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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 [ ]
Check the appropriate box:
[ ] Preliminary Proxy Statement [ ] CONFIDENTIAL, FOR USE OF THE COMMISSION
ONLY (AS PERMITTED BY RULE 14a-6(e)(2))
[X] Definitive Proxy Statement
[ ] Definitive Additional Materials
[ ] Soliciting Material Pursuant to sec.240.14a-11(c) or sec.240.14a-12
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):
[ ] No fee required.
[ ] 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: ...............
(3) Per unit price or other underlying value of transaction computed pursuant to
Exchange Act Rule 0-11 (Set forth the amount on which the filing fee is
calculated and state how it was determined): ...............................
(4) Proposed maximum aggregate value of transaction: ...........................
(5) Total fee paid: ............................................................
[ ] Fee paid previously with preliminary materials.
[ ] Check box if any part of the fee is offset as provided by Exchange Act Rule
0-11(a)(2) and identify the filing for which the offsetting fee was paid
previously. Identify the previous filing by registration statement number,
or the Form or Schedule and the date of its filing.
(1) Amount Previously Paid: ....................................................
(2) Form, Schedule or Registration Statement No.: ..............................
(3) Filing Party: ..............................................................
(4) Date Filed: ................................................................
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NOTICE OF MEETING
The 2004 annual meeting of Eaton Corporation shareholders will be held
Wednesday, April 28, at 10:30 a.m. local time at The Forum Conference and
Education Center, One Cleveland Center, 1375 East Ninth Street, Cleveland, Ohio,
for the purpose of:
1. Electing directors;
2. Approving the 2004 Stock Plan;
3. Ratifying the appointment of independent auditors; and
4. Considering reports and such other business as may properly come before the
meeting.
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 March 1, 2004. Shareholders of record at that time are
entitled to vote at the meeting.
By order of the Board of Directors
/s/ Earl R. Franklin
Earl R. Franklin
Vice President and Secretary
March 19, 2004
Your Vote Is Important
You may vote your shares electronically by using a toll-free telephone number or
the Internet, as described on the proxy card, or you may mark, sign, date and
mail your proxy card in the postage-paid envelope provided. We encourage you to
file your proxy electronically if either of these options is available to you.
The method by which you vote will not limit your right to vote in person at the
annual meeting.
CONTENTS
PAGE
----
Proxy Solicitation ......................... 3
Voting at the Meeting ...................... 3
Election of Directors ...................... 4
Director Nomination Process................. 8
Security Holder Recommendations of Director
Candidates................................ 9
Director Independence....................... 9
Board Committees ........................... 9
Committee Charters and Policies............. 11
Audit Committee Report...................... 12
Compensation of Directors .................. 13
Board of Directors Governance Policies...... 13
Executive Sessions of the Outside
Directors................................. 13
Security Holder Communications to the
Board..................................... 14
Director Attendance at Annual Meetings...... 14
Code of Ethics.............................. 14
Executive Compensation ..................... 14
Compensation and Organization Committee
Report.................................... 18
Approval of the 2004 Stock Plan ............ 26
Ratification of the Appointment of
Independent Auditors ..................... 30
Other Business ............................. 30
Ownership of Outstanding Voting Shares...... 30
Section 16(a) Beneficial Ownership Reporting
Compliance................................ 32
Future Shareholder Proposals ............... 32
APPENDICES
Appendix A:
Charter of Governance Committee and
Relevant Policies......................... 32
Appendix B:
Board of Directors Governance Policies ... 34
Appendix C:
Board of Directors Independence Criteria
and Relevant Policy ...................... 37
Appendix D:
Charter of Audit Committee and Relevant
Policies ................................. 39
Appendix E:
Charter of Compensation and Organization
Committee................................. 42
Appendix F:
Charter of Finance Committee.............. 43
Appendix G:
Code of Ethics ........................... 45
Appendix H:
2004 Stock Plan .......................... 47
PROXY STATEMENT
EATON CORPORATION
Eaton Center
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, 2003 are scheduled to be sent to shareholders on or
about March 19, 2004.
PROXY SOLICITATION
Eaton's Board of Directors solicits your proxy, in the form enclosed, for use at
the 2004 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 approval of the 2004 Stock Plan, and for ratification of the
appointment of Ernst & Young LLP as independent auditors. These matters are
described in the following sections of this proxy statement.
Any shareholder giving a proxy may revoke it by giving Eaton notice in writing
or by facsimile, electronic mail, 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 facsimile. Eaton has retained The
Proxy Advisory Group of Strategic Stock Surveillance, LLC, 331 Madison Ave.,
12th Floor, New York, New York 10017, to assist in the solicitation of proxies,
primarily from brokers, banks and other nominees, for an estimated fee of
$12,500, 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.
VOTING AT THE MEETING
Each Eaton shareholder of record at the close of business on March 1, 2004 is
entitled to one vote for each share then held. On March 1, 151,658,974 Eaton
common shares (par value, 50c each) were outstanding and entitled to vote.
At the 2004 annual meeting, the inspectors 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 inspectors of election intend to treat properly
executed or transmitted proxies marked "abstain" as "present" for these
purposes. The inspectors 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 the greatest number of votes will be elected
directors. Votes withheld in respect of the election of directors will not be
counted in determining the outcome of the election. 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, which requirement
is 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
3
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 an 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, the individuals named in the proxy will vote the
shares represented by the proxy cumulatively for those nominees that they may
determine in their discretion, except that no votes will be cast for any nominee
as to whom the shareholder giving the proxy has directed that his or her vote be
withheld.
1. ELECTION OF DIRECTORS
The Board of Directors is presently composed of ten members. The terms of three
directors will expire in April, 2004, and those directors have been nominated
for re-election. Two of the nominees were elected at the 2001 annual meeting,
and one was elected at the 2003 annual meeting. (See page 5.)
If any of the nominees become unable or decline to serve, the individuals named
as proxies in the enclosed proxy card will have the authority to appoint
substitutes. Eaton's management, however, has no reason to believe that this
will occur.
Following is biographical information about each nominee and each director.
4
NOMINEES FOR ELECTION TO TERMS ENDING IN 2007 OR WHEN THEIR SUCCESSORS ARE
ELECTED AND HAVE QUALIFIED:
E. GREEN PHOTO K. M. PATEL PHOTO
M. J. CRITELLI PHOTO
MICHAEL J. CRITELLI, 55, is ERNIE GREEN, 65, is founder, KIRAN M. PATEL, 55, is
Chairman and Chief Executive President and Chief Executive Vice President and
Officer of Pitney Bowes Executive Officer of Ernie Chief Financial Officer of
Inc., a provider of Green Industries, Inc., a Solectron Corporation, a
messaging and advanced manufacturer of automotive provider of electronics
business communications components. He is also manufacturing services.
solutions. He was elected President of Florida Prior to joining Solectron
Vice Chairman and Chief Production Engineering, in 2001, he was associated
Executive Officer of Pitney Inc., a subsidiary of Ernie with Cummins Inc. for 27
Bowes in 1996, and became Green Industries. He is a years, where he served as
Chairman and Chief Executive director of DP&L Inc., and Vice President and Chief
Officer in 1997. Mr. Pitney Bowes Inc. Financial Officer from 1996
Critelli is non-executive DIRECTOR SINCE 1995 to 2000. In 2000-2001, Mr.
Chairman of the National Patel was the Chief
Urban League. Financial Officer of
DIRECTOR SINCE 1998 iMotors, an Internet-based
valued-added retailer of
used cars. He is a member of
the American Institute of
Certified Public
Accountants, the Tennessee
Society of Certified Public
Accountants, and the
Financial Executive
Institute. He is a director
of Westport Innovations,
Inc.
DIRECTOR SINCE 2003
5
DIRECTORS WHOSE PRESENT TERMS CONTINUE UNTIL APRIL, 2005:
J. R. MILLER PHOTO G. R. PAGE PHOTO V. A. PELSON PHOTO
N. C. LAUTENBACH PHOTO
NED C. LAUTENBACH, 60, is a JOHN R. MILLER, 66, is a GREGORY R. PAGE, 52, is VICTOR A. PELSON, 66, is a
partner of Clayton, Dubilier retired oil industry President and Chief Senior Advisor to UBS
& Rice, Inc., a private executive. Mr. Miller was Operating Officer of Securities LLC, investment
equity investment firm President, Chief Operating Cargill, Incorporated, an bankers. Before becoming
specializing in management Officer and a director of international marketer, associated with UBS
buyouts. He serves as Co- The Standard Oil Company processor and distributor of Securities and its
Chairman of Covansys from 1980 to 1986, also agricultural, food, predecessors in 1996, Mr.
Corporation, a worldwide serving as a member of its financial and industrial Pelson was an employee of
provider of information Management Committee, and products and services. He AT&T from 1959 to 1996,
technology services. Before where he previously held a was Corporate Vice President where he held a number of
joining Clayton, Dubilier, number of other executive & Sector President, executive positions,
Mr. Lautenbach was positions, including that of Financial Markets and Red including Group Executive
associated with IBM from Vice President, Finance for Meat Group of Cargill in and President responsible
1968 until his retirement in three years. He is currently 1998, Corporate Executive for the Communications
1998. At IBM, he held a director of Cambrex Vice President, Financial Services Group, Executive
several executive positions, Corporation and Graphic Markets and Red Meat Group Vice President and member of
including Senior Vice Packaging Corporation. Mr. in 1999, and became the Management Executive
President and Group Miller was a member of the President and Chief Committee. At the time of
Executive - Sales and Board of the Federal Reserve Operating Officer in 2000. his retirement from AT&T,
Distribution, and was a Bank of Cleveland from 1986 Mr. Page is a director of Mr. Pelson was Chairman of
member of IBM's Corporate to 1993, serving as its Cargill, Incorporated. Global Operations and a
Executive Committee. From Chairman during the last two DIRECTOR SINCE 2003 member of the Board of
1999 to 2002, Mr. Lautenbach of those years. From 1988 to Directors. Mr. Pelson is a
served as Chief Executive 2000, he was Chairman, director of Dun & Bradstreet
Officer of Acterna President and Chief and United Parcel Service.
Corporation, a global Executive Officer of TBN DIRECTOR SINCE 1994
provider of communications Holdings Inc., a buyout
test equipment, software and firm, and from 2000 to 2003
services, which filed and he was Chairman, President
had approved in 2003 a and Chief Executive Officer
voluntary plan of of Petroleum Partners, Inc.,
reorganization under Chapter a provider of outsourcing
11. Mr. Lautenbach is a services to the petroleum
director of Covansys industry.
Corporation, a member of the DIRECTOR SINCE 1985
Board of Trustees of
Fidelity Investments, and a
member of the Council on
Foreign Relations.
DIRECTOR SINCE 1997
6
DIRECTORS WHOSE PRESENT TERMS CONTINUE UNTIL APRIL, 2006:
G. L. TOOKER PHOTO D. L. McCOY PHOTO
A. M. CUTLER PHOTO
ALEXANDER M. CUTLER, 52, is GARY L. TOOKER, 64, is an DEBORAH L. MCCOY, 49, is
Chairman, Chief Executive independent consultant and Senior Vice President,
Officer and President of former Chairman of the Flight Operations of
Eaton Corporation. Mr. Board, Chief Executive Continental Airlines, Inc.
Cutler joined Cutler-Hammer, Officer and Director of She joined Continental as a
Inc. in 1975, which was Motorola, Inc., a pilot in 1979, advanced
subsequently acquired by manufacturer of electronics through several senior pilot
Eaton, and became President equipment. Mr. Tooker became positions to become Senior
of Eaton's Industrial Group Motorola's President in Director, Operations
in 1986 and President of the 1990, Vice Chairman and Performance in 1994, Vice
Controls Group in 1989. He Chief Executive Officer in President, Inflight and
advanced to Executive Vice 1993, Chairman in 1997, and Standards Training and
President -- Operations in retired from Motorola in Performance in 1996, and
1991, was elected Executive 1999. Mr. Tooker is a Vice President, Flight
Vice President and Chief director of Avnet, Inc. and Training and Inflight in
Operating Axcelis Technologies, Inc. 1997. Ms. McCoy assumed her
Officer -- Controls in 1993, He serves on the Board of present position in 1999.
President and Chief Trustees of Morehouse DIRECTOR SINCE 2000
Operating Officer in 1995, College.
and assumed his present DIRECTOR SINCE 1992
position in 2000. Mr. Cutler
is a director of Axcelis
Technologies, Inc. and
KeyCorp.
DIRECTOR SINCE 1993
7
DIRECTOR NOMINATION PROCESS -- The Governance Committee of the Board, comprised
entirely of directors who meet the independence requirements of the New York
Stock Exchange, is responsible for overseeing the process of nominating
individuals to stand for election as directors. A copy of the Governance
Committee's current charter is available on the Company's website
(www.Eaton.com) under the heading of "Corporate Governance" and is included in
this proxy statement as Appendix A.
The Company's process of director nominations takes into consideration
individuals recommended by the Company's security holders, members of the Board
and the professional search firm retained by the Governance Committee.
Any director candidates recommended by the Company's security holders will be
given consideration by the Governance Committee, consistent with the process
used for all candidates and in accordance with the Company's policy regarding
such recommendations. This policy, which has been approved by the Governance
Committee, describes the procedures by which security holders may put forth
their recommendations. The policy appears on page 9 of this proxy statement
under the heading "Security Holder Recommendations of Director Candidates."
The Governance Committee's process for identifying and evaluating director
candidates is as follows. The Committee typically retains a professional search
firm to assist the Committee in managing the overall process, including the
identification of director candidates who meet certain criteria set from time to
time by the Committee. All potential candidates, whether identified by the
search firm, security holders or Board members, are reviewed by the Governance
Committee, the Chairman and Chief Executive Officer and the Vice
President -- Human Resources, and at times by the search firm. In the course of
this review, some candidates are eliminated from further consideration because
of conflicts of interest, unavailability to attend Board or Committee meetings
or other relevant reasons. The Committee then decides which of the remaining
candidates most closely match the established criteria and are therefore
deserving of further consideration. The Committee then discusses these
candidates, decides which of them, if any, should be pursued, gathers additional
information if desired, conducts interviews and decides whether to recommend one
or more candidates to the Board of Directors for nomination. The Board discusses
the Committee's recommended candidates, decides if any additional interviews or
further background information is desirable and, if not, decides whether to
nominate one or more candidates. Those nominees are named in the proxy statement
for election by the shareholders at the Annual Meeting (or, if between Annual
Meetings, in rare cases, the nominees may be elected by the Board itself).
In order to be recommended by the Governance Committee, a candidate must meet
the following minimum qualifications, as described in the Company's Board of
Directors Governance Policies, appearing in Appendix B to this proxy statement:
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 both
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.
8
SECURITY HOLDER 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 security holder. Any
security holder wishing to recommend an individual as a nominee for election at
the annual meeting of shareholders to be held in 2005 should send a signed
letter of recommendation, to be received before November 3, 2004, to the
following address: Eaton Corporation, Eaton Center, 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 named as a candidate and, if nominated and elected,
consenting to serve as a director.
DIRECTOR INDEPENDENCE -- The Board of Directors Governance Policies, a copy of
which is included as Appendix B to this proxy statement, provide that all
outside directors should be independent. The listing standards of the New York
Stock Exchange state that no director can qualify as "independent" unless the
Board of Directors affirmatively determines, and discloses in the Company's
annual proxy statement, that the director has no material relationship with the
Company and unless the Company discloses the basis for the Board's
determination. Additional, and more stringent, standards of independence are
required of Audit Committee members.
The Board of Directors has adopted certain independence criteria, which are
consistent with the New York Stock Exchange requirements, for the purpose of
determining each director's independence. A copy of these criteria is included
as Appendix C to this proxy statement. Since director independence includes
consideration of the nature and amount of compensation paid by the Company to
its directors, the Board has adopted a policy to determine when a director is
deemed to have received "compensation" in connection with use of Company planes.
A copy of this policy is also included in Appendix C. The Board of Directors and
its Governance Committee have applied these independence criteria and the policy
on plane usage in assessing the independence of each member of the Board.
