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 2009 annual meeting of Eaton Corporation shareholders will be held Wednesday, April 22, 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 February 23, 2009. 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 13, 2009

 

 

 

 

Important Notice Regarding the Availability of Proxy Materials for the Annual Meeting of Shareholders to be held on April 22, 2009: This proxy statement and the Company’s 2008 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, 2008 are scheduled to be sent to shareholders on or about March 13, 2009.

 

 

Eaton’s Board of Directors solicits your proxy, in the form enclosed, for use at the 2009 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; for the proposed 2009 Stock Plan; and for ratification of the appointment of Ernst & Young LLP as independent auditor for 2009.

 

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 $21,000, 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 February 23, 2009 is entitled to one vote for each share then held. On February 23, 165,379,440 Eaton common shares (par value, 50¢ each) were outstanding and entitled to vote.

 

At the 2009 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 twelve members. The terms of four directors will expire in April 2009 and those directors have been nominated for re-election. Three of those nominees were elected at the 2006 annual meeting. Arthur E. Johnson, who was recommended to the Governance Committee by an Eaton Board member and vetted by our Board search consultant, was elected by the Board of Directors effective as of January 28, 2009, and is standing for re-election at the 2009 annual meeting, when his current term of office expires. (See page 5.)

 

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. Eaton’s management, however, has no reason to believe that this will occur.

 

Following is biographical information about each nominee and each director.

Nominees for election to terms ending in April 2012 or when a successor is elected and has qualified:

 

Directors whose present terms continue until April 2010:

 

Directors whose present terms continue until April 2011:

 

 

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 the Company’s 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. 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.

 

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 the Company’s objectives, and a sensitivity to the Company’s corporate responsibilities. In addition, the Governance Committee from time to time looks for individuals with specific qualifications so that the Board as a whole may maintain an appropriate mix of experience, background, expertise and skills, and of age, gender, ethnic and racial diversity. These specific qualifications may vary from one year to another, depending upon the composition of the Board at that time.

 

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 the Company’s 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 2010 should send a signed letter of recommendation, to be received before November 6, 2009, to the following address: Eaton Corporation, 1111 Superior Avenue, Cleveland, Ohio 44114-2584, attention Corporate Secretary. Recommendation letters 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 and the Board’s

determination in that regard, along with the basis for that determination, is disclosed in the Company’s annual proxy statement. Additional, and more stringent, standards of independence are required of Audit Committee members. The Company’s 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 the Company’s 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 and that each of the following directors qualifies as independent under the Board’s independence criteria and the New York Stock Exchange standards: 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. The basis of the Board’s independence determination was that each of these directors had either no relationship at all with us for the past three years (other than as a director and shareholder) or that none of their relationships with us would likely be sufficient to compromise their independence as directors.

 

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 the Company’s 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 2009, the Governance Committee conducted an annual survey and found that the only related person transactions were those described under the heading “Director Independence” beginning on page 8 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 the Company’s 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 Director-Global Ethics in separate executive sessions; approves the Committee’s report to be included in the Company’s 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 Item 407(d)(5)(ii) of Regulation S-K under the Securities Exchange Act of 1934) and that all members of the Audit Committee have accounting or related financial management expertise. The Audit Committee held eleven meetings in 2008. 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; with input from all outside directors, evaluating the performance of the Chief Executive Officer 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 of each of our senior officers; establishing performance objectives under our short-term 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-term 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, as well as 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 under “Executive Compensation” beginning on page 15. The Compensation and Organization Committee held eight meetings in 2008. Present members are Ms. McCoy (Chair) and Messrs. 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 did not meet during 2008. 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 the Company’s 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 the Company’s dividend policy; reviewing the Company’s 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 2008. 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 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 recommends to the Board 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 2008. Present members are Messrs. Connor, Johnson, Lautenbach (Chair), Miller, Pelson and Tooker.

 

Committee Charters and Policies — The Board of Directors most recently revised the charter of the Governance Committee in September 2007, the charter of the Audit Committee in October 2008, the charter of the Compensation and Organization Committee in January 2009, and the charter of the Finance Committee in October 2007. These 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 eleven meetings in 2008. Each of the directors attended at least 88% of the meetings of the Board and its Committees. 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 2008 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 Statement on Auditing Standards No. 114 (“The Auditor’s Communication with Those Charged with Governance”).

 

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 2007 and 2008, Ernst & Young’s fees for various types of services 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 2008 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 October 2008, 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 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. The non-management directors who chair the Audit Committee, Compensation and Organization Committee, Finance Committee and Governance Committee chair the Executive Sessions on a rotating basis. Shown below are the months when Board meetings are held and the non-employee director who chairs each Executive Session:

 

 

The policy of the Board of Directors is that an Executive Session is held every Board meeting attended only by directors who meet the independence criteria of the Board of Directors and of the New York Stock Exchange. At the present time, all non-employee directors meet these criteria.

