements.

 

We have a policy that prohibits executives from engaging in financial hedging of their investment risk in our shares.

 

Health and Welfare Benefits and Retirement Income Plans — With certain exceptions described below, we provide our executive officers with the same health and welfare and retirement income benefit programs that we provide to our other salaried employees. In place of typical Company-paid group term life insurance, we provide all executive officers and certain other executives with Company-paid life insurance coverage under two separate policies. The aggregate value of the two policies is approximately equal to an executive’s annual base salary and this level of coverage is consistent with the level of coverage provided to other salaried employees through our group term life policy. The majority of the executives’ life insurance is covered under an executive-owned individual whole life policy with the remaining $50,000 of insurance covered under our group term life policy. The value of the Company-paid premium for the whole life policy is imputed as taxable income to each covered executive. We decided to provide this executive life insurance arrangement to allow each executive to have a paid up policy at retirement that would mirror the Company-provided post-retirement group term life insurance but with less post-retirement tax complexity for both the executive and us.

 

The tax-qualified pension plans that we maintain for our U.S. salaried and non-union employees define the term “compensation” to include base salary, overtime pay, pay premiums and awards under any annual variable pay or incentive compensation plan (including amounts deferred for receipt at a later date). We use this same definition for calculating pension benefits under the nonqualified executive retirement income arrangements described below.

Other Retirement and Compensation Arrangements — The pension benefits table on page 48 details retirement benefits for Mr. Cutler and the other Named Executive Officers. Certain provisions of the Internal Revenue Code, as amended, limit the annual benefits that may be paid from a tax-qualified retirement plan. As permitted under the Code, and to align with competitive practices, the Board of Directors has authorized plans under which payment from our general funds will be made for any benefits calculated under the provisions of the applicable tax-qualified retirement plan which may exceed those limits. These non-qualified benefits accrued prior to January 1, 2005 will be paid at retirement in the form of an annuity (unless otherwise determined by the Committee), except that, upon a proposed change of control of the Company, the benefits will be paid at the time of that event (unless otherwise determined by the Board of Directors) in a single sum. These benefits accrued after January 1, 2005 will be paid in the form of a single sum at retirement.

 

In response to market practices and to enhance our ability to attract and retain key executives, the Board of Directors also has adopted plans which provide supplemental annual retirement income to certain executives who we hire mid-career. These executives do not have the opportunity to accumulate significant credited service with us under our tax-qualified retirement income or nonqualified restoration plans, provided that they either retire at age 55 or older and have at least 10 years of service with us or retire at age 65 or older regardless of the years of service.

 

Pension benefits (inclusive of the unfunded benefits described above) for executives under the cash balance plan formula fall below the median of pension programs. The previous final average pay formula (inclusive of the unfunded restoration benefits), which covers executives hired before January 1, 2002 including Mr. Cutler and several of the Named Executive Officers, is approximately at the median of traditional pension plan designs. We do not have a plan that allows for base salary deferrals and do not match 401(k) contributions in excess of the Code limits, resulting in below median retirement benefit values for executives (most of our competitors provide base salary deferral plans with matching contributions in excess of the Code limits).

 

These qualified and nonqualified retirement income plans are the only compensation or benefit plans or programs that we provide to executive officers which consider base salary and earned annual incentive awards in the calculation of the executives’ account balances. Long-term incentives, including cash and amounts realized upon the exercise of stock options and/or vesting of RSUs or restricted share awards, are not factored into these calculations.

 

Employment Contracts and Change of Control Agreements — We do not provide our executive officers with employment contracts. As with all other U.S. salaried employees, our executive officers are “at will” employees. However, we do enter into change of control agreements with each executive officer which provide benefits only upon certain terminations of employment following a change of control (so-called “double trigger” agreements). We believe that such agreements are in our best interests and that of our shareholders because they ensure that we will have the continued dedication and focus of key executives notwithstanding the possibility of a change of control of the Company. Providing these agreements to our executive officers also aligns with competitive practices. Our change of control agreements with each of our executive officers, including Mr. Cutler and the Named Executive Officers conform to the final regulations under Internal Revenue Code Section 409A which covers nonqualified deferred compensation arrangements. Details of our change of control agreements may be found in the narrative discussion accompanying the Potential Payments Upon Termination section beginning on page 51.

 

Deferral Plans — We provide our executives with opportunities to defer the receipt of their earned and otherwise payable awards under our annual and long-term cash incentive plans. We offer these deferral arrangements in order to (a) provide our executives with a competitive opportunity to accumulate additional retirement assets, (b) provide a means for acquiring common shares in order to meet our share ownership guidelines and (c) provide an additional form of retention. As noted above, despite the fact that they are quite common across our industry, we do not currently provide our executives with a nonqualified defined contribution plan that enables them to defer base salary amounts in excess of the Code limits applicable to our tax-qualified defined contribution Section 401(k) plan.

