Compensation principles 2009 and beyond for UBS senior executives

During 2008, the UBS Board of Directors (BoD) reviewed the incentive systems of the UBS Group (Group) and examined their level of alignment with the firm's values and long-term orientation. Towards the end of the year, UBS announced that a new compensation model would apply from 2009 onwards. At the annual general meeting (AGM) to be held in 2009, shareholders will be invited to participate in an advisory vote on the principles of this new compensation model. This section of this report outlines these principles and explains how the new model will apply to the Chairman of the BoD, independent BoD members and Group Executive Board (GEB) members.

Compensation policy

The Chairman of the UBS BoD receives a fixed base salary that comprises cash and a pre-determined, fixed number of shares.¹ The Chairman is not entitled to any variable compensation.

The independent BoD members receive fixed remuneration fees. Independent BoD members are not entitled to any variable compensation.

Compensation for members of the GEB comprises a fixed salary, variable cash compensation and variable equity compensation. Variable compensation awarded to GEB members:

­- is based on long-term performance: Variable compensation remains an important component of the new model, but it is based on clear, long-term performance measures that take business risk into account. Two variable compensation schemes - one in cash ("cash balance plan"), one in equity ("performance equity plan") - have been defined for the members of the GEB. The results of the senior executive's business division will be a key factor in determining the amount of variable cash compensation to be awarded. In unprofitable years no new variable cash compensation will be paid. In the performance equity plan, the final number of shares that each senior executive will receive can be determined only after three years, and will be based on achievement against two performance measures: economic profit and relative total shareholder return.

-­ addresses risk management: Pay that depends upon long-term performance increases risk awareness. Economic profit used to determine vesting of the performance equity plan is a market-recognized standard for measuring risk-adjusted profit taking into account the cost of equity capital, while the new cash plan no longer pays out immediately, but holds compensation at risk, subject to future business performance.

­- incorporates a "malus" system: A maximum of one-third of a senior executive's variable cash incentive will be paid out at the beginning of the following year. Should certain material adverse events occur, a "malus" or negative award may be applied to the cash balance plan. Separately, the performance equity plan will deliver between zero and two times each senior executive's target award. Failure to achieve threshold economic profit targets or a reasonable level of total shareholder return can result in a share delivery that is considerably below target or even zero.

¹ Pending Kaspar Villiger’s election as Chairman of the BoD this renumeration structure would not be applicable to him (but rather a fixed base salary only).

Compensation components

Chairman of the Board of Directors

From January 2009, the Chairman of the BoD receives a fixed base salary comprising cash and a pre-determined fixed number of UBS shares. These shares vest after four years and are subject to a "malus" in loss-making years over the vesting period. This compensation package does not include any variable, performance-dependent component, but does keep the Chairman's pay aligned with long-term, sustainable value creation through its share component.

Independent members of the Board of Directors

The independent members of the BoD receive fixed remuneration only. Fees are paid 50% in cash and 50% in blocked UBS shares. However, members can elect to have 100% of their remuneration paid in blocked UBS shares. These shares are attributed with a price discount of 15% and restricted from sale for four years from the date they are granted.

Group Executive Board

Members of the GEB are entitled to a fixed salary. In addition, they may receive variable compensation under either the cash balance plan or the performance equity plan or a combination of both (these plans are discussed below).

Base salary

Members of the GEB receive a fixed base salary that is determined according to the skills, experience and knowledge they bring to their role in the relevant market segment.

Cash balance plan

The cash balance plan rewards long-term profitability by linking variable cash compensation to sustained business performance. The plan allows for a maximum of one-third of a senior executive's variable cash incentive to be paid out at the beginning of the following year, with the entire cash incentive in question to be paid out over a three-year period. As such, the plan provides a multi-year reflection of performance and compensation. This is designed to ensure that the financial impact of decisions and actions taken in one period impacts the variable compensation over a longer period of time. The system is significantly strengthened through inclusion of a bonus - malus system, which allows for the application of a "malus" or negative award to the balance of variable compensation. Circumstances in which this could occur include: incurring of a financial loss; material restatement of the Group's financial statements; substantial underachievement of individual performance targets; or the taking of excessive risk or causing of harm to UBS. If a senior executive leaves UBS, the cash balance will be kept at risk for the remaining life of the plan in order to capture any tail risk events.