 

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 the Company’s management present, to discuss whatever topics they may deem appropriate.

 

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 or outside directors:

 

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 (e.g., the director who will chair a particular Executive Session), the Chair of a particular Board Committee or the outside 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 directors of the Company 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, and all outside directors are compensated for their attendance. At our 2008 annual meeting held April 23, 2008, 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 five independent non-employee directors and is supported by our Human Resources Department as well as one or more independent executive compensation consultants 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.

 

Under our executive compensation philosophy, which was last reviewed and updated by the Committee in January 2009, we design our executive compensation plans and programs to help us attract, motivate, reward and retain highly qualified executives, to align well with the interests of shareholders and to fairly reflect, in the judgment of the Committee, our performance, and the responsibilities and personal performance of individual executives.

 

 

As warranted, 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 have, for many years, participated in and used the annual surveys sponsored by three separate national compensation consulting firms: Hewitt Associates, Towers Perrin 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 by periodic comprehensive studies conducted with the assistance of the consultant retained by the Committee. For several years, and again in 2008, 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 2008, 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, we will first obtain the Committee’s review and approval prior to awarding any material consulting assignment to any firm that has already been engaged by the Committee. In 2008, the Committee reviewed a report of the consulting work performed for the Committee by Hewitt Associates compared to the total annual consulting work on compensation, benefits and actuarial matters performed for the Company. Based on this comparison, the Committee determined that its senior consultant is well positioned to provide independent advice to the Committee.

 

To support the Committee in overseeing our executive compensation plans and programs, we have for many years employed two primary analytical processes, which follow separate, but complementary, approaches. The first is our “Total Compensation Analysis and Planning Process” and the second is our “Peer Group Pay and Performance Analysis Process.” In addition to these two long-standing processes, in 2008 the Company added a third analytical process to assist the Committee with insights into several key practices employed by the companies in our Peer Group (defined on page 17). This new process, which we have named the “Peer Group Pay Targeting and Performance Hurdle Analysis,” is described on page 18.

 

 

As a key part of this process, each year our Chairman and Chief Executive Officer prepares a proposed total compensation plan (consisting of base salary, the target annual cash incentive opportunity, the target long-term cash incentive opportunity and equity-based incentive awards (consisting of stock options, restricted shares or both) for each executive officer (except with respect to his own compensation). Initially, he 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 as to 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, our Chairman and Chief Executive Officer decides upon and submits to the Committee a draft total compensation plan for each executive officer (other than with respect to his own compensation). 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 any) 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 our Chairman and Chief Executive Officer’s position and to establish a total compensation plan for him. In 2008, the Committee again reviewed and discussed the proposed total compensation plans for our executive officers with its compensation consultant prior to finalizing these plans.

 

 

 

Subsequent to the completion of the 2008 compensation analyses (described below), 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. Starting in 2009, this updated Peer Group, which will be disclosed in the 2010 proxy statement, will be used as the basis for our Strategic Planning and Annual Profit Plan analysis, setting short- and long-term incentive plan performance objectives and in our Peer Group Pay and Performance Analysis (described below).

 

Our Peer Group Pay and Performance Analysis is conducted annually to provide the Committee with the relevant compensation data reported by each Peer Group company for its chairman and chief executive officer, its chief financial officer and, to the extent available, for its chief legal officer and any positions equivalent to our group executive positions. The analysis compares our performance with that of the Peer Group over one-year, three-year and five-year time periods using a wide range of performance

metrics. This provides the Committee with insight into how each of the Peer Group companies has actually rewarded its executive officers in the form of base salaries, short-term and long-term incentive awards and annual equity-based awards in light of the returns that it has produced for its investors. Prior to reviewing this data with the Committee, the Committee’s independent compensation consultant reviews the analysis and provides the Committee with his views and commentary. The Committee has indicated that it finds this insight to be very valuable in helping them to assess whether our pay for performance profile is appropriate and aligned with industry and Peer Group practices. In addition, we and the Committee use this comprehensive peer group financial analysis each year to support the process of reviewing and establishing stretch short-term and long-term cash and equity incentive plan goals intended to drive and reward top quartile performance by the Company.

 

 

In February of each year, prior to making decisions about the compensation of our Chairman and Chief Executive Officer and the other Named Executive Officers, we provide the Committee with a comprehensive tally sheet for each executive officer that sets forth the dollar amount of all components of his or her 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 our Chairman and Chief Executive Officer 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 stock 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 2008 the Committee determined the 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 our Chairman and Chief Executive Officer and the other Named Executive Officers to be competitive, reasonable and not excessive. 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.

