Baker Hughes 2007 Annual Report Download - page 29

2007 Proxy Statement 11
value creation as discussed in more detail below. Less than
fifty percent of each Senior Executive’s compensation package
is contingent upon continued employment and the remainder
is at risk and contingent on Senior Executives driving company
financial success.
While both short and long-term incentives drive the final
compensation levels for Senior Executives, the Committee
encourages a balance between short and long term business
goals by employing both types of compensation programs.
If Senior Executives make business decisions that lead to short-
term profits at the expense of long term value creation, the
value of their short-term incentives will increase while the
value of their long-term incentives will decrease. On the other
hand if business decisions intended to drive long-term financial
gain are detrimental to current year financial profitability, the
compensation levels of the Senior Executives are affected. To
encourage a healthy approach to capital investments, invest-
ments in human resources and growth plans, the Committee
provides a balance of short and long-term incentive plans.
Financial Metrics Used in Compensation Programs
Several financial metrics are commonly referenced in defin-
ing Company performance for Senior Executive compensation.
These metrics and their use in annual and long-term incentive
programs are described below. The impact of certain items
may be excluded from the calculation of these metrics in order
to insure they consistently reflect Company performance and
stockholder return despite certain non-recurring items that
may occur in any given fiscal year.
Earnings Per Share
To ensure compensation is proportional to the return
on investment earned by stockholders, we use Earnings per
Share (“EPS”) as a metric for Senior Executives in the Baker
Hughes Incorporated Annual Incentive Compensation Plan, as
amended (the “Annual Incentive Plan”). EPS is generally defined
as our net income divided by the weighted average number of
shares outstanding during that period. Non-operational items
are generally excluded from the EPS calculation for purposes
of determining Annual Incentive Compensation payouts.
Profit After Tax
A related metric used in the annual incentive calculations
is profit after tax (“PAT”). The use of this metric allows us to
reward Senior Executives for meeting targets related to actual
operating profit earned each year. Operating profit and profit
after tax are non-GAAP measures comprised of income from
continuing operations excluding the impact of certain identi-
fied items. We believe that operating profit and PAT are useful
because they are consistent measures of the underlying results of
our business. Furthermore, management uses operating profit
internally as a measure of the performance of our operations.
Baker Value Added
BVA is a non-GAAP measure that supplements traditional
accounting measures to evaluate the return on capital invested
in the business. BVA is calculated as our financial return in a
given period less our capital charge for that period. Our finan-
cial return is defined as (i) profit before tax (as defined below)
plus interest expense plus non-compete amortization expense,
which is a component of cost of sales, multiplied by (ii) 1 minus
the applicable tax rate. Our capital charge is defined as (i) the
weighted average cost of capital determined for the Company
for the period multiplied by (ii) the average capital employed.
Profit before tax is calculated as total revenues minus total
costs and expenses, minus interest expense plus interest and
dividend income.
Review of Senior Executive Performance
The Compensation Committee reviews, on an annual
basis, each compensation element of a Senior Executive. In
each case, the Compensation Committee takes into account
the scope of responsibilities and experience and balances these
against competitive salary levels. The Compensation Commit-
tee has the opportunity to meet with the Senior Executives at
various times during the year, which allows the Compensation
Committee to form its own assessment of each Senior Execu-
tive’s performance.
In addition, each year, the PEO presents to the Compensa-
tion Committee his evaluation of each Senior Executive, which
includes a review of contribution and performance over the
past year, strengths, weaknesses, development plans and suc-
cession potential. Following this presentation and a review of
the Survey Data, the Compensation Committee makes its own
assessments and approves compensation for each Senior Exec-
utive. Compensation in excess of the median of the Survey
Data is provided through the variable elements of the compen-
sation program to further our pay-for-performance philosophy.
In this way all compensation elements are reviewed and
approved by the Compensation Committee. The PEO, as the
direct manager of the other NEO’s, provides input on their
individual performance and recommends specific compensa-
tion changes for his direct reports; however, the Committee
retains ultimate approval for any compensation changes. The
Committee does take into consideration the PEO and NEOs’
total compensation, including base salary annual incentives
and long-term incentives, both cash and equity, when consid-
ering market based adjustments to the PEO and NEOs’ com-
pensation. Additionally, the Committee, with the assistance of
Mercer, is responsible for reviewing all compensation metrics
and targets for all of the Senior Executives and is responsible
for approving any adjustments to those metrics and targets.
Components of the Executive Compensation Program
The total compensation and benefits program for Senior
Executives consists of the following:
•฀ base฀salaries;
•฀ annual฀incentive฀plan;
•฀ long-term฀incentive฀compensation;
•฀ retirement,฀health฀and฀welfare฀benefits;฀and
•฀ perquisites฀and฀perquisite฀allowance฀payments.
The Compensation Committee targets different compensa-
tion levels for each element of compensation as well as the
compensation levels for the PEO and each NEO based upon
their level of responsibility to the Company (as discussed in
more detail below).