Performance equity plan

The performance equity plan is forward-looking and dependent on results produced over a three-year time period. At the start of each performance period, senior executives are advised of a potential quantity of restricted performance shares that, subject to the achievement of pre-defined business targets, is expected to vest after three years. A final decision on the actual number of shares that will vest and transfer to the senior executive is only possible after the end of the three-year period, depending upon the level of performance achieved. If UBS's performance over the three-year period is below target, the number of shares that vest is reduced and may be zero. Should UBS's performance over the three-year period be above target, the actual number of shares may be adjusted up to two times the original target. Performance measurement for the first award will begin in 2009, with the first possible vesting in 2012. Performance shares are not eligible for dividends during the three-year measurement period.

The final number of shares that will actually vest depends on cumulative achievement against two performance metrics:

-­ Economic profit (EP) is an internal measure for value creation that reflects both profitability and the equity required to support business risk. It is calculated by subtracting the cost of equity capital from the annual net profit attributable to UBS shareholders. EP is only realized when the return on capital achieved is greater than the firm's cost of capital. In order to offset accounting entries which distort the economic perspective, the EP calculation is adjusted for items not reflected in business performance. The three-year EP targets for the performance equity plan are based on the UBS strategic business plan and analyst expectations. Threshold, target and stretch performance goals have been defined for the 2009 - 2011 performance period based on expected EP performance and consideration of the expected market value associated with those EP performance levels. However, the human resources and compensation committee may revise the performance target if an exceptional event occurs that makes this either necessary or advisable.

-­ Total shareholder return (TSR) is an external measurement of value creation that measures the total return on a UBS share, i.e. both the dividend yield and the capital appreciation of the share price. UBS measures TSR over a three-year period relative to banking industry performance as indicated by the components of the Dow Jones Banks Titans 30 Index©. This global index comprises the top 30 companies in the banking sector, as defined by Dow Jones, and has been chosen for its relevance to UBS (banking), for transparency (known listed companies), for sector coverage (30 leading global banks assessed by market capitalization, revenues, and net profit) and for independence (managed by Dow Jones). For greater transparency and consistent with best practice, the TSR for all companies in the index will be measured in a common currency (Swiss franc).

Cumulative EP is the primary and most important performance measure, with relative TSR performance able to either increase or reduce the award indicated by the EP achievement. Both performance conditions will be pre-defined for each three-year performance period. A shortfall in value creation during the performance period, as measured by cumulative EP and relative TSR performance, may result in a "malus" or the vesting of shares below target (this could be as low as zero). However, in case of outperformance against both the EP target and the TSR index, the actual numbers of shares may be adjusted up to two times the original target award. If a senior executive leaves UBS before the vesting of an award, the quantity of shares received will be pro-rated to the actual service period as well as being dependent upon the full three-year performance conditions. Awards may be forfeited under certain circumstances.

Employment contracts

All GEB members will receive new employment agreements during 2009, under which notice periods will be reduced from 12 months to six months. Furthermore, any discretionary variable compensation paid to senior executives who leave UBS will, as per the new employment agreements, be based on Group, business division and personal performance. Any amounts paid would be pro-rated to the end of the notice period and would use only variable cash compensation as a basis. Furthermore, any payments would generally be made under the cash balance plan, with two-thirds of any variable cash award being kept "at risk" for the remainder of the three-year performance cycle in order to capture any tail risk events. "Golden parachutes" (in the sense of ex gratia payments made to senior executives due to termination of employment) do not exist at UBS.

Share retention policy

Effective 1 January 2009, the Chairman of the BoD and all GEB members are required to retain 75% of all vested shares (after payment of taxes) during their time in office and for a period of eight years from the date of grant. This rule applies for all mandatory share-based compensation plans, including the performance equity plan. For example, performance equity plan shares granted in 2009 will continue to be restricted after vesting until 2017 unless the executive leaves UBS.

All shares granted to independent members of the BoD are blocked for a period of four years from the date of grant.

Top