 

 

We use the following balanced components to achieve our objectives relating to hiring, motivating, retaining and rewarding executive officers:

 

 

While the initial percentage of Annual Net Income payouts under the Senior EIC Plan is formula driven, in using its discretion to reduce initial awards, the Committee considers both objective and subjective factors. As in past years, the Committee based the annual cash incentive awards paid to the Named Executive Officers for 2008 on individual target opportunities expressed as a percentage of the participant’s base salary, the level of our achievement of pre-established stretch financial goals set by the Committee and individual performance ratings that reflected a discretionary assessment by the Committee of each executive’s contributions during the year (which are discussed in greater detail below). In 2008, the Committee based performance goals 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 individual and business unit performance objectives. It used

these goals because, over time, they bear a statistical correlation to the market trading price of our shares. In setting demanding annual EPS and CFR goals under the Senior EIC Plan, the Committee reviews market analyses, our annual profit plan as approved by the Board of Directors and external research reports and comparative analyses of our Peer Group companies (as shown above). The Committee took note of the widespread economic downturn that currently affects virtually all of our lines of business and geographic markets and that clearly impacted our 2008 EPS and CFR results. After considering that we achieved record 2008 revenue and operating income results despite this very difficult economic environment, and after also considering individual performance factors (described below), the Committee approved final awards under the Senior EIC Plan. These final awards, while below the individual awards that would have been earned under the Plan’s percent of Annual Net Income formula, were, in the Committee’s view, appropriately aligned with the incentive awards approved for other Company officers. These awards ranged from $320,000, in the case of the Chairman and Chief Executive Officer’s award, to $77,094, in the case of the lowest-compensated Named Executive Officer. Among many other accomplishments, the Committee also took into account: the fact that the Company’s EPS and CFR performance in 2008, while below the stretch performance goals set at the beginning of the year and despite the drastic downturn in the global economy, were near record levels; the successful issuance of $1.5 billion of new equity in April 2008; the generation in 2008 of $1.4 billion in operating cash flow; and the successful completion and the on-schedule integration of two major and four smaller acquisitions and one joint venture during the year.

 

As noted above, the awards to the Named Executive Officers and other participants in the Senior EIC Plan also reflected their individual performance ratings established by the Committee. In establishing the 2008 individual performance ratings for each Named Executive Officer, the Committee took into consideration a variety of objective and subjective factors as described in the process outlined below.

 

In preparing the recommended individual performance ratings for each Named Executive Officer who reports to him, our Chairman and Chief Executive Officer reviewed each individual Senior Vice President and Group President’s performance in four basic operations-oriented goal categories (which impacts approximately 75% of the final recommended performance rating):

 

 

 

In addition to these operating goals, three of our four Group Chief Executive Officers (Messrs. Arnold, Carson and Sweetnam) also have one or more corporate staff responsibilities. Performance against goals set for these staff functions impacts approximately 25% of their final recommended performance rating. For 2008, these included:

 

 

In preparing the recommended individual performance rating for Mr. Fearon, our Vice Chairman and Chief Financial and Planning Officer, our Chairman and Chief Executive Officer took into consideration the following:

 

 

In developing his recommended performance ratings for the Named Executive Officers, our Chairman and Chief Executive Officer does not follow a formulaic approach but instead develops a recommended rating based upon his subjective view of each executive’s overall performance against this wide range of

both objective and subjective goals for the year. While reviewing and discussing each executive’s performance and recommended performance rating with the Committee, he and the Committee also discuss an assessment of additional subjective factors which includes each executive’s:

 

 

Our officers may defer payment of some or all of their Senior EIC Plan cash incentive payments under a plan described in more detail in the narrative accompanying the Nonqualified Deferred Compensation table on pages 41 and 42.

 

 

We believe that stock options are effective in aligning the interests of our executives with those of our shareholders by having a significant component of executive compensation tied directly to changes in the value of our common shares. Stock options also aid executive retention because they are earned over a period of several years.

 

For a number of years and again in 2008, we established our annual stock option grant guidelines by first determining the Black-Scholes value (or a value set by a comparable market pricing model) of a share of our common stock as reported in the Hewitt, Towers Perrin and Hay surveys for our most recently completed annual stock option grant (February 2007). This value is compared to the fair market value on this same grant date to determine a percentage, which is then multiplied by the average price for a share of our common stock over the last 90 trading days of 2007. The resulting dollar value is then divided into the median long-term incentive compensation values, as determined by the surveys, to establish our recommended median grant sizes for the February 2008 grant.