The Board of Directors has affirmatively determined that none of the members of
the Board except for Mr. Cutler has a material relationship with the Company,
that each director except Mr. Cutler qualifies as independent under the Board's
independence criteria and the New York Stock Exchange criteria, and that each
member of the Audit Committee meets the additional standards of independence
required of them under both sets of criteria.
BOARD COMMITTEES -- The Board of Directors has the following standing
committees: Audit, Compensation and Organization, Executive, Finance, and
Governance.
Audit Committee. The function of the Audit Committee includes 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 the Company's independent auditor; the
performance of the internal auditors; and the Company's compliance with legal
and regulatory requirements. The Audit Committee exercises sole authority to
appoint, terminate and compensate the independent auditor; pre-approves all
auditing services and permitted non-audit services to be performed for the
Company by the independent auditor; reviews the annual audited financial
statements with management and the independent auditors before publication,
including major issues regarding accounting and auditing principles and
practices, and the adequacy of internal controls, and recommends to the Board
the inclusion of the financial statements in the annual report on Form 10-K;
reviews analyses of significant financial reporting issues and judgments made in
connection with the preparation of the Company's annual financial statements;
reviews material changes to auditing and accounting principles and
9
practices; reviews legal matters that may have a material impact on the
Company's financial statements; meets with management to review the Company's
material financial risk exposures and the steps taken to monitor and control
them; reviews the report of the Director -- Audits on internal controls and
internal audit results; at least annually obtains written statements from the
independent auditor delineating all relationships between the independent
auditor and the Company and discusses these statements with the auditor;
considers the compatibility of the auditor's non-audit services with the
auditor's independence and satisfies itself of the independence of the auditor;
at least annually obtains and reviews a report by the independent auditor
describing the independent auditor's internal quality control procedures, any
material issues raised by the most recent internal quality control review, or
any governmental or professional inquiry during the last five years regarding
one or more independent audits carried out by the independent auditor, and any
steps taken to deal with such issues; evaluates the performance of the
independent auditor and its lead partner; sets clear hiring policies for
employees or former employees of the independent auditor that comply with the
Sarbanes-Oxley Act of 2002 and the New York Stock Exchange listing standards;
reviews the appointment and any replacement of the Company's Director-Audits;
meets with the Director-Audits and independent auditor prior to the annual audit
to review the scope, planning and staffing of the audit; discusses with the
independent auditor matters relating to the Company's annual audit and quarterly
reviews, including the independent auditor's judgment about the quality of the
Company's accounting principles applied in its financial reporting; reviews with
the independent auditor any problems or difficulties encountered by the auditor
in the annual audit; reviews with management and the independent auditor the
Company's quarterly financial statements prior to the filing of each Form 10-Q
report; reviews and discusses quarterly reports by the independent auditor
regarding all critical accounting policies and practices, all alternative
treatments of financial information within generally accepted accounting
principles that have been discussed with management and the treatment preferred
by the independent auditor, and other material written communications between
the independent auditor and the Company's management; reviews disclosures by the
chief executive officer and chief financial officer during their certification
process for Form 10-K and 10-Q reports in regard to significant deficiencies in
the operation of internal controls or any fraud involving management or
employees who have a significant role in the Company's internal controls;
discusses the types of information to be disclosed in earnings guidance to
analysts and others, and the type of presentation to be made to rating agencies;
meets regularly with the Company's chief financial officer, Director-Audits, and
independent auditor in separate executive sessions; prepares 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. The Audit Committee held nine meetings in 2003.
Present members are Ms. McCoy and Messrs. Miller, Patel and Pelson.
Compensation and Organization Committee. The functions of the Compensation and
Organization Committee include reviewing proposed organization or responsibility
changes at the officer level; evaluating the performance of the Chief Executive
Officer and reviewing the performance evaluations of the other elected officers;
reviewing succession planning for key officer positions; and recommending the
individual to assume the position of Chief Executive Officer if that position
becomes vacant due to unforeseen circumstances. The Committee is also
responsible for determining the salary of each elected officer of the Company,
subject to discussion by the Board and endorsement by the independent directors,
reviewing awards to elected officers under the Executive Incentive Compensation
Plan and the aggregate amount of awards under the Plan, adjusting that amount as
appropriate within the terms of the Plan, establishing and subsequently
determining the attainment of performance objectives under the Company's
long-term incentive compensation plans, annually reviewing awards to elected
officers
10
under the Company's long-term incentive compensation plans, administering stock
option plans and 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 the Company's officers
or primarily benefiting key employees, and preparing an annual report for the
Company's proxy statement regarding executive compensation. The Compensation and
Organization Committee held six meetings in 2003. Present members are Messrs.
Critelli, Green, Lautenbach, Page and Tooker.
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 met once in 2003. Mr. Cutler is a member of the
Committee for the full twelve-month term, and 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 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 two meetings in 2003. Present
members are Messrs. Lautenbach, Miller, Page, Pelson and Tooker.
Governance Committee. The responsibilities of the Governance Committee include
recommending to the Board improvements in the Company's 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 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 the Company's
relationships with shareholders, employees, customers, competitors, suppliers
and the communities in which the Company operates, including such areas as
ethics compliance, environmental, health and safety issues, diversity and equal
employment opportunity, community relations, government relations, charitable
contributions, shareholder and investor relations and the Eaton Philosophy --
Excellence through People. The Governance Committee held four meetings in 2003.
Present members are Ms. McCoy and Messrs. Critelli, Green, Miller and Patel.
COMMITTEE CHARTERS AND POLICIES -- The Board of Directors revised the charters
of the Audit Committee and the Compensation and Organization Committee most
recently in October, 2003, the charter of the Finance Committee in January,
2004, and the charter of the Governance Committee in February, 2004. The charter
of the Governance Committee is attached to this proxy statement as Appendix A,
the charter of the Audit Committee is attached as Appendix D, the charter of the
Compensation and Organization Committee is attached as Appendix E and the
charter of the Finance Committee is attached as Appendix F.
11
Formal policies relating to corporate governance matters have been adopted by
several Board Committees, or by the Board itself upon the Committees'
recommendation. Summaries of these policies are included in Appendices A and D.
The Board of Directors held ten meetings in 2003. All directors attended at
least 75% of the meetings of the Board and its committees. The average rate of
attendance for all directors was 98%.
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
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
auditors, 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 four directors, all of whom are independent under the Sarbanes-Oxley Act of
2002 and the listing standards of the New York Stock Exchange.
The Board of Directors amended the Committee's charter most recently on October
22, 2003. A copy of the charter is attached as Appendix D to this Proxy
Statement.
In carrying out its responsibilities, the Audit Committee has reviewed, and has
discussed with the Company's management, the Company's 2003 audited financial
statements.
The Committee has discussed with Ernst & Young LLP, the Company's independent
auditors, the matters required to be discussed by generally accepted auditing
standards.
The Committee has also received the written disclosures from Ernst & Young
regarding their independence from the Company that are required by Independence
Standards Board Standard No. 1, has discussed with Ernst & Young their
independence and has considered the compatibility of their services, other than
their audit services, with their independence.
For 2002 and 2003, Ernst & Young's fees for various types of services to the
Company were as shown below:
2003 2002
------------ ------------
Audit Fees.............. $7.3 million $6.1 million
Audit-Related Fees...... 1.3 million 1.7 million
Includes employee
benefit plan audits,
and business
acquisitions and
divestitures
Tax Fees................ 5.4 million 6.3 million
Tax compliance
services 3.5 million 3.1 million
Tax advisory services 1.9 million 3.2 million
All Other Fees.......... 0.1 million -0-
Includes expatriate
administrative
services
The Audit Committee did not approve any of the services shown in the above four
categories through the use of the "de minimis" exception permitted by SEC rules.
The Audit Committee has adopted the following procedure for pre-approving audit
services and other services to be provided by the Company's independent
auditors: specific services are pre-approved from time to time by the Committee
or by the Committee Chairman on its behalf. As to any services approved by the
Committee Chairman, 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 financial statements for 2003 be included in the Company's
Annual Report on Form 10-K filed with the Securities and Exchange Commission,
and the Board has approved their inclusion.
12
Respectfully submitted to the Company's shareholders by the Audit Committee of
the Board of Directors.
Victor A. Pelson, Chairman
Deborah L. McCoy
John R. Miller
Kiran M. Patel
COMPENSATION OF DIRECTORS -- Employee directors are not compensated for their
services as directors. Non-employee directors receive an annual retainer of
$60,000. The Chairman of the Finance Committee receives an annual retainer of
$5,000; the Chairman of the Compensation and Organization Committee and the
Chairman of the Governance Committee each receives an annual retainer of $7,500;
and the Chairman of the Audit Committee receives an annual retainer of $10,000.
Non-employee directors also receive a fee of $2,000 for each Board meeting
attended and for attendance at any special presentation on non-Board meeting
days, and a fee of $2,000 for each Board committee and shareholder meeting
attended.
Non-employee directors first elected before 1996 may defer payment of their
annual fees not to exceed $30,000 at a rate of interest specified in their
deferred compensation agreements. The rate of interest is based upon the number
of years until a director's normal retirement date and, in general, is higher
than prevailing market rates. All non-employee directors may defer payment of
their fees at a rate of return which varies, depending on whether the director
defers the fees as retirement compensation or as short-term compensation. At
least 50% of retirement compensation, or any greater portion which the director
elects, is converted to share units and earns share price appreciation and
dividend equivalents. The balance of retirement compensation earns 10-year
Treasury note returns plus 300 basis points. Short-term compensation earns
13-week Treasury bill returns. These arrangements provide for accelerated lump
sum or installment payments upon a failure by the Company to pay or termination
of service in the context of a change in control of the Company.
Under the Company's Stock Plans, as approved by the shareholders, each person
who on April 22, 1998 or thereafter becomes a non-employee director
automatically is granted a stock option for 10,000 shares upon the date of his
or her election. So long as each non-employee director continues to serve in
that capacity, beginning in the year after the director receives his or her
initial grant, he or she is automatically granted an option for a number of
shares equal to the quotient resulting from dividing (i) four times the annual
retainer for each non-employee director in effect on the granting date, by (ii)
the closing price of an Eaton common share on the New York Stock Exchange
Composite Transactions on the last business day immediately preceding the
granting date. The granting date is the Tuesday immediately before the fourth
Wednesday of each January.
Upon leaving the Board, non-employee directors who were first elected prior to
1996 are eligible to receive an annual benefit, as described below. For Board
service of at least five years, eligible directors receive an annual benefit
equal to the annual retainer in effect at the time the directors leave the
Board. Eligible directors having fewer than five years but more than one year of
Board service at the time of their Board retirement receive a proportionately
reduced annual benefit. The annual benefit is paid for the lesser of ten years
or life. The present value of payments under this plan will be paid in a lump
sum upon a "proposed change in control" of the Company, unless otherwise
determined by a committee of the Board. Directors who are first elected in 1996
or later are not eligible to receive the annual benefit.
BOARD OF DIRECTORS GOVERNANCE POLICIES -- The Board of Directors revised the
Board of Directors Governance Policies most recently in February, 2004, as
recommended by the Governance Committee of the Board. The revised Governance
Policies are attached as Appendix B to this proxy statement.
EXECUTIVE SESSIONS OF THE OUTSIDE DIRECTORS -- The policy of the Board of
Directors is that the outside 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 outside
13
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 outside director who chairs each Executive Session:
January -- Chairman of the Audit
Committee
February -- Chairman of the Compensation
and Organization Committee
April -- Chairman of the Governance
Committee
July -- Chairman of the Finance
Committee
September -- Chairman of the Audit
Committee
October -- Chairman of the Compensation
and Organization Committee
The policy of the Board of Directors is that at least one such Executive Session
is held every year 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 outside 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.
SECURITY HOLDER COMMUNICATIONS TO THE BOARD -- The Company's Board of Directors
provides the following process for security holders to send communications to
the Board:
Security holders may send such communications by mail or courier delivery
addressed as follows:
Mr. Earl R. Franklin
Vice President and Secretary
Eaton Corporation
Eaton Center
1111 Superior Avenue
Cleveland, Ohio 44114-2584
In general, the Vice President and Secretary forwards all such communications to
the Chairman of the Governance Committee. The Committee Chairman 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 or the Chairman of a particular
Board Committee, the Vice President and Secretary forwards those communications
directly to the Board member in question.
DIRECTOR ATTENDANCE AT ANNUAL MEETINGS -- The policy of the Company's Board of
Directors is that all directors should attend Annual Meetings and are
compensated for their attendance. At the Company's 2003 Annual Meeting, held
April 23, 2003, all nine members of the Board were in attendance.
CODE OF ETHICS -- In July, 2003, the Board of Directors approved a new Code of
Ethics for the Company, replacing its former Statement on Ethical Business
Conduct. The Company has provided training globally for all employees on the new
Code of Ethics. Eaton requires that all directors, officers and employees of
Eaton, its subsidiaries and affiliates abide by the new Code of Ethics, which is
attached as Appendix G to this proxy statement.
EXECUTIVE COMPENSATION -- The following table summarizes the total compensation
of the Chairman and Chief Executive Officer of Eaton and the four other most
highly compensated executive officers for fiscal year 2003. The table also
summarizes compensation of the named executive officers for fiscal years 2002
and 2001. The number of shares shown in the table has been adjusted to reflect
the two-for-one stock split in the form of a stock dividend distributed on
February 23, 2004, to shareholders of record on February 9, 2004.
14
SUMMARY COMPENSATION TABLE
LONG-TERM
COMPENSATION
----------------------------------
AWARDS PAYOUTS
--------------------- ----------
RESTRICTED STOCK
ANNUAL COMPENSATION OTHER ANNUAL STOCK OPTIONS LONG-TERM ALL OTHER
---------------------------- COMPENSATION AWARD(S) (SHARES) INCENTIVE COMPENSATION
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS (1) (2) (3) PAYOUTS (4)
----------------------------------------------------------------------------------------------------------------------------
A. M. Cutler 2003 $950,004 $1,504,807 $93,678 $931,665 242,000 $1,826,607 $36,872
Chairman, 2002 950,004 1,745,633 87,245 944,790 224,000 918,496 31,497
Chief Executive Officer 2001 941,670 654,588 14,923 699,100 180,000 317,771 25,579
and President
C. Arnold 2003 $411,750 $ 445,372 $ 0 $175,125 44,000 $ 602,763 $22,858
Senior Vice President 2002 399,125 456,934 0 204,500 44,000 326,552 22,464
and Group Executive -- 2001 384,375 135,780 0 174,775 40,200 126,911 12,099
Fluid Power
S. M. Buente 2003 $413,362 $ 408,885 $ 273 $175,125 44,000 $ 619,212 $47,756
Senior Vice President 2002 393,517 486,816 0 204,500 44,000 294,535 11,177
and Group Executive -- 2001 359,374 156,282 0 174,775 40,200 132,548 18,297
Automotive
R. W. Carson 2003 $437,588 $ 452,125 $25,312 $175,125 44,000 $ 602,763 $26,992
Senior Vice President 2002 418,614 515,456 1,054 204,500 44,000 363,468 28,576
and Group Executive -- 2001 420,121 148,405 0 174,775 40,200 132,715 20,474
Electrical
R. H. Fearon 2003 $439,184 $ 476,110 $ 0 $175,125 44,000 $ 407,289 $25,685
Executive Vice 2002 301,045 507,616 0 422,900 44,000 73,909 17,227
President --
Chief Financial and 2001 0 0 0 0 0 0 0
Planning Officer
----------------------------------------------------------------------------------------------------------------------------
(1) Reported in this column is annual compensation representing (i) amounts
reimbursed by the Company for the payment of income taxes on certain
executive perquisites and (ii) $77,732 in executive perquisites received by
Mr. Cutler in 2003, including $50,616 which represents the incremental cost
for personal use of company-owned aircraft. Due to concerns for his personal
security, the Board of Directors has directed Mr. Cutler to use the
company-owned aircraft for his and his family's personal travel.
