Eli Lilly 2004 Annual Report Download - page 88

PROXY STATEMENT
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Performance-based options tie compensation more closely to company performance. Premium-priced and
performance-vesting options encourage senior executives to set and meet ambitious but realistic performance tar-
gets. Indexed options may have the added benefi t of discouraging repricing in the event of an industry downturn.
We believe that adopting performance-based options is the logical next step for Lilly to better align its com-
pensation practices with long term shareholder interests.
The need for clearer standards is, we believe, illustrated by the compensation award to the Chairman and
Chief Executive Offi cer (“CEO”). In 2003, the CEO received a raise in each of these categories: salary, bonus, and
long-term compensation. The 350,000 stock options that he received in 2003 (identical to the number awarded in
2002) were not based upon objective performance measures with relative weights assigned, but were based upon
“internal relativity, peer group data, and the size of grants previously made.” His total 2003 compensation exceed-
ed the median for CEOs in Lilly’s peer group and came to an estimated $9.9 million when the value of 350,000 stock
options granted is added to salary, bonus and all other compensation totaling over $2.8 million.
We believe that equity compensation for senior executives should be more closely tied to Lilly’s performance.
Lilly stock has consistently underperformed the S&P 500 index for the one-, three- and fi ve-year periods ending
November 10, 2004. In addition, average earnings have trailed Lilly’s peers in recent years, as the company has
experienced the early loss of patent protection for Prozac, as well as a hiring freeze and layoffs.
Statement in Opposition to the Performance Based Stock Option Proposal
The compensation committee of the board of directors has reviewed this proposal and believes that, on balance, it
is not in the best interests of shareholders.
The shareholder states that executive compensation policies should “provide challenging performance objec-
tives and motivate executives to achieve long-term shareholder value.” We agree. For many years our executive
compensation policy has been grounded on the principle that compensation should foster the long-term focus
necessary for success in the pharmaceutical industry. We do not agree, however, that the best way to achieve that
objective is to adopt the mandate suggested by the shareholder. Although in some circumstances the types of stock
options recommended by the shareholder may be useful, we believe that the compensation committee needs fl ex-
ibility to grant other forms of options, including the currently used market-price options, as circumstances require.
For Lilly executives, cash and equity compensation are tied closely to both individual and company perfor-
mance. The compensation committee takes into account individual performance in establishing base salaries as
well as the size of bonus and equity targets. As to company performance, a signifi cant proportion of total cash com-
pensation is awarded under the company’s bonus plan, which is based on growth in sales and earnings per share. In
establishing the performance targets under the plan, we consider the expected performance of Lilly and the other
companies in our peer group. With respect to equity compensation, we use a mix of stock options and performance
awards, which are stock grants that are payable only if the company achieves certain earnings-per-share growth
targets. As with the cash bonuses, we set the targets for performance awards with reference to our projections of
peer group performance. Finally, as we move into 2005 and beyond, we are reducing the size of stock option grants
at all levels of management in favor of a greater emphasis on performance awards.
The past three years demonstrate that pay for performance is very much a part of both cash and equity com-
pensation at Lilly. The company has faced a number of diffi cult internal and external challenges in that time, and
executive compensation refl ects those challenges:
• There were no cash bonuses paid for 2002.
• Cash bonuses for 2003 and 2004 were below target.
• There were no performance awards earned with respect to 2002 or 2003.
Additionally, as of early February 2005, virtually all stock options granted since 1997 are “under water”—that is, the
exercise price is higher than the current market price of the stock. We do not reprice options.
Regarding Mr. Taurel’s 2003 compensation, we note that while he did receive an increase in base salary, Mr.
Taurel—at his own request—worked for a $1 base salary in 2002. Further, his 2003 salary was only a 4 percent
increase over his 2001 salary. His increase in cash bonus in 2003 was a result of there being no bonus payout in
2002. Finally, with respect to his long-term compensation in 2003, he did not receive a performance award payout,
and his stock option grant was the same number of shares as the previous year.
The compensation committee, aided by its independent compensation consultant, will continue to review
compensation trends and consider new ideas, including performance-based options. However, to ensure that the
company attracts and retains talented leadership and motivates its leaders to deliver long-term growth in share-
holder value, the compensation committee must have fl exibility to design programs as it deems most appropriate,
without being restricted by mandates such as the one proposed by the shareholder.