 

Starting with this basis for determining appropriate median stock option grant levels, as part of the annual Total Compensation Analysis and Planning Process, the Committee then reviews our Chairman and Chief Executive Officer’s recommended stock option grants for each Named Executive Officer. Based on individual factors such as the level of sustained personal performance, long-term career potential and competitive market conditions, the Committee may adjust an individual executive’s stock option grant, if any, to a level that is at, above or below median market practice. Using this same process, in Executive Session the Committee determines the size of the annual stock option grant, if any, that it will make to our Chairman and Chief Executive Officer.

 

In 2008, the Committee approved stock option grants for the Named Executive Officers which were at approximately 50% of the median long-term grant values provided to similar positions as reported in the most recent data for similarly-sized industrial companies in the Hewitt, Towers Perrin and Hay annual surveys. Grants at this level were deemed by the Committee

to be appropriate when considered in the aggregate with the other compensation elements approved for these executives.

 

We set the strike price for all stock option grants at the fair market value of our common shares on the date of the grant (using the process described below). We have never selected strike prices or otherwise timed the grant of stock options to enable executives to profit from an artificially low strike price.

 

Our grant recommendation and approval processes have always been disciplined, straightforward, and consistent. In 1995, under a stock plan previously approved by the shareholders, we added annual grants of stock options to the compensation provided to non-employee directors, and the process for making these grants in 2008 is set forth in the stock plan document. In 2008, the shareholders approved the 2008 Stock Plan under which the non-employee directors received a restricted stock grant in January 2009. This grant process is described on page 48. At the time of its adoption, we anticipated that the number of shares available under the 2008 Stock Plan would be exhausted after the 2009 equity grants. As a result, the Board of Directors has approved a new 2009 Stock Plan with a new allocation of shares and this Plan is being submitted to the shareholders for approval at the 2009 Annual Meeting. Details on the 2009 Stock Plan can be found beginning on page 51, and the plan document is Appendix B to this proxy statement.

 

Under the various Company stock plans, all of which have been approved by the shareholders, a committee of independent directors has exclusive authority to fix the date and all terms and conditions of equity grants to executive officers. Currently, the Committee has this responsibility.

 

 

Key stock option grant practices are as follows:

 

 

 

In 2008 the Committee did not make any mid-year grants to executives who joined the Company as a result of an acquisition.

 

 

The Committee establishes ESIP performance goals at the beginning of each four-year award period based on a comprehensive analysis prepared by management that includes: (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.

 

Absent any unusual circumstances, the Committee typically 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. Prior to the 2005-2008 performance period, we expressed these incentive awards in the form of contingent share units. Contingent share units aligned the interests of the executives with those of the shareholders because the units reflected appreciation or depreciation and earnings on our common shares during the performance period. Beginning with awards for the 2005-2008 performance period, the Committee amended the plan to provide that incentive awards would not be expressed in the form of contingent share units, but would be denominated in cash instead. 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, however, annually reviews this element of the design of the ESIP to ensure that it aligns well with competitive practice and provides an effective long-term incentive structure. As a result of this review in late

2007, the Committee determined that the Plan design should again return to the use of contingent share units in order to rebalance the long-term incentive portfolio and to align the interests of executives and shareholders. This contingent share design feature was included in the Plan approved by the shareholders at the 2008 Annual Meeting and was used in making the 2008-2011 ESIP grants.

 

For the payout of the awards under the 2005-2008 performance period (which, as noted above, were not based on contingent shares), each Named Executive Officer’s target cash award opportunity was multiplied by 163% to reflect the fact that our actual performance exceeded the maximum EPS and CFR goals established by the Committee at the start of this four-year period. The executive’s adjusted cash award opportunity was then multiplied by his or her individual performance rating for the four-year period to determine his or her actual ESIP award payout. As in prior years, the individual performance ratings established by the Committee for each Named Executive Officer were set at approximately the average of his or her individual annual performance ratings, as previously described, for each of the four years in this performance cycle. Actual individual ratings ranged from 110% to 125%. When combined with the 163% adjustment related to our EPS and CFR performance, the final adjusted cash awards ranged from 179% to 204% of the executives’ original target incentive opportunities.

 

Executive officers may defer payment 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 on pages 41 and 42.