(2) At year-end 2003 the number and value of unvested restricted shares held by
each of the named executive officers were as follows: A. M. Cutler, 57,080,
$3,081,749; R. W. Carson, 12,000, $647,880; S. M. Buente, 12,000, $647,880;
C. Arnold, 78,446, $4,235,300; and R. H. Fearon, 13,000, $701,870. Value is
calculated by multiplying the closing price of an Eaton share on that date
by the number of restricted shares. The restricted share awards shown in the
table vest over four-year periods. Dividends are paid to the executives with
respect to the unvested restricted shares they hold at the same rate and
time as dividends are paid on outstanding Company shares generally.
(3) For a number of years, grants have been determined by dividing (i) the
median long-term incentive compensation values paid by similar companies, as
reported in the most recent compensation surveys, by (ii) the product of the
average Black-Scholes (or comparable model) percentage ascribed to the
Company's most recent stock option grant by national compensation consulting
firms, and the then most recent five-year average Eaton common share price.
This procedure reduces variability resulting from short-term stock price
fluctuations.
(4) All Other Compensation contains several components. Beginning in 2002, the
Eaton Savings Plan permits an employee to contribute from 1% to 5% of his or
her salary to the matching portion of the plan. Eaton makes a matching
contribution which equals $1.00 for each dollar contributed by the
participating employee with respect to the first 3% of his or her salary
contributed to the plan and $.50 for each dollar contributed by the
participating employee with respect to the next 2% of his or her salary
contributed to the plan. Prior to 2002, Company matching contributions
ranged between $.25 and $1.00 for each dollar contributed by the
participating employee, up to 6% of his or her salary, as determined under a
formula based on Eaton's quarterly earnings per share. The amounts the
Company contributed during 2003 for the named executive officers were as
follows: C. Arnold, $6,641; S. M. Buente, $8,000; A. M. Cutler, $8,000; R.
W. Carson, $8,000; and R. H. Fearon, $8,000. The Company maintains plans
pursuant to which incentive compensation may be deferred. Earnings on such
deferrals, which are above rates established by the Internal Revenue
Service, are disclosed in this table. Those earnings during 2003 for each of
the named executive officers were as follows: C. Arnold, $0; S. M. Buente,
$0; A. M. Cutler, $2,647; R. W. Carson, $0; and R. H. Fearon, $0. Under a
Company program, each executive officer may acquire and maintain an
automobile at Company expense. For each of the named executive officers for
2003 the approximate cost to the Company under this program was as follows:
C. Arnold, $13,555; S. M. Buente, $36,000 (paid in 2003 covering both 2002
and 2003); A. M. Cutler, $17,606; R. W. Carson, $13,311; and R. H. Fearon,
$14,485. The Company provides certain executives, including the named
executive officers, with the opportunity to acquire individual whole-life
insurance. The annual premium paid by the Company during 2003 for each of
the named executive officers was as follows: C. Arnold, $2,662; S. M.
Buente, $3,756; A. M. Cutler, $8,619; R. W. Carson, $5,681; and R. H.
Fearon, $3,200. Each executive officer is responsible for paying individual
income taxes due with respect to the Company's automobile and insurance
programs.
15
EQUITY COMPENSATION PLANS -- The following table summarizes information, as of
December 31, 2003, relating to equity compensation plans of the Company pursuant
to which grants of options, restricted stock, deferred compensation units or
other rights to acquire company common shares may be awarded from time to time.
The number of shares under these plans has been adjusted to reflect the
two-for-one stock split in the form of a stock dividend distributed on February
23, 2004, to shareholders of record on February 9, 2004.
(A) (B) (C)
NUMBER OF
SECURITIES
NUMBER OF WEIGHTED- REMAINING AVAILABLE
SECURITIES TO BE AVERAGE FOR FUTURE ISSUANCE
ISSUED UPON EXERCISE PRICE OF UNDER EQUITY
EXERCISE OF OUTSTANDING COMPENSATION
OUTSTANDING OPTIONS, PLANS (EXCLUDING
OPTIONS, WARRANTS WARRANTS AND SECURITIES REFLECTED
PLAN CATEGORY AND RIGHTS RIGHTS IN COLUMN (A))
------------- ----------------- ----------------- --------------------
Equity compensation plans approved by security
holders (1).................................. 17,554,168(3) $ 33.22(5) 4,169,702
Equity compensation plans not approved by
security holders (2)......................... 1,599,458(4) N/A (2)
------------ -------- ---------
TOTAL........................................ 19,153,626 $ 33.22(5) 4,169,702
============ ======== =========
---------------
(1) These plans are the Company's 2002 Stock Plan, 1998 Stock Plan, 1995 Stock
Plan, 1991 Stock Option Plan, and the Incentive Compensation Deferral Plan
(amended and restated as of October 1, 1997).
(2) The 1996 Non-Employee Director Fee Deferral Plan and the Deferred Incentive
Compensation Plan (amended and restated as of March 31, 2000) are not
considered to be "equity compensation plans" which require shareholder
approval under the rules of the New York Stock Exchange. Under the 1996 Non-
Employee Director Fee Deferral Plan, all non-employee directors may defer
payment of their fees at a rate of return which varies, depending on whether
the director defers the fees as retirement compensation or as short-term
compensation. At least 50% of retirement compensation, or any greater
portion which the director elects, is converted to Company share units and
earns Company share price appreciation and dividend equivalents. The balance
of retirement compensation earns 10-year U.S. Treasury note returns plus 300
basis points. Short-term compensation earns 13-week U.S. Treasury bill
returns. These arrangements provide for accelerated lump sum or installment
payments upon a failure by the Company to pay or termination of service in
the context of a change in control of the Company. After retirement or other
termination of services as a director, the Governance Committee determines
whether fees deferred are to be paid in a lump sum or periodic installments
and whether the amounts converted to Company share units are to be paid in
cash or Company common shares. Under the Deferred Incentive Compensation
Plan, participants, including officers and other eligible executives, may
elect to defer receipt of their annual incentive compensation award as
either short-term deferrals (5 years) or retirement compensation. Amounts
deferred until retirement earn the greater of Company share price
appreciation plus dividend equivalents or 13-week U.S. Treasury bill
returns. Short-term deferrals earn 13-week U.S. Treasury bill returns.
Amounts deferred as retirement compensation which are converted to Company
share units are payable in Company common shares in such method, whether a
lump sum or periodic installments, as determined by the Company's Corporate
Compensation Committee which is comprised of Company officers. Participants
may defer the full amount of eligible cash compensation under these Plans.
To the extent that cash compensation is deferred pursuant to these Plans, or
pursuant to the Incentive Compensation Deferral Plan, the Company may be
able to preserve the deductibility of the compensation under Section 162(m)
of the Internal Revenue Code. However, in some circumstances cash
compensation paid to executive officers is not deductible by the Company.
(3) Includes an aggregate of 258,714 restricted shares, 3,916,868 of
performance-based stock options and 352,158 shares underlying stock units,
payable on a one-for-one basis, credited to stock unit accounts as of
December 31, 2003 under the Incentive Compensation Deferral Plan (amended
and restated as of October 1, 1997).
(4) Represents shares underlying stock units, payable on a one-for-one basis,
credited to stock unit accounts as of December 31, 2003 under the 1996
Non-Employee Director Fee Deferral Plan and the Deferred Incentive
Compensation Plan (amended and restated as of March 31, 2000).
(5) Weighted average exercise price of outstanding stock options; excludes
restricted stock and deferred compensation share units.
16
AGGREGATED OPTION EXERCISES AND FISCAL YEAR-END VALUES -- The following table
provides information concerning the exercise of stock options during fiscal year
2003 and the value of unexercised stock options at the end of fiscal year 2003
with respect to the named executive officers. The number of shares in these
options has been adjusted to reflect the two-for-one stock split in the form of
a stock dividend distributed on February 23, 2004 to shareholders of record as
of the close of business on February 9, 2004.
TOTAL VALUE OF
TOTAL NUMBER OF UNEXERCISED,
UNEXERCISED OPTIONS IN-THE-MONEY OPTIONS
SHARES HELD AT HELD AT
ACQUIRED ON FISCAL YEAR END FISCAL YEAR END
EXERCISE VALUE --------------------------- ---------------------------
NAME (#) REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---------------------------------------------------------------------------------------------------------
A. M. Cutler 117,848 $2,840,388 853,726 740,218 $18,931,855 $13,659,644
C. Arnold 0 0 41,052 87,148 652,139 1,470,051
S. M. Buente 32,974 792,112 163,024 134,892 3,489,619 2,471,738
R. W. Carson 46,672 827,084 250,160 87,148 4,714,409 1,470,051
R. H. Fearon 0 0 14,520 73,480 168,505 1,185,595
---------------------------------------------------------------------------------------------------------
OPTION GRANTS -- The following table provides information concerning grants of
stock options made during fiscal year 2003 to each of
the named executive officers. For a number of years, the Company has established
its annual guidelines for stock option grants by referencing the average
percentage Black-Scholes values (or comparable market pricing models) ascribed
to the Company's most recent actual stock option grant by the same nationally
known compensation consulting firms used for annual market analysis and applying
this average percentage to the then most recent five-year average price for an
Eaton common share. The resulting dollar value is then divided into the median
long-term incentive compensation values as reported in the most recent surveys
to establish the recommended median grant sizes for the next stock option grant
cycle. This process was established to provide a more stable basis for making
annual stock option grants with less year-to-year variability in overall grant
sizes and share usage, particularly taking into account the historic variability
of the Company's stock price. The number of shares in these grants and the
option prices have been adjusted to reflect the two-for-one stock split in the
form of a stock dividend distributed on February 23, 2004 to shareholders of
record as of the close of business on February 9, 2004. No stock appreciation
rights were granted during fiscal year 2003.
INDIVIDUAL GRANTS
------------------------------------------------
PERCENT OF
TOTAL
NUMBER OF OPTIONS POTENTIAL REALIZABLE VALUE AT ASSUMED
SECURITIES GRANTED TO ANNUAL RATES OF STOCK PRICE
UNDERLYING EMPLOYEES EXERCISE APPRECIATION FOR OPTION TERM
OPTIONS IN FISCAL OR BASE EXPIRATION -------------------------------------
NAME GRANTED (#) YEAR(1) PRICE DATE 0% 5% 10%
---------------------------------------------------------------------------------------------------------------
A. M. Cutler 242,000 9.41% $34.65 2/25/2013 $0 $ 5,282,739 $ 13,332,627
C. Arnold 44,000 1.71% 34.65 2/25/2013 0 960,498 2,424,114
S. M. Buente 44,000 1.71% 34.65 2/25/2013 0 960,498 2,424,114
R. W. Carson 44,000 1.71% 34.65 2/25/2013 0 960,498 2,424,114
R. H. Fearon 44,000 1.71% 34.65 2/25/2013 0 960,498 2,424,114
All Shareholders(2) 0 3,360,788,701 8,481,990,531
---------------------------------------------------------------------------------------------------------------
(1) Based on a total of 2,570,428 options granted to all employees. As granted,
one-third of the options become exercisable upon each of the first, second
and third anniversary of the date of grant.
(2) At the assumed annual rates of stock price appreciation of 0%, 5% and 10%,
at a base price of $34.65, the value of all 153,956,284 shares outstanding
on January 31, 2004, would increase by the amounts shown. There can be no
assurance that the market price of Eaton shares will increase in the future.
--------------------------------------------------------------------------------
17
LONG-TERM INCENTIVE PLAN AWARDS -- The following table provides information
regarding long-term incentive plan awards made during fiscal year 2003 to each
of the named executive officers. The number of share units in these awards and
the value of the share units have been adjusted to reflect the two-for-one stock
split in the form of a stock dividend distributed on February 23, 2004 to
shareholders of record as of the close of business on February 9, 2004.
PERFORMANCE ESTIMATED FUTURE PAYOUTS UNDER NON-STOCK
NUMBER OF OR OTHER PRICE BASED PLANS
SHARES, PERIOD UNTIL ----------------------------------------
UNITS OR MATURATION THRESHOLD TARGET MAXIMUM
NAME OTHER RIGHTS(1) OR PAYOUT (SHARES) (SHARES) (SHARES)
---------------------------------------------------------------------------------------------------
A. M. Cutler 47,900 4 years 23,950 47,900 95,800
C. Arnold 11,000 4 years 5,500 11,000 22,000
S. M. Buente 11,000 4 years 5,500 11,000 22,000
R. W. Carson 11,000 4 years 5,500 11,000 22,000
R. H. Fearon 13,300 4 years 6,650 13,300 26,600
---------------------------------------------------------------------------------------------------
(1) These units were awarded during 2003 under the Company's long-term incentive
plan at a target price per unit of $37.64. The actual, final value of the
units will be determined after the completion of the four-year award period
based upon the achievement of corporate and individual performance goals.
The corporate goals relate to cash flow return on gross capital and growth
in earnings per Company common share. Payouts are made in cash, unless the
executive has elected to defer receipt of the payment under the Company's
long-term deferral plan.
STOCK OWNERSHIP GUIDELINES -- The Company maintains stock ownership guidelines
for senior executives for the purpose of aligning their motivations with the
interests of the Company's owners and assuring that the individuals principally
responsible for the Company's stewardship and growth have a significant personal
stake in its progress.
The guidelines call for executives to reach the following levels of Eaton stock
ownership over a five-year period:
Chief Executive
Officer 3-5 times base salary
Other officers 2-4 times base salary
General managers and
key staff managers 1 times base salary
For purposes of achieving these guideline levels, the following shares are
included: Eaton shares owned outright by the executive, Eaton share units
credited to the executive's Eaton Savings Plan account, and Eaton share units
credited to the executive's deferred compensation accounts. All of the officers
named in the Summary Compensation Table on page 15 are in compliance with these
stock ownership guidelines.
COMPENSATION AND ORGANIZATION COMMITTEE REPORT -- The Committee, consisting of
five independent non-employee directors, met six times in 2003. The Committee
has adopted a comprehensive formal executive compensation philosophy that has
been discussed with the Board of Directors. This philosophy statement is
consistent with the Company's long-standing belief that executive compensation
must to a large extent be at risk, in the sense of being dependent on achieving
rigorous Company, business unit and individual performance objectives that are
designed to enhance shareholder value. It is also Committee policy that
executive compensation must be competitive in the employment marketplace in
order to allow the Company to attract, motivate and retain highly qualified
executives, and that executive compensation must fairly reflect, in the judgment
of the Committee, accomplishments and responsibilities within the Company.
The administration of the Company's executive compensation is consistent with
these basic tenets. This is confirmed by periodic comprehensive studies of
Company and industry practices conducted with the assistance of a nationally
recognized consulting firm retained by the Committee. The most recent such study
was completed in 2003 and, following Committee review and discussions, the
results of the study were summarized and presented to the Board of Directors.
The consultant's study concluded that Eaton's executive compensation programs
and the Committee processes meet all of the firm's recommended audit standards.
The report also noted that, with few exceptions, the Company's executive total
compensation programs met in
18
whole or in part the consulting firm's current best practice evaluation
criteria. The Committee also commissioned a separate detailed consulting study
of evolving market practices with respect to long-term incentive compensation
plans with a special focus on stock-based programs and this work confirmed that
the Company's practices have been consistently applied for a number of years and
continue to be solidly in the mainstream of competitive practice.
Seventy-three percent of the 2003 aggregate cash compensation of the executive
officers named in the compensation table was based directly on specific
financial performance objectives. For 2003, the Committee targeted base salaries
at approximately the median range of compensation paid by similar companies
included in the survey databases of several nationally recognized
compensation-consulting firms. The Committee also established short-term and
long-term incentive opportunities and stock option grants at approximately the
median range, with provisions for larger payments if the Company achieves
superior performance and for smaller payments if the Company does not achieve
target performance.
Salary -- In setting executive salaries, the Committee uses input from outside
sources as noted above and management recommendations for individual
adjustments. In judging performance, the Committee typically considers
performance against annual plans, accomplishment of other objectives and the
financial results of similar companies. The Committee also normally considers
factors such as initiative and leadership, as well as time in position,
experience, knowledge and level of competitive compensation in the marketplace.