On February 10, 2010, the Committee approved the termination of the Deferred Incentive Compensation Plan and the Incentive Compensation Deferral Plan, as described on page 48, with respect to all participant accounts. The amounts credited to the terminated accounts will be distributed in 2010 to the participants in a single sum consisting of cash and/or Eaton common shares, depending upon the type of investments applicable to the Accounts.

 

Details on our deferral programs may be found in the narrative discussion and footnotes accompanying the Nonqualified Deferred Compensation Table beginning on page 48.

 

Personal Benefits — In order to align with competitive practices in our industry, we also provide our executive officers with a limited amount of personal benefits, all of which are treated as taxable income to the executive. These benefits are described in more detail in the footnotes accompanying the Summary Compensation Table beginning on page 40.

 

Use of Our Aircraft — We own, operate and maintain Company aircraft to enhance the ability of our executive officers and other corporate and operations leaders to conduct our business in an effective manner. This principle guides how the aircraft is used. Our stringent aircraft use policy ensures that the primary use of this mode of transportation is to satisfy business needs and that all aircraft use is accounted for at all times and in accordance with applicable laws. To ensure his personal security and enhance his productivity, the Board of Directors has directed Mr. Cutler to use our aircraft for all business and personal travel whenever feasible. Our aircraft policy does not permit other executives to use Company-owned aircraft for personal use without the advance approval of the Chairman and Chief Executive Officer. No Named Executive Officers received tax protection on the imputed income for personal use of Company aircraft in 2009.

 

Senior Officer Retirement Arrangement — On January 28, 2009, we announced that Randy W. Carson, Chief Executive Officer-Electrical Group, would retire effective May 1, 2009. Pursuant to the terms of our applicable Stock Plans, the Committee exercised its discretionary authority to provide Mr. Carson with our customary benefits for retiring senior executives, which included the accelerated vesting of 22,839 stock options and 9,000 restricted shares, which otherwise would have been forfeited upon Mr. Carson’s retirement. In addition, the Committee approved a total payment equivalent to 12 months of Mr. Carson’s salary plus 100% of his 2009 target annual incentive opportunity. In consideration for the payment representing salary and incentive compensation and the vesting of the restricted shares, Mr. Carson agreed to provide advice through year-end 2010 as reasonably requested by the senior management of our Electrical Sector.

 

Tax and Accounting Considerations — We carefully monitor and comply with any changes in the tax laws and regulations as well as accounting standards and related interpretive guidance that impact our executive compensation plans and programs. Tax and accounting considerations, however, have never played a central role in the process of determining the compensation or benefit plans and programs that are provided to our executives. Instead, the Committee has consistently structured our executive compensation program in a manner intended to ensure that it is (a) competitive in the marketplace for executive talent and (b) provides incentives and rewards that focus executives on reaching desired internal and external performance levels. Once the appropriate programs and plans are identified, we administer and account for them in accordance with applicable requirements.

 

$1 Million Tax Deduction Limit — Prior to 2008, we did not qualify our short- and long-term incentive awards as “performance based” compensation under Internal Revenue Code Section 162(m). Under this law, any remuneration in excess of $1 million paid to Mr. Cutler and the three other most highly compensated executive officers of the Company (other than the Chief Financial Officer) in a given year is not tax deductible unless paid pursuant to formula-driven, performance-based arrangements that preclude Committee discretion to adjust compensation upward after the beginning of the period in which the compensation is earned. The shareholders approved a Senior Executive Incentive Compensation Plan (as previously discussed) and an amended Executive Strategic Incentive Plan (as

previously discussed), which meet the requirements needed to qualify incentive payments under these Plans as deductible compensation under Internal Revenue Code Section 162(m). In 2009, no incentive payments were made under either of these Section 162(m)-compliant plans.

 

Policy on Incentive Compensation, Stock Options and Other Equity Grants Upon the Restatement of Financial Results — The Board of Directors has adopted a formal policy stating that, if an executive engaged in any fraud, misconduct or other bad-faith action that, directly or indirectly, caused or partially caused the need for a material accounting restatement for any period as to which a Performance-Based Award was paid or credited to the executive during the twelve-month period following the first public issuance of the incorrect financial statement, such award shall be subject to reduction, cancellation or reimbursement to the Company at the discretion of the Board. As used in this policy, the term “executive” means any executive who participates in either the Executive Strategic Incentive Plan I or the Executive Strategic Incentive Plan II, or both, or any successor plans. Our incentive compensation plans, stock plans and deferral plans include the provisions of this policy. Additional details regarding this policy and related processes may be found on our website at http://www.eaton.com/governance.