 

 

After reviewing the 2008 Peer Group Pay and Performance Analysis (described on pages 17 and 18), the Committee again determined that, despite the fact that the competitive position of the Company’s total compensation for its key executives was at or near the median of market practices as reported for all similarly-sized industrial companies in the Hewitt, Towers Perrin and Hay surveys, our executives’ total compensation was below the median total compensation reported for our Peer Group. In response, the Committee approved additional restricted stock grants for key executives with such awards having shorter vesting schedules than the Committee has typically approved for previous restricted stock awards. Additional details about these restricted stock awards to the Named Executive Officers may be found in the table and footnotes of the Outstanding Equity Awards at Fiscal Year-End Table on pages 37 and 38.

 

 

Our executives do not engage in financial hedging of their investment risk in our shares and we actively and strongly discourage, and do not provide executives

with any advice or assistance related to, such practices.

 

 

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 pay (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.

 

 

In response to typical 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 are hired in mid-career and would therefore 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.

 

Additional details on our retirement income programs can be found in the narrative discussion and footnotes accompanying the Pension Benefits Table on pages 39 and 40.

 

These qualified and nonqualified retirement income plans are the only compensation or benefit plans or programs that we provide to executive officers which take into consideration the amounts realized by the executive from prior compensation awards. For example, any previously-paid awards under annual or long-term incentive plans and any gains realized upon the exercise of employee stock options do not affect the amounts payable as a future award under any other of our compensation plans or programs. Moreover, we do not take these past payouts or stock gains into consideration when we set the level of any future incentive targets or equity award opportunities.

 

 

 

To ensure his personal security and enhance his productivity, the Board of Directors has directed that our Chairman and Chief Executive Officer use our aircraft for all business and personal travel whenever feasible. As a result of this long-standing policy, the Board of Directors also has directed that we provide full tax protection to him with respect to the imputed income attributable to the personal use of such aircraft. While this tax protection was provided in 2008 (as disclosed in the footnotes to the Summary Compensation table beginning on page 32), the Chairman and Chief Executive Officer recommended, and the Board of Directors has approved, the elimination of this tax protection on the imputed income for personal use of Company aircraft by all executives beginning in 2009.

 

 

 

The Director inputs on these performance areas, along with any narrative commentary, were compiled anonymously by the Committee Chair, who then prepared a draft consensus evaluation for review and approval by 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 the Chair of the Committee. The Committee uses this appraisal as a factor to determine, with respect to our Chairman and Chief Executive Officer’s compensation, the payouts under our short-and long-term incentive plans and, as part of the Total Compensation Analysis and Planning Process, any increase in base salary, new short- and long-term incentive targets and equity awards.

 

 

In late 2007, the Committee again reviewed the short- and long-term incentive plans in light of Section 162 (m) and in early 2008 approved a new Senior Executive Incentive Compensation Plan (an annual incentive plan) and an amended Executive Strategic Incentive Plan (our multi-year incentive plan), both of which meet the requirements needed to qualify incentive payments under the Plans as deductible compensation under Section 162(m). These Plans were approved by the shareholders at the 2008 Annual Meeting.

 

Policy on Incentive Compensation, Stock Options and Other Equity Grants Upon the Restatement of Financial Results — In 2007, our Audit and Compensation and Organization Committees, along with the Board of Directors, thoroughly reviewed current market practices and the issues related to compensation recovery practices in the event of a material restatement of financial results due to executive misconduct. Following these deliberations, the Board of Directors adopted a formal policy stating that, if the Board determines that 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 Eaton 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 were amended during 2008 to include provisions reflecting this policy. Additional details regarding this policy and related processes may be found on our website at http://www.eaton.com/governance.

 

As part of its annual Total Compensation Analysis and Planning Process in February 2008, and its review of the December 31, 2007 tally sheet, the Committee reviewed all components of our Chairman and Chief Executive Officer’s compensation, including base salary, target annual cash incentive opportunity, long term cash incentive opportunity and equity based incentives. Based upon these reviews, the Committee concluded that our Chairman and Chief Executive Officer’s total compensation (including compensation payable upon employment termination whether in connection with a change of control of the Company or otherwise) in the aggregate was reasonable and not excessive.

 

The Committee confirmed that the 2008 compensation for our Chairman and Chief Executive Officer was earned pursuant to the procedures, policies and factors described in earlier sections of this Compensation Discussion and Analysis. Following the completion of the 2008 performance evaluation, the Committee Chair advised our Chairman and Chief Executive Officer that the Board of Directors had given him a very favorable overall performance evaluation and that, as in past years, this overall performance appraisal was a key factor used by the Committee in reviewing and approving his annual and long-term incentive awards that were determined at year-end (as previously described in the proxy statement sections entitled “Short-Term Incentives” beginning on page 19 and “Long-Term Cash Incentive Plan” beginning on page 24) and that it would be one element considered by the Committee when it reviews and approves any future annual compensation adjustments, awards and grants under the Committee’s Total Compensation Analysis and Planning Process.