Consistently effective individual performance is a threshold requirement for any
salary increase. The Committee considers these same factors when adjusting the
base salary of the Company's Chairman and Chief Executive Officer. In
consideration of the continuing challenging business environment, the Chairman
and Chief Executive Officer again requested that he not receive a 2003 base
salary increase. For the same reason, Mr. Cutler requested only moderate base
salary adjustments for certain elected officers. Following a review and
discussion of these proposals, the Committee approved base salary adjustments
for certain elected officers as proposed by the Chairman.
Short-Term Incentives -- Annual performance awards for 2003 were based on
individual target opportunities for each executive expressed as a percentage of
the participant's base salary. Actual awards are determined by adjusting the
target incentive opportunity based on whether the Company has achieved
predetermined levels of cash flow return on gross capital employed in the
business ("CFR"), earnings per share and business unit performance (for
operating managers). Actual awards are also determined by individual performance
ratings and Committee discretion. A philosophical cornerstone of short-term
incentive compensation is the belief that CFR and earnings per share are easily
understood by incentive participants, and that consistently high performance
against these measures provides a good statistical correlation with sustained
high stock market valuation. No incentive payments are made under the Plan
unless the Company achieves the predetermined minimum levels of CFR, and no
incentive payments above plan minimum level can be made unless the Company
achieves the predetermined minimum level of earnings per share. Individual
performance ratings take into account factors such as unanticipated challenges
and opportunities, actual performance against profit plan, personal objectives,
general economic conditions and the performance of other large industrial
corporations. Individual ratings emphasize pay for performance, and may result
in payments ranging from zero to 150% of the amount otherwise payable. The
Committee may adjust the total amount available for payment under the Plan up or
down by 20%, and retains the right to pay up to 20% of the normal incentive fund
to recognize extraordinary contributions to the Company in a year when awards
would not otherwise be payable. The Committee did not exercise this discretion
with respect to the 2003 incentive awards. Executives may defer payment of their
bonuses. Amounts deferred until retirement earn the greater of share price
appreciation and dividend equivalents or 13-week Treasury bill returns. Amounts
deferred for shorter periods earn Treasury bill returns.
Long-Term Incentives -- Long-term incentives under the Company's Executive
Strategic Incentive Plan are granted annually and cover four-year performance
periods. Final awards to participants under the Plan are based on the
19
Company's success in achieving aggressive CFR and growth in earnings per share
goals and include a discretionary assessment of the participants' individual
performance. Performance goals are established by the Committee at the beginning
of each four-year award period based upon a review with management of the
Company's past performance in comparison to that of its peer group companies and
also based upon the Company's strategic objectives and annual business plans.
Individual incentive targets are expressed as phantom share units, and final
awards are paid in cash, instead of shares. Final phantom share unit awards are
determined based upon Company and individual performance as described above. In
light of the significant adverse changes in the global economy in recent years,
the Committee determined in 2002 that the original performance objectives for
award periods that were open (1999-2002, 2000-2003 and 2001-2004) no longer
provided effective incentives. The Committee therefore approved in 2002 separate
performance objectives for the remaining years of these periods. The aggregate
awards with respect to both the original performance objectives and these
separate objectives were capped at 100%, 125% and 150%, of the original target
incentive opportunities for the periods ending 2002, 2003 and 2004,
respectively. For the award period ending in 2003, the Company's performance
exceeded the original performance objectives necessary to earn a minimum award,
and exceeded the separate performance objectives established in 2002 necessary
to earn a maximum award. Aggregate awards were capped at 125%, and were adjusted
to reflect individual performance.
Executive officers may defer payment of their awards. At least 50% of any
deferrals that will be paid after retirement are converted to share units and
earn share price appreciation and dividend equivalents. The balance earns
10-year Treasury note returns plus 300 basis points. Short-term deferrals earn
13-week Treasury bill returns.
Tax Deduction -- Any non-deferred annual compensation of more than $1 million
for the Company's Chief Executive Officer and each of its four other most
highly-compensated officers is not tax deductible unless paid pursuant to
formula-driven, performance-based arrangements that preclude Committee
discretion to adjust compensation after the beginning of the period in which the
compensation is earned. The Committee attempts to preserve deductibility by
encouraging deferrals of otherwise nondeductible payments.
Equity Compensation -- Stock options align the interests of the Company's
officers and other executives with those of its shareholders by having a
significant component of their compensation tied directly to increases in
shareholder value. For a number of years, the Company has established its annual
guidelines for stock option grants by referencing the average percentage
Black-Scholes values (or comparable market pricing models) ascribed to the
Company's most recent actual stock option grant by the same nationally known
compensation consulting firms used for annual market analysis and applying this
average percentage to the then most recent five-year average price for an Eaton
common share. The resulting dollar value is then divided into the median
long-term incentive compensation values as reported in the most recent surveys
to establish the recommended median grant sizes for the next stock option grant
cycle. This process was established to provide a more stable basis for making
annual stock option grants with less year-to-year variability in overall grant
sizes and share usage, particularly taking into account the historic variability
of the Company's stock price. All officers and key executives of the Company are
expected to hold a multiple of from one to five times their base salary in
Company shares depending on their level in the organization and the Committee
annually reviews the progress of individual elected officers toward their
ownership goals. Options have been granted annually, have an exercise price
equal to the fair market value of the shares on the date of the grant, vest over
a minimum of 3-years and, to further encourage a long-term perspective, have an
exercise period of ten years. The Company does not reprice stock options after
they have been granted and does not grant stock appreciation rights. The
Committee has adopted guidelines that limit the Company's regular total stock
option grants, during any five-year period, to a maximum of 10% of the Company's
outstanding shares.
When circumstances warrant, the Company does make grants of restricted stock to
selected
20
elected officers or other executives. Under the 2002 Stock Plan, no more than
10% of the total number of shares authorized for delivery under the Plan may be
granted as restricted shares, performance shares, stock appreciation rights or
other share awards (other than stock options). In addition, no more than 5% of
the total number of shares authorized for delivery under this Plan may be
granted as restricted shares, performance shares, stock appreciation rights or
other share-based awards (other than stock options) which vest within less than
one year after the date of grant. With respect to such awards in excess of 5% of
the total number of authorized shares in this Plan, the vesting period must
exceed one year, with no more than one third of those shares becoming vested at
the end of each of the twelve-month periods following the date of grant. While
the 10% limit noted above was appropriate when the 2002 Stock Plan was submitted
to the shareholders, the Committee would like to point out that the Board of
Directors has requested approval at the 2004 Shareholder Meeting for a 2004
Stock Plan that would allow up to 40% of the total authorized shares for
delivery under the Plan to be used for grants of restricted shares, performance
shares, stock appreciation rights or other share awards (other than stock
options). The Committee believes this recommended change is in line with its
long-term incentive compensation strategy that was developed with the assistance
of a special consultant retained by the Committee in 2003. Under this strategy,
the Committee will continue to drive executive performance by using a balanced
portfolio of long-term incentive compensation components but it also recognizes
that the competitive environment in executive compensation may be altered during
the life of the proposed 2004 Stock Plan by a number of factors including a
potential ruling by the Financial Accounting Standards Board that mandates
accounting for stock options. Such action would largely equalize the treatment
of stock options when compared to other potential incentive and equity elements
that could be used in executive incentive programs. In this environment it is
important for the Committee to have greater flexibility in considering awards of
other forms of long-term incentive compensation in order to create effective
incentive programs that are aligned with sustained shareholder valuation
creation and which meet competitive practice as it continues to evolve.
Chief Executive Officer Compensation -- The 2003 compensation for Mr. Cutler was
earned pursuant to the arrangements described above.
Due to the continued challenging business environment throughout the past year,
Mr. Cutler again recommended to the Committee that he not be considered for a
base salary adjustment in 2003 and the Committee endorsed this suggestion. As a
result, Mr. Cutler's base salary was not adjusted in 2003.
Mr. Cutler's 2003 short-term incentive payout reflected the award formula of the
Company's incentive compensation plan, which was based on the Company's
financial performance, as measured by CFR and earnings per share compared to the
targets set by the Committee for 2003. Consistent with the Plan's design, the
Committee evaluated the performance of Mr. Cutler, and his final award reflects
his individual rating. In establishing that rating, the Committee took into
account Mr. Cutler's leadership in expanding and driving the use of the Eaton
Business System throughout the Company, achieving 2003 profit plan and earnings
per share goals, strengthening the balance sheet, outgrowing end markets,
continuing to implement effective cost reduction measures including those
related to the integration of recent acquisitions and the implementation of the
Company's initiatives in moving toward a lower capital intensity business model,
successfully closing two acquisitions that increases the Eaton Electrical
Group's global reach and three joint ventures that offer significant potential
for growth in the electrical, Asian truck and Asian fluid power markets,
continuing to support the Board of Directors in advancing corporate governance
procedures that meet or exceed the letter and spirit of evolving accountability
requirements, recruiting and developing an outstanding leadership team,
continuing success in improving the Company's diversity profile, generating
consistent improvements across the organization in the annual employee
engagement survey results and effectively communicating the Company's vision as
a premier diversified industrial company.
Mr. Cutler's earned payouts from the long-term incentive plans for the periods
ending in 2003 were based upon the Company's CFR and cumulative earnings per
share performance as
21
described above, and upon Mr. Cutler's personal performance over that period.
His grants of stock options, restricted stock and long-term incentives were
based on the factors described in earlier sections of this report.
Mr. Cutler's 2003 long-term incentive plan, restricted stock and stock option
grants compared appropriately with the median of long-term grants made to Chief
Executive Officers as reported in the survey databases of several nationally
recognized compensation consulting firms.
Respectfully submitted to the Company's shareholders by the Compensation and
Organization Committee of the Board of Directors.
Gary L. Tooker, Chairman
Michael J. Critelli
Ernie Green
Ned C. Lautenbach
Gregory R. Page
22
COMPANY STOCK PERFORMANCE -- The following graph compares the cumulative total
shareholder return for the five years ending December 31, 2003 for Eaton common
shares, the S&P 1500 Industrial Machinery, and the S&P 500. These figures assume
all dividends are reinvested when received, and are based on $100 invested in
Eaton common stock on December 31, 1998.
EATON S&P 500 S&P 1500 IND MACH
----- ------- -----------------
1998 100 100 100
1999 105 121 112
2000 111 110 105
2001 130 97 114
2002 140 76 106
2003 198 87 118
23
RETIREMENT PLANS -- Effective January 1, 2003, employees who were then earning
benefits under the "Average Final Annual Compensation" (AFAC) benefit formula
under the Company's retirement plan were given the option to either: (a)
continue earning benefits under the AFAC benefit formula; or (b) commence
earning benefits under the Eaton Personal Pension Account (EPPA) formula.
Salaried employees hired on or after January 1, 2002 automatically earn benefits
under the EPPA formula upon becoming eligible for participation in the
retirement plan.
AVERAGE FINAL ANNUAL COMPENSATION FORMULA -- The following table shows the
annual normal retirement benefits payable to officers and other employees of the
Company under the AFAC benefit formula upon retirement at age 65 at the
compensation and years specified. The table assumes retirement under the
standard post-retirement single life annuity option. Under the standard
post-retirement surviving spouse option, the participant receives a reduced
pension, and a pension equal to 50% of the reduced pension is payable to his or
her surviving spouse. The benefit for an employee electing that option whose
spouse is three years younger would be approximately 11% less than the amounts
shown in the table.
PENSION PLAN TABLE -- AVERAGE FINAL ANNUAL COMPENSATION
ANNUAL NORMAL RETIREMENT BENEFITS PURSUANT TO STANDARD
AVERAGE FINAL SINGLE LIFE ANNUITY OPTION FOR YEARS OF CREDITED SERVICE INDICATED
ANNUAL -----------------------------------------------------------------------
COMPENSATION 15 YEARS 20 YEARS 25 YEARS 30 YEARS 35 YEARS 40 YEARS
=======================================================================================
500,000 109,542 146,056 182,570 219,083 255,597 292,111
600,000 132,042 176,056 220,070 264,083 308,097 352,111
700,000 154,542 206,056 257,570 309,083 360,597 412,111
800,000 177,042 236,056 295,070 354,083 413,097 472,111
900,000 199,542 266,056 332,570 399,083 465,597 532,111
1,000,000 222,042 296,056 370,070 444,083 518,097 592,111
1,100,000 244,542 326,056 407,570 489,083 570,597 652,111
1,200,000 267,042 356,056 445,070 534,083 623,097 712,111
1,300,000 289,542 386,056 482,570 579,083 675,597 772,111
1,400,000 312,042 416,056 520,070 624,083 728,097 832,111
1,500,000 334,542 446,056 557,570 669,083 780,597 892,111
1,600,000 357,042 476,056 595,070 714,083 833,097 952,111
1,700,000 379,542 506,056 632,570 759,083 885,597 1,012,111
1,800,000 402,042 536,056 670,070 804,083 938,097 1,072,111
1,900,000 424,542 566,056 707,570 849,083 990,597 1,132,111
2,000,000 447,042 596,056 745,070 894,083 1,043,097 1,192,111
2,100,000 469,542 626,056 782,570 939,083 1,095,597 1,252,111
The information contained in the preceding table is based on the assumption that
the AFAC formula in the retirement plan will be continued in its present form.
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 ($39,444 for 2003 retirements) plus 1 1/2% of
average final annual compensation in excess of the Social Security integration
level, multiplied by the employee's years of credited service.
An employee's average final annual compensation is the average annual amount of
his or her total compensation (which includes salary and bonus as so identified
in the Summary Compensation Table on page 15) for service during the five
consecutive years within the last ten years of employment for which the
employee's total compensation was greatest. Years of credited service means the
number of years of employment between age 21 and retirement, with a maximum of
44 years. As of January 31, 2004, the number of years of credited service for
the following individuals, who are named in the Summary Compensation Table on
page 15 and who - effective January 1, 2003 -- elected to continue to earn
benefits under the AFAC benefit formula, was
24
as follows: A. M. Cutler, 28.4; C. Arnold, 3.3; R. W. Carson, 5.0; and S. M.
Buente, 27.3.
EATON PERSONAL PENSION ACCOUNT FORMULA -- Under this benefit formula, a
participant's single sum retirement benefit is accumulated throughout his or her
career with the Company. This single sum amount is represented as a nominal
account balance that is regularly credited with a percentage of his or her total
compensation (which includes salary and bonus as so identified in the Summary
Compensation Table on page 15) as well as with interest at a specified rate. The
percentage of total compensation credited to the participant's nominal account
balance varies over his or her career based on the sum of the participant's age
and service with the Company. For the period when that sum is less than 50, 5.0%
of compensation is credited, for the period when the sum is between 50 and 59
(inclusive), 6.0% is credited. When the sum is between 60 and 69 (inclusive),
7.0% of compensation is credited and, when the sum is 70 or greater, 8.0% of
compensation in credited. Upon termination of employment, the nominal account
balance is available as a single sum or may be converted to one of several
annuity forms. As with the AFAC benefit formula, under the standard
post-retirement surviving spouse option, a participant receives a reduced
pension, and a pension equal to 50% of the reduced pension is payable to his or
her surviving spouse. By way of example, the benefit for an employee electing
that option whose spouse is three years younger would be approximately 11% less
than the amount of the participant's annual benefit. This information assumes
that the EPPA formula in the retirement plan will be continued in its present
form.
Having been hired in 2002, R. H. Fearon automatically began earning pension
benefits under the EPPA benefit formula. The estimated annual benefit payable to
Mr. Fearon at normal retirement age under the EPPA benefit formula is $215,103.
The assumed interest rate credited to his account, as well as the annuity
conversion rate, is 6%. The calculation uses 4% as the rate for annual increases
in compensation. As of January 31, 2004, the number of years of service for Mr.
Fearon was 1.8 years.
Certain provisions of the Internal Revenue Code, as amended, limit the annual
benefits that may be paid from a tax-qualified retirement plan. As permitted
under the Code, the Board of Directors has authorized the payment from Eaton's
general funds of any benefits calculated under the provisions of the applicable
retirement plan which may exceed those limits. The present value of these
benefits will be paid in a single installment upon a proposed change in control
of the Company unless otherwise determined by the Board of Directors.
