Linda Herman joined Best Buy as senior manager, executive compensation, knowing that the pace was going to be faster than she was accustomed to at her old job in financial services. “In retail, you need to be able to turn on a dime,” she says. That’s why she shouldn’t have been surprised when she came back to work after a long weekend in July to a request, by CEO Brad Anderson, to be more creative with the 2006 long-term incentive program. Specifically, Anderson asked Herman and her staff why the company couldn’t offer employees a plan that provided an array of options. Up until 2003, Best Buy relied primarily on stock options to retain and reward 2,600 managers and executives. But the Minneapolis-based elec- tronics retailer, like many employers, realized that stock options aren’t always the best retention tool, particularly during times of market volatility, Herman says. And the company knew that accounting rule changes were looming. The rules have since come to pass, and they require companies to expense options. With all that in mind, the firm wanted to try alternatives. So in 2003, the retailer replaced its stock option plan with a mix of performance shares, which employees would get if they reach specific performance criteria, and restricted stock, which are grants of shares that vest at the end of a given period if an employee remains on staff. The final plan, introduced on September 30, 2005, offers participants four choices. Choice 1 is 100 percent stock options with a four-year vesting schedule and a 10-year life. Choice 2 is 50 percent stock options and 50 percent perfor- mance shares, which are based on the company’s total shareholder return compared with the S&P 500 over a three-year period. “The first two choices are catering to people who are willing to roll the dice,” Herman says, adding that the payouts are vulnerable to market conditions. The third and fourth choices are quite different. They are based on “economic value added,” a metric devised by Best Buy that uses an internal for- mula that changes from year to year. They involve the meeting of one-year performance targets, but employees can’t access the rewards for three years. Choice 3 offers 50 percent stock options and 50 percent restricted stock, which is awarded at the end of three years for performance measured against the company’s economic-value-added goal at the end of 2007. Choice 4 offers 50 percent restricted stock and 50 percent performance units, both earned at the end of three years, based on company performance against the economic- value-added goal at the end of 2007. A majority of eligible employees opted for Choice 1 or 2, while only 11 per- cent took Choice 3 and 2 percent chose Choice 4. Herman attributes this imbal- ance to the difficulty of explaining economic value added to its employees.

Questions:

1.Why do you think so many of Best Buy executives opted for Choice 1 or 2? What would you do to encourage more employees to adopt Choices 3 and 4?

2. Does this Best Buy compensation program satisfy line of sight requirements? Which of the four choices do you think has the most direct line of sight?

3. What additional compensation elements would you add to the Best Buy compensation package?