 

In the February 2008 Total Compensation Analysis and Planning Process, the Committee increased our Chairman and Chief Executive Officer’s annual base salary by 8% effective April 1, 2008 in order to better align his base salary with market practices. This adjustment aligned his base salary just above the median annual salary level as reported in the Hewitt, Towers Perrin and Hay surveys for similarly-sized industrial companies. The Committee determined that this was an appropriate target in light of his consistently high performance and length of service in his position. The Committee also increased our Chairman and Chief Executive Officer’s 2008 annual cash incentive target opportunity to 115% of his base salary (from 105% of base salary which was his incentive target opportunity for 2005, 2006 and 2007) and that this incentive opportunity was positioned at approximately the market median reported in the Hewitt, Towers Perrin and Hay surveys for similarly-sized industrial companies. The Committee uses the annual cash incentive target opportunity and other criteria as a means of reducing, at its discretion, the annual award under the Senior Executive Incentive Compensation Plan.

 

As previously noted, under the Senior EIC Plan, the Committee approved an award of $320,000 for our Chairman and Chief Executive Officer. Although this award was less than the amount that would have been earned under the Plan’s percent of Annual Net Income formula, the Committee determined that this incentive payment would appropriately align the Chairman and Chief Executive’s annual bonus with the payments made to our other executives who also received reduced 2008 incentive awards. In establishing our Chairman and Chief Executive Officer’s 2008 individual performance rating for purposes of determining his final award under the Senior EIC Plan, the Committee reported that it took into account the results of the annual Chairman and Chief Executive Officer Performance Appraisal process and such factors as:

 

 

 

As part of the Total Compensation Analysis and Planning Process in February 2008, the Committee established our Chairman and Chief Executive Officer’s target long-term cash incentive opportunity at 153% of base salary for the 2008-2011 performance period which, together with his Committee-approved stock option grant (which will vest in equal installments over a four-year period), positioned the value of the total long-term incentive compensation elements at approximately the market median as reported in the Hewitt, Towers Perrin and Hay surveys for similarly-sized industrial companies. The Committee also approved a restricted stock grant of 17,000 shares for our Chairman and Chief Executive Officer in 2008 which will vest in equal installments over a two-year period. While we use restricted stock awards from time to time to provide an additional level of retention, the Committee also noted that, in addition to retention, it wanted this award to improve the alignment of our Chairman and Chief Executive Officer’s total compensation with that paid to chief executive officers in our Peer Group.

 

The Committee reported that our Chairman and Chief Executive Officer earned a long-term performance plan cash award for the 2005-2008 performance period based upon our EPS and CFR performance and his Committee-approved individual rating, which resulted in a cash award equal to 204% of his target opportunity for this period. This percentage was based upon actual cumulative CFR results and our EPS growth over the 2005-2008 period, which exceeded the maximum pre-established EPS growth and cumulative CFR goals for the period, thus generating an initial 163% adjustment to his target and the individual performance rating of 125% established by the Committee. The Committee also noted that this individual performance rating percentage was approximately equal to his average individual performance rating for each of the four annual incentive plan years in this award period, and that it appropriately reflected his sustained individual performance over this period.

 

As a result of the Committee’s decisions with respect to our Chairman and Chief Executive Officer’s compensation, his total compensation is significantly higher than any of the other Named Executive Officers. This reflects the accumulated difference found in competitive market practices for chief executive officers of large industrial organizations and the very different relative job responsibilities of this position as compared to the job responsibilities and pay practices for other executive positions, as well as increases in the value of his accumulated pension benefits (which are driven by his pay history and long tenure with us).

 

Expected Adjustments to Programs and Practices in 2009 — As we enter 2009, the Committee recognizes the unprecedented crisis in the financial markets and the resulting depressed and unstable market conditions will make it difficult to set precise performance goals. The Committee plans to exercise its discretion by tempering its traditional focus on driving rigorous