---------------
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 Eaton, provided that they retire at
age 55 or older and have at least ten years of service with Eaton. 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 as well as retirement plans maintained
by the executive's previous employers). 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 20% (for retirements at age 55
with less than 15 years of service) to 45% (for retirements at age 65 with 15
years or more of service). Under the plan, the present value of payments will be
paid in a single installment upon a proposed change in control of the Company
unless otherwise determined by the Board of Directors. Currently, it is expected
that nine officers would receive a benefit under the plan, including C. Arnold,
R. W. Carson and R. H. Fearon, who are named in the Summary Compensation Table
on page 15. The estimated annual benefits payable under this plan are $84,204 to
Mr. Arnold, $216,259 to Mr. Carson and $332,810 to Mr. Fearon, based on the
assumption that they retire at age 65, and their base salary and target
incentive compensation increase at 4% per annum.
---------------
The Company has entered into agreements with its officers, including those named
in the
25
Summary Compensation Table on page 15, which provide for payments and benefits
in the event of a termination of employment in the context of a change of
control of the Company. The purpose of these agreements is to assure continued
dedication, and to diminish the inevitable distraction caused by personal
uncertainties and risks, in the event of a corporate change of control.
The agreements provide that each officer, for three years following a change of
control, will have duties, salary, bonus, fringe benefits and opportunities for
savings, incentive earnings and retirement compensation no less favorable than
was previously the case. If the Company were to terminate an officer's
employment during this three-year period for reasons other than cause or
disability, or if the officer were to terminate employment because of changed
circumstances, then the officer would be entitled to receive certain amounts and
benefits under these agreements. These amounts and benefits would include (i)
long-term incentive compensation reflective of the portion of the award periods
completed prior to termination, (ii) salary and bonus multiplied by three (or
any lesser number of years and portions thereof until age 65), and (iii)
continuation of medical, life insurance and other welfare benefits for two years
(or any lesser number of years and portions thereof until age 65), subject to
reduction for comparable benefits received in any subsequent employment. The
officer would be entitled to receive an additional payment, net of taxes, to
compensate for the excise tax imposed on these and other payments if they are
determined to be "excess parachute payments" under the Internal Revenue Code.
The agreements provide that, upon the occurrence of a proposed change of
control, the Company would deposit in trust a cash amount sufficient to provide
the benefits and payments to which the officers would be entitled under the
agreements upon a change of control and termination of employment. The
agreements also provide that the Company would reimburse the officers for any
costs incurred to enforce the agreements.
---------------
Certain grantor trusts established by the Company hold approximately $1.5
million of marketable securities and 1,066,580 Company shares, in order to
provide for a portion of the Company's deferred compensation obligations. The
trust assets, which are subject to the claims of the Company's creditors, will
be used to pay those obligations in proportion to trust funding. The trusts
provide for full funding upon a change in control of the Company and for
accelerated lump sum or installment payments upon a failure by the Company to
pay amounts due under the plans or upon a termination of employment in the
context of a change in control.
2. APPROVAL OF THE 2004 STOCK PLAN
The Board believes that share-based incentives are important factors in
attracting and retaining highly qualified individuals, and that they help to
align the interests of those individuals with the interests of the Company's
shareholders. It believes that the shareholder-approved 2002 Stock Plan has been
instrumental in producing the Company's strong financial performance. As of
January 31, 2004, 3,046,120 common shares (post-stock split) remained available
for additional awards under that plan. The Board is therefore submitting to the
Company's shareholders for their approval a new share-based plan, called the
2004 Stock Plan (the "Plan").
The Board believes that the potential dilutive effect of the issuance of stock
options has been mitigated by periodic share repurchase programs over the last
several years. From 1996 through January 31, 2004, Eaton has repurchased
27,723,800 (post-stock split) of its shares, largely offsetting grants made in
recent years. Under share repurchase programs authorized in January, 2000 and
July, 2000, the Company has remaining authority to purchase up to $458,722,658
worth of shares. Earlier this year, a plan was initiated to repurchase 4.2
million common shares (after giving effect to the two-for-one stock split
announced on January 21, 2004) to offset the shares issued during 2003 from the
exercise of stock options. In addition, the Company now intends, depending upon
circumstances, to purchase additional shares as necessary to help offset
dilution resulting from shares issued as a result of stock options exercised
over the course of 2004.
26
The Plan, which is substantially the same as the 2002 Stock Plan, will authorize
the granting of stock options to non-employee directors, and the granting of
stock options and other share-based awards to non-union salaried employees
selected by the Board's Compensation and Organization Committee (the
"Committee"). The purpose of the Plan is to continue to provide long-term
incentives for outstanding service to the Company and its shareholders and to
assist in recruiting and retaining highly qualified individuals. A copy of the
Plan is included as Appendix H to this proxy statement, and the following
summary is qualified in its entirety by the provisions of the Plan.
ADMINISTRATION -- The Committee, which is comprised of non-employee directors,
will administer employee awards. The Governance Committee of the Board, which is
also comprised of non-employee directors, will administer non-employee director
options.
SHARES AVAILABLE -- Subject to adjustments for stock splits, stock dividends and
other events affecting the shares, the total number of the Company's common
shares with a par value of 50c each ("shares") that may be delivered under the
Plan will not exceed 7,000,000, and the total number of shares or share units
underlying options or related to other awards that may be granted to any
employee during any period of three consecutive calendar years will not exceed
1,200,000. No more than 40% of the total number of shares authorized for
delivery under the Plan may be granted as performance shares, restricted shares,
stock appreciation rights or other share-based awards (other than stock
options). In addition, no more than 5% of the total number of shares authorized
for delivery under the Plan may be granted as performance shares, restricted
shares, stock appreciation rights or other share-based awards (other than stock
options) which vest within less than one year after the date of grant. With
respect to such awards in excess of 5% of the total number of such authorized
number of shares, the vesting period must exceed one year, with no more than one
third of shares becoming vested at the end of each of the twelve-month periods
following the date of grant. Shares related to awards that are forfeited,
terminated or unexercised upon expiration shall immediately become available for
other awards.
STOCK OPTIONS --
Employee Stock Options. Each option will be exercisable at such times and for
such number of shares as determined by the Committee as of the date of grant.
Grants to officers will not be exercisable for at least six months after those
options are granted. Although the Plan does not impose any similar time
requirement on grants to non-officer employees, such grants historically have
become exercisable as follows: after one year as to 33% of the shares covered by
the grant, after the second year as to another 33%, and after the third year as
to the remaining 34%. The Committee may accelerate the times when an option may
be exercised, and the Management Compensation Committee (comprised of Company
officers) may do likewise for employees who are not officers. The Committee may
grant employee options which are intended to qualify as incentive stock options
("Incentive Stock Options") under the Internal Revenue Code.
Non-employee Director Stock Options. Each person who becomes a non-employee
director at the 2004 annual shareholders meeting or thereafter automatically
will be granted an option for 10,000 shares upon the date of his or her
election. On each granting date thereafter that each non-employee director
continues to serve in that capacity, he or she will automatically be granted
options for a number of shares equal to the quotient resulting from dividing (i)
four times the annual retainer for non-employee directors in effect on the
granting date by (ii) the closing price of a share on the last business day
immediately preceding the granting date. The granting date is the Tuesday
immediately before the fourth Wednesday of each January. Each non-employee
director option shall be fully exercisable six months following the date of
grant.
Term. The term of each option will be ten years from the date of grant.
Price. The option price will be the fair market value of the shares subject to
the option on the date of grant. The fair market value shall be the mean of the
high and low prices as quoted on the New York Stock Exchange Composite
27
Transactions. The fair market value of a share as of March 1, 2004 was $59.46.
Payment. The exercise price will be payable in cash or, if permitted by the
terms of the option, by other consideration, including shares valued at fair
market value on the date of exercise. Delivery of the shares by the Company to
the option holder upon exercise of an option may be deferred, as authorized by
the Committee.
PERFORMANCE SHARES -- The Committee may grant performance shares for no cash
consideration, if permitted by applicable law, or for such consideration as may
be determined by the Committee. The Committee will establish award periods and
the number of performance shares to be earned if Company performance objectives
are met during the award periods. The performance objectives will be stated in
terms of cash flow return on gross capital employed in the Company's business
("CFR"). CFR equals the total of net income plus depreciation and after-tax net
interest divided by the total of capital plus accumulated depreciation (minus
goodwill and short-term investments). After performance shares have been awarded
and performance objectives have been established, the Committee may not increase
the number of performance shares that may be earned by any employee upon
attainment of any performance objective. The actual levels of CFR to be achieved
and other terms and conditions of the performance shares will be determined by
the Committee. If performance shares are not earned, they will be available for
future grants.
OTHER AWARDS -- The Company has not granted stock appreciation rights for many
years, primarily because of their adverse accounting consequences. However, in
some countries stock appreciation rights are more advantageous to the recipients
than conventional stock options. Therefore, the Plan permits their use at the
discretion of the Committee. Stock appreciation rights entitle the holder to
receive a number of shares or cash equal to the increase in the fair market
value of the designated number of shares from the date of grant to the date of
exercise. Stock appreciation rights may be exercised as determined by the
Committee.
The Committee may grant other share-based awards, including restricted shares,
for no cash consideration, or for such consideration as may be determined by the
Committee. Subject to the provisions discussed under "Shares Available" above,
the Committee will determine the criteria or periods for payment or vesting and
the extent to which those criteria or periods have been met. Any such grants
shall have such other terms and conditions as determined by the Committee.
OTHER MATTERS -- The Plan will become effective if and when approved by the
shareholders at the 2004 annual meeting of shareholders, and no awards may be
granted after December 31, 2013.
Shares available for awards may consist, in whole or in part, of authorized and
unissued shares or treasury shares.
The Board of Directors may, without shareholder approval, terminate the Plan,
curtail the scope of the Plan, or make amendments to the Plan that are not
considered material. However, the Plan may not be amended without shareholder
approval to (i) materially increase the aggregate number of shares which may be
issued under the Plan, (ii) increase the maximum number of shares which may be
granted to any employee, (iii) grant options or stock appreciation rights at a
purchase price below fair market value on the date of grant or (iv) materially
modify the requirements as to eligibility for participation in the Plan, or in
any respect as to which shareholder approval is required under the rules of the
New York Stock Exchange, provided that the Company is subject to such rules at
the time of the amendment.
The Board of Directors is presently comprised of nine non-employee directors and
one employee director. The number of employees to whom employee stock options
are typically granted is approximately 500.
The benefits that will be received by employees under the Plan or which would
have been received under the Plan if it had been in effect in 2003 are not
currently determinable, because awards will be made at the discretion of the
Committee.
28
FEDERAL INCOME TAX IMPLICATIONS --
General. The Plan has been designed to meet the requirements in Section 162(m)
of the Internal Revenue Code for stock options, stock appreciation rights and
performance shares, but may not meet those requirements for other awards.
Stock Options. Employees may be granted Incentive Stock Options or nonqualified
options. Under present federal income tax law and regulations, no tax is imposed
as a result of the grant or exercise of an Incentive Stock Option. The amount by
which the fair market value of the shares received upon exercise exceeds the
option price is an item of tax preference and may be subject to the alternative
minimum tax. If the shares received upon the exercise of an Incentive Stock
Option are not disposed of within two years from the date the option was granted
and within one year after the date the shares are transferred to the holder,
upon the sale of the shares, the difference between the amount realized on the
sale and the option price will be taxed as long-term capital gain or loss and
Eaton will not be entitled to a tax deduction. If these holding period rules are
not met, the holder will realize ordinary income upon disposition equal to the
amount by which the fair market value of the shares at the time of exercise (or,
if lower, the proceeds of sale) exceeds the option price and Eaton will be
entitled to a tax deduction equal to the ordinary income realized by the holder.
Any gain in excess of the amount taxed as ordinary income will be taxed as
short-term capital gain.
A person granted a non-qualified stock option will not be taxed upon the grant
of the option, and Eaton will not be entitled to a tax deduction by reason of
the grant. The option holder will realize taxable income upon exercise of the
option in the amount by which the fair market value of the shares received
exceeds the option price. Eaton will be entitled to a tax deduction equal to the
ordinary income to the employee.
Performance Shares. Performance shares will not result in taxable income to the
recipient or a tax deduction for Eaton during any period that the recipient's
rights to shares under the award are contingent on Eaton's attainment of
performance goals. At the time the Committee certifies that the Company's
performance goal has been met, the recipient will realize taxable ordinary
income equal to the fair market value of the shares at the time of
certification. Eaton will be entitled to a tax deduction in the same amount.
Other Awards. Restricted shares will not be taxable to the recipient, or
deductible by Eaton, upon receipt of the shares or during the period the shares
are restricted, unless the recipient makes an election under Section 83(b) of
the Internal Revenue Code within 30 days of receipt of the shares. An election
under Section 83(b) of the Internal Revenue Code allows the recipient to realize
taxable ordinary income, and allows Eaton a tax deduction, equal to the fair
market value of the shares at the time of their receipt. Absent a Section 83(b)
election, the recipient will realize taxable ordinary income, and Eaton will
take a tax deduction, equal to the fair market value of the shares (less the
amount, if any, paid by the recipient for the shares) at the time their
restriction lapses. The amount of the tax deduction taken by Eaton, either at
the time of receipt in the case of a Section 83(b) election or at the time of
lapse absent a Section 83(b) election by the recipient, may be subject to the
provisions of Section 162(m) of the Internal Revenue Code.
ACCOUNTING PRACTICE -- There is currently no accounting charge to the income of
the Company in connection with the grant or exercise of a stock option. The
Company's income will be charged to the extent of any appreciation in the fair
value of stock appreciation rights which are outstanding and expected to be
exercised in the future. The Company's income will be charged for the expected
fair value of shares awarded in the future as performance shares.
VOTE REQUIRED -- The Board's adoption of the Plan is conditioned upon the Plan's
receiving the approval of holders of the majority of the outstanding Eaton
common shares.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR APPROVAL OF THE 2004 STOCK PLAN.
29
3. RATIFICATION OF THE APPOINTMENT OF INDEPENDENT AUDITORS
The Audit Committee of the Board of Directors has appointed the accounting firm
of Ernst & Young LLP as independent auditors to conduct the annual audit of
Eaton's books and records for 2004. The submittal of this matter to the
shareholders at the annual meeting is not required by law or by Eaton's Amended
Regulations. This matter is nevertheless being submitted to the shareholders to
ascertain their views. If this proposal is not approved at the annual meeting by
the affirmative vote of holders of a majority of the outstanding shares, the
Audit Committee intends to reconsider its appointment of Ernst & Young LLP as
independent auditors.
A representative of Ernst & Young LLP will be present at the annual meeting to
answer any questions concerning the independent auditor's areas of
responsibility, and will have an opportunity to make a statement if he desires
to do so.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR RATIFICATION OF THE APPOINTMENT OF
ERNST & YOUNG LLP.
4. OTHER BUSINESS
Management does not know of any other matters requiring shareholder action that
may come before the meeting; but, if any are properly presented, the individuals
named in the enclosed form of proxy will vote on those matters according to
their best judgment.
OWNERSHIP OF OUTSTANDING VOTING SHARES -- Set forth below is certain information
concerning persons who are known by Eaton to have reported owning beneficially
more than 5% of the Company's common shares as of the most recent practicable
date. The number of shares set forth below has been adjusted to reflect the
two-for-one stock split in the form of a stock dividend distributed on February
23, 2004 to shareholders of record as of the close of business on February 9,
2004.
TITLE OF CLASS: COMMON SHARES
NAME AND ADDRESS OF NUMBER PERCENT
BENEFICIAL OWNER OF SHARES OF CLASS
--------------------------------------------------
Lord, Abbett & Co. 8,489,104(1) 5.58%
90 Hudson Street
Jersey City, NJ 07302
--------------------------------------------------
(1) Lord, Abbett & Co. has filed with the Securities and Exchange Commission a
Schedule 13G dated January 26, 2004, which reports the beneficial ownership
of 8,489,104 common shares by it and certain affiliated entities and
individuals. As reported in the Schedule 13G, Lord, Abbett & Co. and such
affiliated entities and individuals have sole voting power with respect to
8,489,104 shares and have shared power to dispose or to direct the
disposition of 8,489,104 common shares.