 

In 2009, in response to the SEC’s heightened focus on risk in incentive plans, the Committee and management conducted a comprehensive review of our compensation programs, including executive compensation and major broad-based compensation programs in which salaried and hourly employees at various levels of the organization participate. The goal of this review was to assess whether any of our compensation programs, either individually or in the aggregate, would encourage executives or employees to undertake unnecessary or excessive risks that were reasonably likely to have a material adverse impact on us.

 

The Committee reviewed an inventory of our variable pay and sales commission plans and considered the number of participants in each plan, the participants’ level within the organization, the target and maximum payment potential and the performance criteria under each plan, and the type of plan (for example, management-by-objective, goal sharing, etc.). The Committee concluded that none of the broad-based programs (base salary, traditional sales commission or variable incentive arrangements) that extend to regular hourly and salaried employees would likely give rise to a material risk.

 

The Committee also applied a risk assessment to those plans that were identified as having the potential to deliver a material amount of compensation, which for 2009 were the annual and long-term incentive plans that are described earlier in the Compensation Discussion and Analysis. The analysis included, but was not limited to, the following items:

 

 

Management and the Committee also concluded that our executive compensation strategy and programs do not pose a material risk due to a variety of mitigating factors. These factors include:

 

 

 

As a result of this review, both management and the Committee concluded that our total compensation plans, programs and practices are structured in the best interest of the Company and its stakeholders.

 

The Committee intends to monitor economic conditions and the effect on our compensation plans and programs. As market conditions continue to stabilize, we and the Committee are optimistic that during 2010 certain practices that were suspended or changed in 2009 will be restored, such as:

 

 

The Compensation and Organization Committee of the Board of Directors has reviewed and discussed with the Company’s management the Compensation Discussion and Analysis required by Item 402(b) of Regulation S-K and, based on this review and discussion, the Compensation and Organization Committee recommended to the Board that the Compensation Discussion and Analysis be included in this proxy statement.

 

COMPENSATION AND ORGANIZATION COMMITTEE

 

Deborah L. McCoy, Chair

Todd M. Bluedorn

Christopher M. Connor

Michael J. Critelli

John R. Miller

Gregory R. Page

 

The following table sets forth the total compensation of our Chairman and Chief Executive Officer, our Vice Chairman and Chief Financial and Planning Officer, our three other most highly compensated executive officers in 2009, as well as two executive officers who retired in 2009 (the “Named Executive Officers”). Prior to setting total compensation for each of the Named Executive Officers, the Committee reviewed tally sheets which showed the executive’s current compensation, including equity and non-equity based compensation. “Salary,” as shown in column (c), consists of base salary, which accounted for approximately 12% of the total compensation of the Named Executive Officers in 2009. The Named Executive Officers were not entitled to receive “Bonus” payments under column (d) for 2009 (“Bonus” payments are defined under the disclosure rules as discretionary payments that are not based on any performance criteria). Column (e), “Stock Awards,” consists of the grant date fair value of awards delivered to each Named Executive Officer in the year reported. Column (f), “Option Awards,” reports the grant date fair value of stock options awarded in each respective year shown below. The grant date fair value is based on the Black-Scholes Model. Column (g), “Non-Equity Incentive Plan Compensation,” is the amount paid under the four-year ESIP for the 2006-2009 award period. As previously discussed, no annual incentive was paid for 2009. The long-term incentive payments reported in Column (g) were approved by the Committee at its January 26, 2010 meeting and, to the extent not deferred by the executive, will be paid on March 15, 2010. Column (h), “Change in Pension Value and Nonqualified Deferred Compensation Earnings,” contains two distinct components. “Change in Pension Value” represents the total change in the actuarial present value of each Named Executive Officer’s accumulated benefit under all of our defined benefit pension plans (both tax qualified and nonqualified) from the measurement date used for financial reporting purposes. “Nonqualified Deferred Compensation Earnings” include earnings on deferred compensation that exceed 120% of a specified rate of interest for long-term debt instruments established by the Internal Revenue Service. Column (i), “All Other Compensation,” consists of compensation that does not fit within any of the foregoing definitions of compensation. This compensation includes personal benefits, our contributions to defined contribution plans, the value of insurance premiums paid by us and the value of any dividends paid on restricted shares because they are not factored into the grant date fair values reported in column (e).

 

 

 

 

 

 

 

 

 

 

The following table summarizes the potential awards payable to the Named Executive Officers with respect to the short-and long-term incentive award opportunities granted in 2009.