long-term growth goals with a renewed focus on annual incentive goals which will reward top quartile operating performance and management of the balance sheet in depressed market conditions. The Committee has also concluded that the current economic conditions have not only severely compromised the potential for awards under our open long-term incentive award periods but have also created a very problematic environment for setting performance goals for the next several four-year award periods. In recognition of these challenging conditions, the Committee has determined that making long-term incentive grants to executives for the next four-year performance period (2009-2012) under the shareholder approved Executive Strategic Incentive Plan would not be advisable since that Plan requires performance goals for the four-year period to be set within the first ninety (90) days of the award period. In light of the current unsettled global economic conditions, the Committee concluded that setting finite incentive goals would not be prudent or in the interests of either the participants or our shareholders. Instead, the Committee adopted a new four-year incentive plan which will provide the Committee with the necessary flexibility to approve performance goals each year over the next four years and use the aggregate performance against the separate annual goals as the means for determining long-term incentive payments for the four-year period ending in 2012. Awards under this new plan will not be deductible under Internal Revenue Code Section 162(m). In addition, the Committee intends to establish and then reward performance against additional short- and mid-term incentive plans with related performance goals that will focus management on continuing to create value for the shareholders throughout the depressed economic conditions and positioning the Company to quickly react to and capitalize on market conditions as they improve. Finally, while the Committee continues to believe that executive compensation programs should reflect a balanced portfolio, given the fact that there are insufficient authorized shares under the 2008 Stock Plan to support the preferred mix of long-term incentives (described in earlier sections of this report), the Committee approved a change to this mix in 2009 which increases the portion of the long-term incentive opportunity granted in the Company’s four-year cash incentive plan and, in order to better conserve shares, the Committee made equity grants in the form of restricted share units instead of stock options. The Committee intends to review this mix each year in light of the shares available under our stock plans and, consistent with the Committee’s interest in providing equity-based components that support an “ownership orientation,” it would intend to return to its preferred long-term incentive mix at the earliest opportunity.

 

Compensation and Organization Committee Report — 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

Michael J. Critelli

Christopher M. Connor

John R. Miller

Gregory R. Page

 

The following table sets forth the total compensation of our Chairman and Chief Executive Officer, our Executive Vice President-Chief Financial and Planning Officer and the three other of our most highly compensated executive officers in 2008 (the “Named Executive Officers”). We have not entered into any employment agreements with any of the Named Executive Officers, other than the change of control agreements described beginning on page 46. Prior to setting total compensation for each of the Named Executive Officers, the Committee reviews tally sheets which show 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 29% of the total cash compensation of the Named Executive Officers. The Named Executive Officers were not entitled to receive “Bonus” payments under column (d) for 2008 (“Bonus” payments are defined under the disclosure rules as discretionary payments that are not based on any performance criteria). The “Non-Equity Incentive Compensation” provided by us, as shown in column (g), is performance-based and accounted for approximately 71% of the total cash compensation of the Named Executive Officers. Column (e), “Stock Awards,” consists of the amount recognized for financial statement reporting purposes with respect to grants of restricted shares under our stock plans. Column (f), “Option Awards,” consists of the amount recognized for financial statement reporting purposes with respect to grants of stock options under our stock plans. Column (g), “Non-Equity Incentive Plan Compensation,” is comprised of two cash components that do not involve any “share based payment” for financial reporting purposes. One component is the amount paid as annual executive incentive compensation for 2008. The other component is the amount paid under the four-year executive incentive plan for the 2005-2008 award period. These payments were approved by the Committee at its January 27, 2009 meeting and, to the extent not deferred by the executive, will be paid on March 13, 2009. 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, tax “gross-up” payments, our contributions to defined contribution plans, the value of insurance premiums and the value of any dividends paid on restricted shares since they are not factored into the grant date fair values reported in columns (e) or (f).

 

 

 

 

 

 

The following table summarizes the potential awards payable to the Named Executive Officers with respect to the short-term and long-term incentive award opportunities granted in 2008.

 

 

 

 

The following table summarizes the outstanding equity awards held by the Named Executive Officers at year-end 2008. The closing price of our common shares on the last trading day in 2008 ($49.71) was used to determine the market value of unvested restricted shares shown in column (h).

 

 

 

 

 

The following table provides information regarding exercises of stock options and vesting of restricted shares during the year ended December 31, 2008 with respect to the Named Executive Officers. The values reflect (a) in the case of exercised stock options, the difference between the aggregate option exercise price and the market price of the applicable number of our common shares on the date of exercise, and (b) in the case of any restricted stock award that vested during 2008, the per share closing price of our common shares on the vesting date multiplied by the number of shares that vested.

 

 

 

 

The following table shows the estimated present value of the benefits payable under each of our retirement income plans to each Named Executive Officer. We maintain three basic types of retirement income plans for our U.S. salaried employees: (a) a tax-qualified defined benefit pension plan (referred to as the Pension Plan for Eaton Corporation Employees in the Pension Benefits table) that has two separate benefit formulas: a final average pay formula and a cash balance formula, (b) two defined benefit restoration plans (collectively referred to as the DB Restoration Plan in the Pension Benefits table) and (c) a plan that allows us to supplement the pension benefits earned under our qualified pension plan and nonqualified DB Restoration Plan to executives who are recruited by us in mid-career (referred to as the Limited Service Supplemental Plan in the Pension Benefits table).