30
The following table shows the beneficial ownership, reported to the Company as
of January 31, 2004, of Company common shares by each director, each executive
officer named in the Summary Compensation Table on page 15 and all of those
individuals and all other officers as a group, and also sets forth the number of
share units held under various deferred compensation plans.
The numbers of shares and share units shown below have been adjusted to reflect
the two-for-one stock split in the form of a stock dividend distributed on
February 23, 2004 to shareholders of record as of the close of business on
February 9, 2004.
TITLE OF CLASS: COMMON SHARES
NAME OF NUMBER PERCENT TOTAL NUMBER OF
BENEFICIAL OF SHARES OF DEFERRED SHARES AND
OWNER OWNED(1,2) CLASS(3) SHARE UNITS(4) DEFERRED SHARE UNITS
-----------------------------------------------------------------------------------------------
C. Arnold 173,218(5) 19,818 193,036
S. M. Buente 243,594(5) 38,286 281,880
R. W. Carson 308,796(5) 40,514 349,310
M. J. Critelli 36,918 0 36,918
A. M. Cutler 1,221,476(5,6) 248,536 1,470,012
R. H. Fearon 43,360 14,786 58,146
E. Green 44,512 4,876 49,388
N. C. Lautenbach 43,034 13,232 56,266
D. L. McCoy 29,968 8,104 38,072
J. R. Miller 40,894 0 40,894
G. R. Page 11,000 558 11,558
K. M. Patel 11,500 0 11,500
V. A. Pelson 35,894(6) 9,392 45,286
G. L. Tooker 41,894(6) 5,578 47,472
Directors and Executive
Officers as a Group of 25 3,347,472 587,492 3,934,964
-----------------------------------------------------------------------------------------------
(1) Each person has sole voting and investment power with respect to the shares
listed, unless otherwise indicated.
(2) Includes shares which the person has the right to acquire within 60 days
after January 31, 2004 upon the exercise of outstanding stock options as
follows: C. Arnold, 83,760; S. M. Buente, 205,732; R. W. Carson, 292,868; A.
M. Cutler, 1,068,706; R. H. Fearon, 29,040, and all directors and executive
officers as a group, 2,823,410 shares.
(3) Each of the individuals listed holds less than 1% of outstanding common
shares.
(4) For a description of these units, see pages 13 and 18.
(5) Includes shares held under the Eaton Savings Plan as of January 31, 2004.
(6) Includes shares held jointly or in other capacities, such as by trust.
31
Employee benefit plans of the Company and its subsidiaries on January 31, 2004
held 10,762,718 common shares for the benefit of participating employees, or
approximately 7% of common shares outstanding. The number of shares has been
adjusted to reflect the two-for-one stock split in the form of a stock dividend
distributed on February 23, 2004 to shareholders of record as of the close of
business on February 9, 2004.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE -- Section 16(a) of the
Securities Exchange Act of 1934 requires the Company's directors and officers to
file reports of holdings and transactions in the Company's equity securities
with the Securities and Exchange Commission. The Company believes that its
directors and officers complied fully with all such filing requirements with
respect to 2003.
FUTURE SHAREHOLDER PROPOSALS -- Shareholders who wish to submit proposals for
inclusion in the proxy statement and for consideration at the annual meeting
must do so on a timely basis. In order to be included in the proxy statement for
the 2005 annual meeting, proposals must relate to proper subjects and must be
received by the Corporate Secretary, Eaton Corporation, Eaton Center, Cleveland,
Ohio 44114-2584, before November 20, 2004.
By order of the Board of Directors
/s/ EARL R. FRANKLIN
Earl R. Franklin
Vice President and
Secretary
March 19, 2004
APPENDIX A
CHARTER OF GOVERNANCE COMMITTEE
The Governance Committee shall be comprised of at least three Directors, all of
whom meet the independence requirements of the New York Stock Exchange and the
Board of Directors. The Committee members shall be appointed by the Board upon
the recommendation of the Governance Committee or a majority of the independent
members of the Board. Committee members may be removed by the Board at any time
upon the recommendation of the Governance Committee or a majority of the
independent members of the Board.
The Governance Committee shall have the following responsibilities:
1. Recommend to the Board improvements in the Company's processes of corporate
governance, including proposed changes in the Board Governance Policies.
2. Advise the Board on changes in the size and composition of the Board.
3. Make recommendations to the Board regarding the structure and
responsibilities of Board Committees, recommend one year in advance a member
of each standing Board Committee to be appointed Chairman of the Committee,
and annually submit to the Board candidates to be appointed members and
Chairman of each standing Committee.
4. In consultation with the Chairman and Chief Executive Officer, identify and
recommend to the Board candidates for Board membership, based on the
criteria for Board membership listed in the Board Governance Policies.
5. Recommend to the Board individuals to be nominated for election or
re-election to the Board, taking into account input from all Directors.
6. Oversee the orientation of new Directors and regularly review the continuing
education needs of the Directors relating to their roles and
responsibilities as members of the Board and its Committees. In regard to
continuing education, the Committee will recommend seminars, provide
guidance and monitor the process.
32
7. Recommend to the Board compensation of non-employee Directors.
8. Administer the Board's policy on Director retirements and resignations.
9. Administer the Directors' stock ownership guidelines.
10. Recommend to the Board guidelines and procedures to be used by the Directors
to evaluate the Board's performance.
11. Provide oversight regarding significant public policy issues with respect to
the Company's relationships with shareholders, employees, customers,
competitors, suppliers and the communities in which it operates, including
the following areas:
(a) Ethics compliance
(b) Environmental, health and safety issues
(c) Diversity and equal employment opportunity
(d) Community relations
(e) Government relations
(f) Charitable contributions
(g) Shareholder and investor relations, including recommended responses to
shareholder proposals
(h) Eaton Philosophy of Excellence through People
12. Review the Company's Code of Ethics, including its programs to promote
ethical and legal conduct, to facilitate anonymous reporting of violations
and to assure protection of employees who report violations in good faith,
and from time to time recommend the adoption or amendment of the Code of
Ethics.
13. Periodically report to the Board concerning the Committee's actions,
conclusions and recommendations.
14. Assure that performance evaluations of the Governance Committee are
conducted annually.
The Governance Committee shall have the authority to retain and terminate
consultants and other advisors to advise the Committee in the performance of its
responsibilities, including search firms to be used to identify Director
candidates and compensation consultants to assist in the evaluation of Director
compensation. The Committee shall exercise sole authority to approve the fees
and other retention terms for such consultants and other advisors, who will
report directly to the Committee.
POLICIES ADOPTED BY THE BOARD OF DIRECTORS UPON THE RECOMMENDATION OF THE
GOVERNANCE COMMITTEE
Upon the recommendation of the Governance Committee, the Board of Directors on
July 24, 2002 adopted a policy regarding any business transactions between the
Company and other businesses in which its non-employee directors are executive
officers or major shareholders. The purpose of the policy is to assure that all
such transactions are undertaken strictly upon an objective assessment of the
economic value of the transactions to each party, and not because of personal
relationships between the director and the Company or its executives. The policy
provides, in effect, that in any business transactions between the Company and
such other businesses, there shall be no direct communication between the
director and any Company personnel and no direct communication between the
Company's Chief Executive Officer and any employees of the director's business.
The policy further provides that, if a proposed transaction is potentially
significant to either the Company or the director's business, or if the
director's independence may be compromised (or appear to be compromised), the
Chairman of the Company's Governance Committee shall be so informed.
---------------
Upon the recommendation of the Governance Committee, the Board of Directors on
October 23, 2002 adopted a policy that all non-employee directors shall be
"independent" according to the criteria set forth in the policy. Those criteria
have been updated by the Board of Directors most recently in February, 2004 and
are consistent with the independence criteria contained in the New York Stock
Exchange listing standards. The purpose of this policy is to assure the
independence of the Company's non-employee directors.
33
APPENDIX B
EATON CORPORATION
BOARD OF DIRECTORS GOVERNANCE POLICIES
I. BOARD ORGANIZATION AND COMPOSITION
A. Size and Structure of Board. The size of the Board should be in the range of
8-15. Only one Director should be an employee of the Company. The Board believes
that it is desirable for the Company's Board to be divided into three
approximately equal classes, one of which is elected each year, since this
structure assures continuity and has worked well historically.
B. Director Independence. Except for any Director who is a Company employee, all
Directors should be independent. A Director will be considered independent if
the Director meets the criteria set forth in the independence standards of the
New York Stock Exchange and the independence criteria adopted by the Company's
Board of Directors.
C. Director Tenure. Each Director is elected for a three-year term. There is no
limit to the number of terms a Director may serve. However, the Company's
retirement policy calls for each outside Director to retire at the Annual
Shareholders Meeting following the Director's 70th birthday and for the inside
Director to retire from the Board when he or she retires as an employee, no
later than the end of the month in which the Director reaches age 65. The
Chairman and Chief Executive Officer should not continue on the Board after
retiring as an employee. Directors who retire from their employment or who
otherwise significantly change the position they held when initially elected to
the Board should not necessarily leave the Board. However, the Board will review
the continued appropriateness of Board membership under these new circumstances.
D. Membership on Other Boards. Each Director is responsible to notify the
Chairman of the Governance Committee before accepting invitations to join other
Boards of Directors. One purpose of this policy is to avoid actual or potential
conflicts of interest or the appearance of conflicts of interest. Appropriate
legal advice will be obtained as necessary. Another purpose of this policy is to
insure that Directors do not have an excessive number of Board assignments that
would put the Directors' effectiveness at risk. Directors with full-time
employment may serve on a maximum of three for-profit Boards in addition to the
Company's Board, the Board of the Company that employs the Director, and any
other Boards on which the Director is required to serve as part of his or her
full-time employment responsibilities. Directors without full-time employment
may serve on a maximum of four for-profit Boards in addition to the Company's
Board.
E. New Directors. Director candidates will be selected on the basis of their
ability to make contributions to the Board of Directors and to the Company's
governance activities. Among the most salient strengths to be considered are
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. The initial screening
of Director candidates is conducted by the Chairman of the Governance Committee
in consultation with the Chairman and Chief Executive Officer. The Governance
Committee then identifies the recommended candidate for possible approval by the
Board of Directors.
F. Combining the Positions of Chairman and Chief Executive Officer. It is the
Board's policy that the positions of Chairman of the Board and Chief Executive
Officer should be held by the same person. The Board believes that this practice
provides the most efficient and effective leadership model for the Company.
G. No Lead Director. The Board believes that designating a lead Director is not
necessary or appropriate for the best interests of the Company and its
shareholders unless the Chairman and Chief Executive Officer is absent, and then
only for the duration of his or her absence.
II. COMMITTEE COMPOSITION AND LEADERSHIP
A. Membership of Committees. All Board Committees are comprised entirely of
outside independent Directors, except for the Executive Committee, which is
chaired by the Chairman and Chief Executive Officer.
34
B. Rotation of Committee Memberships and Chairs. In order to assure that each
Director has a broad exposure to the work of the various Board Committees, and
at the same time to provide for continuity in the membership of each Committee,
the Board has adopted the practice of rotating each outside Director's Committee
assignments approximately every four to six years, except that, for continuity,
Committee Chairs normally continue on their Committees for up to ten years. The
Director who will become the Chair of a Committee should be selected from among
the current members of the Committee and should be designated at least one year
in advance in order to permit adequate preparation time and a smooth transition.
C. Committee Descriptions. There are five standing Committees of the Board: the
Audit Committee, Compensation and Organization Committee, Executive Committee,
Finance Committee and Governance Committee. The responsibilities and membership
of these Committees are described in the Company's annual proxy statement.
III. PERFORMANCE ASSESSMENT AND SUCCESSION PLANNING
A. Board and Committee Assessments. Performance self-assessments are conducted
annually by the Board and the Audit, Compensation and Organization, Finance and
Governance Committees.
B. Chairman and Chief Executive Officer Performance Assessment. The performance
of the Chairman and Chief Executive Officer is thoroughly assessed annually by
the Compensation and Organization Committee, taking into account input from all
outside Directors. Key performance and leadership categories are established. As
to each category, each outside Director answers a set of specific questions,
provides written comments, suggests opportunities for improvement, and comments
on individual strengths. An external third party consolidates the feedback and
provides a summary report to the Chair of the Compensation and Organization
Committee who, in turn, reviews it with the full Board. The Chair of the
Committee then reviews the report with the Chairman and Chief Executive Officer.
C. Senior Management Performance Assessment. One of the most important
responsibilities of the Board is to assure that the Company's senior management
is well qualified to conduct the Company's business affairs. The Board has
delegated to the Chairman and Chief Executive Officer the responsibility to
assess the performance of the senior management team. The Chairman and Chief
Executive Officer, then, reports annually to the Board, giving his assessment of
each officer's performance and his thoughts on succession planning. The Board of
Directors takes these thoughts into account in its evaluation and direction of
succession planning, especially in regard to the position of Chief Executive
Officer.
D. Chief Executive Officer Succession Planning. It is the policy of the Board to
be adequately prepared to deal with Chief Executive Officer succession, should
the need arise, whether via emergency, resignation or retirement. The Board has
established several processes that work together to achieve this result. The
Chief Executive Officer annually leads a formal discussion with the Board to
review all key executives, including each executive's performance, leadership
attributes and readiness to assume additional responsibility. The Board also
utilizes the annual review to discuss short- and long-term succession planning
and emergency succession issues. By focusing on both the short and the long
term, the Board identifies specific individual development needs, that are then
communicated to each executive by the Chief Executive Officer in annual
performance reviews and ongoing coaching sessions. In addition to the annual
review, the Board feels it is important for each Director to interact personally
and frequently with the key executives. For this purpose, the Board has
established a formal process for each Director to meet with each key executive
individually so that all Directors are able to evaluate first-hand the
executive's readiness and potential to assume greater responsibility within the
Company or to step into the Chief Executive Officer role, if needed.
IV. OPERATION OF THE BOARD AND COMMITTEES
A. Director Responsibilities. The Board expects all Directors to fulfill the
following basic
35
responsibilities: (1) attend all meetings of the Board, relevant Board
Committees and Annual Shareholders Meetings, (2) participate actively in
meetings of the Board and relevant Board Committees after review of materials
that are provided to the Directors in advance of meetings, (3) act in a manner
consistent with the best interests of the Company and its shareholders (avoiding
conflicts of interest that would interfere with their doing so) and (4) exercise
proper diligence and business judgment in performing their duties as members of
the Board and its Committees.
B. Agendas and Background Information. The Agenda for each meeting of the Board
and Committees should be sent to the Directors or Committee members in advance,
along with background information on important subjects. Any Board or Committee
member may ask that an item be added to the Agenda.
C. Access to Management and Independent Advisors. Directors should request from
management, or any other sources they may desire, information that they consider
helpful in the performance of their duties. The Board and each Board Committee
may retain independent legal counsel, consultants or other advisors as the Board
or such Committee deems necessary and appropriate, the cost of which is borne by
the Company.
D. Executive Sessions. At each Board meeting, the Board holds an executive
session, in which only the Directors are present. The outside Directors also
meet in executive session at each Board meeting, without the inside Director
present, to discuss whatever topics they may deem appropriate. These executive
sessions are chaired on a rotating basis by the outside Directors who chair the
Audit, Compensation and Organization, Finance and Governance Committees. At
least one such executive session is held every year attended only by Directors
who meet the independence criteria of the Board of Directors and of the New York
Stock Exchange. In addition, at each meeting of the Audit, Compensation and
Organization, Finance and Governance Committees, an executive session is held,
which is attended only by the Committee members, all of whom are independent
Directors, without any members of the Company's management present, to discuss
whatever topics they may deem appropriate.
E. Board Meetings on Strategic Planning. The Board devotes one extended meeting
per year to strategic planning, along with portions of additional meetings
throughout the year. Company performance is to be measured in terms of the
Company's strategic objectives and its relative performance among its peers.
F. Concurrent Committee Meetings. Because of scheduling constraints, certain
meetings of Board Committees are held concurrently, although doing so requires
the inside Director to be absent from certain Committee meetings.
G. Minutes. Minutes of all Committee meetings are sent to all Directors for
their information in advance of the following Board meeting, together with the
minutes of the prior Board meeting.
H. Company Spokesperson. The Board of Directors has delegated to the Chairman
and Chief Executive Officer, or his designees, the responsibility to serve as
Company spokesperson.
I. Orientation for New Directors. An orientation process has been developed for
new Directors, including background briefings by the Chairman and Chief
Executive Officer, other senior officers and the Secretary.
J. Continuing Education for Directors. The Governance Committee regularly
reviews the continuing education needs of the Board members, provides guidance
and monitors the continuing education process. All Directors are encouraged to
obtain Governance Committee-approved continuing education relating to their
roles and responsibilities as members of the Board and its Committees.
V. COMPENSATION OF OUTSIDE DIRECTORS
A. Director Compensation. The Board of Directors with the advice of its
Governance Committee determines the compensation of the outside Directors. The
form and amount of Director compensation are intended to be competitive with
Director compensation at peer companies, appropriate to the time and energy
required of the Directors (as members of the
36
Board and as members or Chairs of Board Committees) and consistent with the
Directors' independence from the Company and its management.
B. Regular Reviews of Compensation. Regularly scheduled reviews of outside
Director compensation are conducted by the Governance Committee to assure that
the compensation remains competitive and appropriate. In this way, compensation
reviews are not specially scheduled at management's initiative.
C. Pensions. In 1996, the Company's pension plan for outside Directors was
discontinued as to newly-elected outside Directors. Those first elected in 1996
or later are not eligible to receive pension payments after retiring from the
Board. However, each of the Directors is encouraged to take advantage of the
opportunity under the 1996 Director Deferral Plan to defer Director fees into
phantom shares of the Company, which are paid out to the Director following
retirement from the Board in the form of shares, the cash equivalent, or a
combination of shares and cash, at the discretion of the Governance Committee.
D. Stock Options. Upon election each outside Director receives stock options for
10,000 common shares of the Company, exercisable at the market price of the
shares on the date of grant. Thereafter, each outside Director annually receives
stock options for a number of additional shares, with a market value on the date
of grant equal to four times the outside Directors' annual retainer. These
options also are exercisable at the market price of the shares on the date of
grant.
E. Share Ownership Guidelines. The Board has adopted guidelines calling for each
outside Director to acquire within five years a number of Company shares with a
market value equal to three times the amount of the outside Directors' annual
retainer.
VI. GENERAL
These Policies will be reviewed by the Governance Committee annually and may be
amended from time to time.
APPENDIX C
BOARD OF DIRECTORS
INDEPENDENCE CRITERIA
An Eaton Corporation Director will be considered independent if the Director
meets all of the following criteria:
1. The Director is not, and has not been within the previous three years (or
the one-year period permitted initially by the NYSE rules(1)), an employee
of Eaton Corporation or any of its subsidiaries or affiliates. No member of
the Director's immediate family(2) is, or has been within the previous
three years (or the one-year period permitted initially by the NYSE
rules(1)), an executive officer of Eaton Corporation or any of its
subsidiaries or affiliates.
2. Neither the Director nor any member of his or her immediate family(2) has
received at any time in the prior three years (or the one-year period
permitted initially by the NYSE rules(1)), more than $100,000 per year in
direct compensation from Eaton Corporation or any of its subsidiaries or
affiliates (including, without limitation, any consulting, advisory or
other compensatory fees) except that which Eaton Corporation pays to its
Directors for their services as members of the Board and members or Chairs
of Board Committees; provided that compensation paid to an immediate
family(2) member for service as a non-executive employee will not be
considered in determining the Director's independence.
3. The Director is not affiliated with or employed by, and no member of the
Director's immediate family(2) is affiliated
---------------
(1) During the first year following SEC approval of the new NYSE rules, the
three-year "look-back" provisions of these criteria are shortened to one year.
The full three-year "look- back" period is deemed to begin at the end of the
first year following SEC approval.
(2) "Immediate family" means a Director's spouse, parents, children, siblings,
mothers- and fathers-in-law, sons- and daughters-in-law, brothers- and
sisters-in-law, and anyone (other than the Director's domestic employees) who
shares the Director's home.
37
with or employed in a professional capacity by, a present or former
internal or external auditor for Eaton Corporation or any of its
subsidiaries or affiliates, and has not held such a position for at least
three years (or the one-year period permitted initially by the NYSE
rules(1)) since the end of his or her affiliation or employment or the end
of the auditing relationship, whichever occurred first.
4. Neither the Director nor any member of his or her immediate family(2) is
employed as an executive officer of any company whose compensation
committee includes a current employee of Eaton Corporation and has not held
such a position for at least three years (or the one-year period permitted
initially by the NYSE rules(1)) since the end of his or her service as an
executive officer or the end of the Eaton employee's membership on the
compensation committee, whichever occurred first.
5. The Director is not an executive officer or an employee, nor is any member
of his or her immediate family(2) an executive officer, of another company
for which payments by Eaton Corporation to that company, or from that
company to Eaton Corporation, including their respective subsidiaries and
affiliates, for property or services have accounted for the greater of $1
million or 2% of the other company's consolidated gross revenues, in any
fiscal year during the past three years (or the one-year period permitted
initially by the NYSE rules(1)).
6. The Board of Directors has affirmatively determined that the Director has
no material(3) relationship (whether financial, business, personal or
otherwise) with Eaton Corporation or any of its subsidiaries or affiliates,
either directly or as a partner, shareholder or officer of an organization,
including a charitable organization, that has a relationship with Eaton
Corporation or any of its subsidiaries or affiliates. Eaton Corporation
will publicly disclose any contributions it has made to any charitable
organization in which a Director serves as an executive officer, if within
the preceding three years (or the one-year period permitted initially by
the NYSE rules(1)) contributions in any single fiscal year have exceeded
the greater of $1 million or 2% of the charitable organization's
consolidated gross revenues.
Audit Committee members will be considered independent if they meet all of the
above six criteria and the following additional two criteria:
1. The Committee member has received no direct compensation from Eaton
Corporation or any of its subsidiaries or affiliates (including, without
limitation, any consulting, advisory or other compensatory fees) except
that which Eaton Corporation pays to its Directors for their services as
members of the Board and members or Chairs of Board Committees.
2. The Committee member is not an affiliate of the Company (i.e., not
controlling, controlled by, or under common control with, the Company),
such as a 10%-plus shareholder.
The Board of Directors has determined that simultaneous service by any Audit
Committee member on a maximum of three public company audit committees,
including the Eaton Corporation Audit Committee, does not impair his or her
ability to effectively serve on the Eaton Corporation Audit Committee.
Directors and members of Eaton Corporation's management are encouraged to bring
questions or concerns regarding Director independence or these criteria promptly
to the attention of the Governance Committee Chairman for guidance.
---------------
(3) "Materiality" is to be considered from the standpoint of the Director and
that of each organization of which the Director is a partner, shareholder or
officer. The determination that, as to each Director individually, there is no
material relationship (whether financial, business, personal or otherwise) will
be made by the Board of Directors after consideration of the recommendation of
its Governance Committee, based upon information provided by the Director and
any other information that may be known to the Board. The purpose of Item #6 is
ultimately to determine whether a Director has any relationship with Eaton
Corporation, either directly or through any other person or organization, that
may interfere with the exercise of the Director's independence from Eaton
Corporation and its management.
38
---------------
BOARD OF DIRECTORS POLICY ON DIRECTORS' USE OF
COMPANY PLANES
The Board of Directors believes that the Company should provide transportation
to facilitate Director attendance at meetings of the Board and Board Committees,
Annual Shareholders Meetings, Board visits to Company facilities and other
appropriate Company events. Transportation may be provided through the use of
Company planes and cars or through reimbursement of the Directors for the cost
of commercial transportation. At the same time, the Board believes it is
important that the independence of the outside Directors not be compromised, or
appear to be compromised, by their accepting transportation from the Company for
other purposes.
Therefore, the Board of Directors has adopted the following policy relating to
the use of Company planes for transportation of outside Directors:
1. Directors may be transported on Company planes to facilitate their
attending meetings of the Board and Board Committees, Annual Shareholders
Meetings, Board visits to Company facilities and other appropriate Company
events. This policy contemplates transportation to and from Directors'
homes, places of business or other locations, and may include
transportation to and from Directors' other business commitments, unrelated
to the Company, if necessary to facilitate the Directors' attending Company
events. However, in no event may outside Directors be transported on
Company planes to locations, or under circumstances, where the
transportation would constitute compensation to the Directors. Directors
will be deemed to have received compensation if the transportation would be
treated as imputed income for U.S. federal tax purposes.
2. The use of Company planes by the Directors pursuant to this policy is
intended to be normal practice. It is not, and should not appear to be,
discretionary with the Company's management.
3. Company planes may not be used to transport spouses, other family members
or guests of the outside Directors under circumstances where the
transportation would be treated as imputed income to the Directors or to
the family members for U.S. federal tax purposes.
4. The Governance Committee of the Board is authorized to provide more
detailed guidance on the appropriate use of Company planes by the
Directors, within the intent of this policy.
APPENDIX D
CHARTER OF AUDIT COMMITTEE
The Audit Committee shall be responsible to assist the Board of Directors in
overseeing (1) the integrity of the Company's 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 Audit Committee shall be comprised of at least three Directors recommended
by the Governance Committee or by a majority of the independent members of the
Board and appointed by the Board. Each Committee member shall meet the
independence requirements, and all Committee members collectively shall 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. No
Committee member shall concurrently serve on the audit committees of more than
two other publicly-held companies. Members of the Audit Committee may be removed
at any time by the Board of Directors upon the recommendation of the Governance
Committee or a majority of the independent members of the Board.
The Committee shall exercise sole authority to appoint, terminate and compensate
the independent auditor, which shall report directly to the Committee.
The Audit Committee shall have the authority to retain and terminate special
legal, accounting or
39
other consultants to advise the Committee. The Committee shall exercise sole
authority to approve the fees and other retention terms for such consultants,
who will report directly to the Committee. The Audit Committee may request any
officer or employee of the Company or the Company's outside counsel or
independent auditor to attend a meeting of the Committee or to meet with any
members of, or consultants to, the Committee.
The Company shall provide appropriate funding to the Audit Committee to
compensate the auditors and any advisors to the Committee.
The Audit Committee shall establish procedures for the receipt, retention and
treatment of complaints received by the Company regarding accounting, internal
accounting controls or auditing matters, and the confidential, anonymous
submission by employees of concerns regarding questionable accounting or
auditing matters.
The Audit Committee shall make regular reports to the Board concerning the
Committee's actions, conclusions and recommendations.
The Audit Committee shall:
1. Review and reassess the adequacy of this Charter at least annually and
recommend any proposed changes to the Board for approval.
2. Pre-approve all auditing services and permitted non-audit services
(including the fees and terms thereof) to be performed for the Company by
the independent auditor. The Committee shall be responsible to resolve any
disagreements between the independent auditor and the Company's management.
3. Non-audit engagements with the independent auditor shall exclude in any
event non-audit services prohibited by law.
4. At least annually, obtain and review a report by the independent auditor
delineating all relationships between the independent auditor and the
Company, consider the compatibility of the independent auditor's non-audit
services (if any) with its independence and take appropriate action to
satisfy itself of the independence of the independent auditor.
5. At least annually, obtain and review a report by the independent auditor
describing the following: (a) the independent auditor's internal
quality-control procedures and (b) any material issues raised by the most
recent internal quality-control review, or peer review, of the independent
auditor, or by any inquiry or investigation by governmental or professional
authorities, within the preceding five years, respecting one or more
independent audits carried out by the independent auditor, and any steps
taken to deal with any such issues.
6. Evaluate the performance of the independent auditor and, if so determined by
the Audit Committee, replace the independent auditor. The evaluation shall
include a review and evaluation of the performance of the independent
auditor's lead partner. The lead partner and the audit partner responsible
for reviewing the Company's audit shall be rotated off the Company's audit
at least once every five years, or any time that the Audit Committee may
determine. The Committee also shall consider whether, in order to assure
continuing auditor independence, it is appropriate to rotate the independent
auditor.
7. Set clear hiring policies for employees or former employees of the
independent auditor that comply with the requirements of the Sarbanes-Oxley
Act of 2002 and the listing standards of the New York Stock Exchange.
8. Review the annual audited financial statements with management and the
independent auditor before publication, including major issues regarding
accounting and auditing principles and practices as well as the adequacy of
internal controls that could significantly affect the financial statements,
and recommend to the Board whether the financial statements should be
included in the annual report to shareholders and annual report on Form
10-K. The Committee's review shall include a discussion of the disclosures
to be made by the Company under "Management's Discussion and Analysis of
Financial Condition and Results of Operations" in the Form 10-K report.
40
9. Review analyses prepared by management and the independent auditor of
significant financial reporting issues and judgments made in connection with
the preparation of the Company's annual financial statements.
10. Review with management and the independent auditor the Company's quarterly
financial statements prior to the filing of each Form 10-Q report. This
review shall include a discussion of the type of information to be disclosed
in the Company's earnings press release. The Committee's review also shall
include a discussion of the disclosures to be made by the Company under
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" in the Form 10-Q report.
11. Review and discuss quarterly reports by the independent auditor on:
(a) all critical accounting policies and practices to be used;
(b) all alternative treatments of financial information within generally
accepted accounting principles that have been discussed with
management, ramifications of the use of such alternative disclosures
and treatments, and the treatment preferred by the independent auditor;
(c) other material written communications between the independent auditor
and the Company's management, such as a management letter or schedule
of unadjusted differences.
12. Review material changes to the Company's auditing and accounting principles
and practices as suggested by the independent auditor, internal auditors or
management.
13. Discuss with the independent auditor any matters raised by the independent
auditor under generally accepted auditing standards relating to the conduct
of the Company's annual audit and quarterly reviews, including the
independent auditor's judgment about the quality of the Company's accounting
principles as applied in its financial reporting.
14. Review with the independent auditor any problems or difficulties the
independent auditor may have encountered in the annual audit.
15. Review with the Company's General Counsel legal matters that may have a
material impact on the Company's financial statements.
16. Meet periodically with management to review the Company's material financial
risk exposures and the steps management has taken to monitor and control
such exposures.
17. Review the report of the Director -- Audits on internal controls and
internal audit results.
18. Review and approve the appointment and any replacement of the Company's
Director -- Audits.
19. Meet with the Director -- Audits and independent auditor prior to the
Company's annual audit to review the scope, planning and staffing of the
audit.
20. Review disclosures by the chief executive officer and chief financial
officer during their certification process for Form 10-K and Form 10-Q
reports in regard to any significant deficiencies in the design or operation
of internal controls or material weaknesses therein and any fraud involving
management or other employees who have a significant role in the Company's
internal controls.
21. Discuss the types of information to be disclosed in earnings guidance to
analysts and others, and the type of presentation to be made to rating
agencies, with the understanding that the Committee need not discuss in
advance each instance in which the Company may provide earnings guidance.
22. Meet several times per year with the Company's chief financial officer,
Director -- Audits and independent auditor in separate executive sessions.
23. Prepare the report required by the rules of the Securities and Exchange
Commission to be included in the Company's annual proxy statement.
24. Assure that performance evaluations of the Audit Committee are conducted
annually.
41
While the Audit Committee shall have the responsibilities and powers set forth
in this Charter, it shall not be the duty of the Committee to plan or conduct
audits or to determine that the Company's financial statements and disclosures
are complete and accurate and in accordance with generally accepted accounting
principles and applicable rules and regulations. These instead shall be the
responsibility of management and the independent auditor.