 

Tax-qualified Retirement Income Plans — Effective January 1, 2003, employees who were then earning benefits under the “Average Final Annual Compensation” benefit formula (the “AFAC benefit formula”) under the Pension Plan for Eaton Corporation Employees (the “Pension Plan”) were given the option to either: (a) continue earning benefits under the AFAC benefit formula; or (b) commence earning benefits in an “Eaton Personal Pension Account” under the cash balance formula (the “EPPA benefit formula”). Salaried employees hired on or after January 1, 2002 automatically earn benefits under the EPPA benefit formula upon becoming eligible for participation in the retirement plan. Under the AFAC benefit formula, annual normal retirement benefits are computed at the rate of 1% of average final annual compensation up to the applicable Social Security integration level ($51,348 for 2008 retirements) plus 11/2% of average final annual compensation in excess of the Social Security integration level, multiplied by the employee’s years of credited service. In addition, the employee receives a supplement equal to 1/2% of average final annual compensation up to the applicable Social Security integration level payable until the Social Security Normal Retirement Age. An employee’s average final annual compensation is the average annual amount of his or her eligible compensation (consisting of salary plus annual executive incentive compensation for service during the five consecutive years within the last 10 years of employment for which the employee’s total compensation was the greatest). Years of credited service includes the number of years of employment between age 21 and retirement, with a maximum of 44 years. Corporate policies require that the Named Executive Officers retire at age 65. Under the EPPA benefit formula, a participant’s single sum retirement benefit is accumulated throughout his or her career with us. This single sum amount is represented as a notional account balance to which is regularly added credits equal to a percentage of his or her eligible compensation (consisting of salary and annual executive incentive compensation) plus interest at a specified rate. The percentage of eligible compensation credited to the participant’s notional account balance varies over his or her career based on the sum of the participant’s age and service with us. For any period when that sum is less than 50, 5.0% of compensation is credited. For any period when the sum is between 50 and 59 (inclusive), 6.0% of eligible compensation is credited. When the sum is between 60 and 69 (inclusive), 7.0% of compensation is credited. When the sum is 70 or greater, 8.0% of compensation in credited. Except as noted below, upon termination of employment, the notional account balance is available as a single sum or may be converted to one of several annuity forms. Pursuant to the requirements of the Pension Protection Act, beginning with benefit payments on or after April 1, 2009, no more than 50% of a benefit may be paid as a lump sum and the remaining 50% of the benefit must be paid in the form of a monthly annuity. Under the Pension Plan full lump sum distributions will again become available once the Pension Plan’s funded status is at or above 80%. This restriction applies to both the AFAC and EPPA benefit formulas. Under the standard post-retirement surviving spouse option for the AFAC and EPPA benefit formulas, the participant receives a reduced pension, and a pension equal to 50% of the reduced pension is payable to his or her surviving spouse. For example, the benefit for an employee electing that option at age 65 whose spouse is five years younger would be approximately 11.5% less than the amount of the participant’s annual benefit.

 

Nonqualified Defined Benefit Retirement Plans — Certain provisions of the Internal Revenue Code, as amended, limit the annual benefits that may be paid from a tax-qualified retirement plan (including a limitation on the amount of annual compensation that may be taken into account in calculating a participant’s benefit under a qualified retirement plan ($230,000 in 2008)). As permitted under the Code, the Board of Directors has authorized the payment from our general funds of any benefits calculated under the provisions of the applicable retirement plan which may exceed those limits to any participant, including the Named Executive Officers, whose benefits are impacted by these provisions.

Limited Eaton Service Supplemental Retirement Income Plan  — The Board of Directors has adopted a plan which provides supplemental annual retirement income to certain executives who do not have the opportunity to accumulate significant credited service with us under our tax-qualified retirement income 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. The amount of the annual supplement is generally equal to the amount by which a percentage (described below) of the executive’s average final annual compensation exceeds his or her earned retirement income (which includes amounts receivable pursuant to the retirement plans described above). The percentage of average final annual compensation used for this purpose depends upon an executive’s age and years of service at retirement. The percentage ranges from 25% (for retirements at age 55 with less than 15 years of service) to 50% (for retirements at age 62 or older with 15 years or more of service).

 

Benefits accrued and vested before January 1, 2005 under either the nonqualified or the limited service plans (described above) generally are paid in one of the forms available under our qualified pension plans as elected by the participant. Benefits earned after 2004 are paid as single lump sum. With respect to all benefits, regardless of when accrued, the present value of the benefit will be paid in a single installment upon a change of control of the Company.