POLICIES ADOPTED BY THE AUDIT COMMITTEE OR BY THE BOARD OF DIRECTORS UPON THE
RECOMMENDATION OF THE AUDIT COMMITTEE
Upon the recommendation of the Audit Committee, the Board of Directors on July
24, 2002 adopted a policy regarding the Company's not hiring personnel of the
Company's independent auditors. The purpose of the policy is to help assure the
independence of those personnel. In summary, the policy provides: (A) the
Company will not hire in any capacity an individual who has served as an
engagement audit partner, tax partner, senior manager or manager of the
independent auditors and who has worked on the Company's audit during the
previous two years and (B) the Company will not hire in the capacity of Chief
Executive Officer, Chief Operating Officer, Chief Financial Officer, Chief
Accounting Officer, or an equivalent position, an individual who has been a
partner, manager or employee of the Company's independent auditors during the
previous five years. Any exceptions to this policy must be approved by the Audit
Committee on the grounds that an exception is in the best interests of the
Company and its shareholders.
---------------
On February 25, 2003, the Audit Committee adopted procedures under Section 301
of the Sarbanes-Oxley Act of 2002 for (A) the receipt, retention and treatment
of complaints received by the Company regarding accounting, internal accounting
controls or auditing matters and (B) the confidential, anonymous submission by
Company employees of concerns regarding questionable accounting or auditing
matters. The Committee approved for these purposes the use of the Company's
Ethics and Financial Integrity Help Line (see the Code of Ethics in Appendix G
to this proxy statement), with the understanding that any such complaints or
concerns received on the Help Line shall be reported to the Committee or its
Chairman in a timely manner but in no event later than the next meeting of the
Committee.
APPENDIX E
CHARTER OF
COMPENSATION AND ORGANIZATION COMMITTEE
The Compensation and Organization Committee shall be comprised of at least three
Directors, all of whom meet the independence requirements of the New York Stock
Exchange and the Board of Directors. The Committee members shall be appointed by
the Board of Directors upon the recommendation of the Governance Committee or a
majority of the independent members of the Board. Committee members may be
removed by the Board of Directors at any time upon the recommendation of the
Governance Committee or a majority of the independent members of the Board.
The Compensation and Organization Committee shall have the following
responsibilities:
1. Annually evaluate the performance of the Chairman and Chief Executive
Officer, taking into account input from all outside Directors, and review
the performance evaluations of the other elected officers of the Company;
2. Maintain and periodically review a succession plan for key officer positions
of the Company, including the positions of Chairman and Chief Executive
Officer and Chief Operating Officer;
3. Recommend to the Board the individual who should assume the position of
Chairman and Chief Executive Officer if that position becomes vacant due to
unforeseen circumstances;
4. Annually review the aggregate amount of awards to be made under the
Executive Incentive Compensation Plan and adjust that amount as the
Committee deems appropriate within the terms of the Plan;
5. Establish performance objectives under the Company's long-term incentive
42
compensation plans and determine the attainment of such performance
objectives;
6. Annually determine the salary of each elected officer of the Company,
subject to discussion by the Board and endorsement by the independent
Directors;
7. Annually review the awards to be made to the elected officers under the
Executive Incentive Compensation Plan;
8. Annually review the awards to be made to the elected officers under the
Company's long-term incentive compensation plans;
9. Administer the Company's stock plans and periodically approve grants of
stock options and other equity-based awards to Company employees;
10. In determining the compensation of the Chairman and Chief Executive Officer,
the Committee shall (a) review and approve corporate goals and objectives
that the Committee deems to be relevant to Chairman and Chief Executive
Officer compensation, (b) evaluate the Chairman and Chief Executive
Officer's performance in light of those goals and objectives and (c) set the
Chairman and Chief Executive Officer's compensation level based on that
evaluation.
11. Review proposed organization or responsibility changes at the officer level;
12. Periodically review all of the Company's compensation and perquisite
practices for employees who are key to the Company's business to confirm
that such practices remain equitable and competitive;
13. Establish such share ownership retention guidelines for Company officers and
other executives as the Committee may deem appropriate and monitor the
administration of those guidelines;
14. Review (a) proposed new employee benefit plans for very large employee
populations, (b) material changes to the basic conceptual direction of any
such existing plans, (c) changes to such plans that would substantially
increase or decrease benefits for officers in any manner that is not
generally similar for all participants and is therefore disproportionate,
(d) proposed new employee benefit plans that are material and primarily for
the benefit of employees who are key to the Company's business, (e) equity
compensation plans which, under the New York Stock Exchange listing
standards, are subject to shareholder approval and (f) changes to any such
existing plans that would substantially increase or decrease the benefits
provided by those plans;
15. Prepare an annual report for the Company's proxy statement regarding
executive compensation, as required by the rules of the Securities and
Exchange Commission and the New York Stock Exchange;
16. Periodically report to the Board concerning the Committee's actions,
conclusions and recommendations; and
17. Assure that performance evaluations of the Committee are conducted annually.
The Compensation and Organization Committee shall have the authority to retain
and terminate compensation consultants and other advisors to advise the
Committee in the evaluation of compensation for the Chairman and Chief Executive
Officer and other officers or on other matters. The Committee shall exercise
sole authority to approve the fees and other retention terms for such
consultants or other advisors, who will be directly responsible to the
Committee.
APPENDIX F
CHARTER OF FINANCE COMMITTEE
The Finance Committee shall be comprised of at least three Directors, all of
whom qualify as "independent" under the standards adopted by the New York Stock
Exchange and the Board of Directors. The Committee members shall be appointed by
the Board upon the recommendation of the Governance Committee or a majority of
the independent members of the Board. Committee members may be removed by the
Board at any time upon the recommendation of the Governance Committee or a
majority of the independent members of the Board.
The Finance Committee shall have the following responsibilities:
1. Periodically review the financial condition of the Company, including its
total financial resources, strengths and capabilities, and
43
recommend financial policies to the Board of Directors;
2. Analyze Company policy with respect to its debt-equity relationship and make
recommendations to the Board with respect thereto;
3. Review the Company's dividend policy and make recommendations to the Board
with respect thereto;
4. Review the Company's cash flow, including its total capital expenditure
program, working capital changes and other current and anticipated financial
requirements;
5. Review proposals for share issuances and repurchases;
6. Review proposals for long- and short-term debt financing;
7. Review the Company's risk management program and its adequacy to safeguard
the Company against extraordinary liabilities and losses;
8. Periodically meet with, and review the performance of, the Pension
Investment Committee, the Pension Administration Committee and any other
fiduciaries that the Board may appoint with respect to the Company's pension
and other retirement income plans (including employee share purchase or
similar plans);
9. Annually review the key assumptions used to calculate annual pension
expense, including the assumed long-term return on pension plan assets and
the discount rate used to determine the present value of pension plan
liabilities;
10. Periodically report to the Board concerning the Committee's actions,
conclusions and recommendations;
11. Assure that performance evaluations of the Finance Committee are conducted
annually.
The Finance Committee shall have the authority to retain and terminate
consultants and other advisors to advise the Committee in the performance of its
responsibilities. The Committee shall exercise sole authority to approve the
fees and other retention terms for such consultants and other advisors, who will
report directly to the Committee.
44
APPENDIX G
CODE OF ETHICS
To my fellow Eaton employees
Ethical values are fundamental to Eaton. They define our heritage and our
future, and distinguish us from other organizations that go about their work
without regard for what is right and what is wrong.
Why do people at Eaton work so hard and so successfully? I think that one reason
is their belief in our company's values, a foundation that is a source of great
strength.
Every one of us can--and should--be a role model for honesty and integrity. We
must communicate the message of Eaton's ethics to our colleagues, associates,
customers and suppliers--in what we say and, even more importantly, in what we
do.
We're here to achieve great results, but each of us must demonstrate that we
care intensely about how we get those results. They are worth little and are
unlikely to endure if achieved unethically.
We should all be proud that we start from a track record of success. And I want
you to know that I will do everything possible to see that this Eaton tradition
of integrity continues. However, ethics is everyone's responsibility, and I want
everyone at Eaton to feel comfortable talking about these subjects--expressing
concerns, raising issues and encouraging the highest levels of integrity.
This guide gives you lots of information and sources for help. Please use it to
the fullest. If you've done everything we've asked you to do and are not getting
the help you need, contact me.
/s/ Alexander Cutler
Alexander M. Cutler
Chairman and Chief Executive Officer
------------------------------------
Eaton Corporation requires that all directors, officers and employees of Eaton,
its subsidiaries and affiliates ("Eaton"), abide by the fundamental principles
of ethical behavior listed here in performing their duties.
OBEYING THE LAW--We respect and obey the laws, rules and regulations applying to
our businesses around the world.
INTEGRITY OF RECORDING AND REPORTING OUR FINANCIAL RESULTS--We properly maintain
accurate and complete financial and other business records, and communicate
full, fair, accurate, timely and understandable financial results. In addition,
we recognize that various officers and employees of Eaton must meet these
requirements for the content of reports to the U.S. Securities and Exchange
Commission, or similar agencies in other countries, and for the content of other
public communications made by Eaton.
RESPECTING HUMAN RIGHTS--We respect human rights and require our suppliers to do
the same.
DELIVERING QUALITY--We are committed to producing quality products and services.
Our business records and communications involving our products and services are
truthful and accurate.
COMPETING ETHICALLY--We gain competitive advantage through superior performance.
We do not engage in unethical or illegal trade practices.
RESPECTING DIVERSITY AND FAIR EMPLOYMENT PRACTICES--Throughout the world we are
committed to respecting a culturally diverse workforce through practices that
provide equal access and fair treatment to all employees on the basis of merit.
We do not tolerate harassment or discrimination in the workplace.
AVOIDING CONFLICTS OF INTEREST--We avoid relationships or conduct that might
compromise judgment or create actual or apparent conflicts between our personal
interests and our loyalty to Eaton. We do not use our position with Eaton to
obtain improper benefits for others or ourselves. We do not compete with Eaton.
45
PROTECTING OUR ASSETS--We use Eaton property, information and opportunities for
Eaton's business purposes and not for unauthorized use. We properly maintain the
confidentiality of information entrusted to us by Eaton or others.
OFFERING/ACCEPTING GIFTS, ENTERTAINMENT, BRIBES OR KICKBACKS--We do not offer or
accept gifts or entertainment of substantial value. We do not offer or accept
bribes or kickbacks.
SELLING TO GOVERNMENTS--We comply with the special laws, rules and regulations
that relate to government contracts and relationships with government personnel.
POLITICAL CONTRIBUTIONS--We do not make contributions on behalf of Eaton to
political candidates or parties even where lawful.
REPORTING ETHICAL, LEGAL OR FINANCIAL INTEGRITY CONCERNS--Any person may openly
or anonymously report any ethical concern or any potential or actual legal or
financial violation, including any fraud, accounting, auditing, tax or
record-keeping matter, to the Director--Global Ethics of Eaton. For reports that
are not made anonymously, confidentiality will be maintained to the extent
possible while permitting an appropriate investigation.
Reports may be made openly or anonymously by regular mail to Director-Global
Ethics, Eaton Corporation, Eaton Center, Cleveland, Ohio 44114. Reports may also
be made to the office of the Director--Global Ethics by e-mail or telephone
through Eaton's Ethics and Financial Integrity Help Line:
E-MAIL Access the Ethics and Financial Integrity Help Line through the
Employee Services tab on Eaton's intranet. The message will be
anonymous unless the sender identifies himself or herself.
Alternatively, send a regular Outlook e-mail, which will not be
anonymous, to Ethics@eaton.com.
TELEPHONE From the U.S. and Canada, dial toll free 1-800-433-2774. This call
will be anonymous unless the caller identifies himself or herself.
From all other countries, dial your country's AT&T access code
(found on e-net), and then dial toll free 1-800-433-2774. This
call will be anonymous unless the caller identifies himself or
herself.
NON-ENGLISH If you are not comfortable making your report in English through
the Ethics and Financial Integrity Help Line, please use your
native language to e-mail or write your concern to the address
above, and we will translate your letter or e-mail.
Eaton will not permit any retaliation against any employee who reports an
ethical, legal or financial concern nor will it discipline any employee for
making a report in good faith.
------------------------------------
PERSONAL RESPONSIBILITY
Every officer, director and employee has the personal responsibility to read,
know and comply with the principles contained in this Code of Ethics. Compliance
with these principles is a condition of employment, and failure to comply will
result in discipline up to and including termination.
The Board of Directors shall determine, or designate appropriate management
personnel to determine, the actions to be taken in the event of violations of
the Code of Ethics. Such actions shall be reasonably designed to deter
wrongdoing and to promote accountability for adherence to the Code of Ethics.
Every officer, director and employee has the duty to bring to the attention of a
supervisor or another member of management, or the Director--Global Ethics, or
the Chairs of the Audit or Governance Committees of the Board of Directors, or
directly to the full Board of Directors, any activity that in his or her
judgment would violate these principles. Potential violations may be reported to
the Board or relevant Committee Chair by mail in care of the Director-Global
Ethics, at the above address. The Director will forward it unopened to the
addressee(s).
46
APPENDIX H
2004 STOCK PLAN
1. PURPOSE
The Plan enables non-employee directors and professional and management
employees who contribute significantly to the success of Eaton Corporation (the
"Company") to participate in its future prosperity and growth and to identify
their interests with those of the shareholders. The purpose of the Plan is to
provide long-term incentive through outstanding service to the Company and its
shareholders and to assist in recruiting and retaining people of outstanding
ability and initiative in non-employee director, professional and management
positions.
2. ADMINISTRATION
(A) Employee Awards
With respect to employee awards, the Plan shall be administered by the
Compensation and Organization Committee of the Board of Directors (the
"Committee"), which shall consist of at least three non-employee directors.
(B) Non-employee Director Options
With respect to non-employee director options, the Plan shall be administered by
the Governance Committee of the Board of Directors, which shall consist of at
least three non-employee directors.
(C) Authority of Committees
With respect only to those awards for which it has administrative
responsibility, the Committee and the Governance Committee shall each have
complete authority (except as otherwise expressly provided herein) to interpret
all provisions of the Plan consistent with law, to determine the type and terms
of awards consistent with the provisions of the Plan, to prescribe the form of
instruments evidencing awards, to adopt, amend and rescind general and special
rules and regulations for its administration, and to make all other
determinations necessary or advisable for its administration of the Plan. The
determinations of each committee shall be final and conclusive. The committees
may act by resolution or in any other manner permitted by law. The Committee may
delegate its authority to officers of the Company with respect to the granting
of awards to employees who are not officers or directors of the Company.
3. SHARES AVAILABLE
The aggregate of (a) the number of Eaton common shares delivered by the Company
in payment and upon exercise of awards to employees and non-employee directors
and (b) the number of shares subject to outstanding awards to employees and
non-employee directors shall not exceed 7,000,000 at any one time, subject to
adjustments as authorized herein. Shares related to awards that are forfeited,
terminated, unexercised upon expiration, settled in cash in lieu of shares or in
such manner that all or some of the shares covered by an award are not issued,
or exchanged for awards that do not involve shares, shall immediately become
available for other awards. Shares available for awards may consist, in whole or
in part, of authorized and unissued shares or treasury shares.
The maximum aggregate number of shares or share units underlying options or
related to other awards that may be granted to any employee during any three
consecutive calendar year period is 1,200,000. No more than 40% of the total
number of shares authorized for delivery under the Plan may be granted as
performance shares, restricted shares, stock appreciation rights or other
share-based awards (other than stock options). In addition, no more than 5% of
the total number of shares authorized for delivery under the Plan may be granted
as performance shares, restricted shares, stock appreciation rights or other
share-based awards (other than stock options) which vest within less than one
year after the date of grant. With respect to such awards in excess of 5% of the
total number of such authorized number of shares, the
47
vesting period must exceed one year, with no more than one third of shares
becoming vested at the end of each of the twelve-month periods following the
date of grant.
Awards may be made under the Plan at any time after approval of the Plan by
shareholders at the 2004 annual meeting until December 31, 2013.
4. ELIGIBILITY FOR AWARDS
Any non-union salaried employee (including officers) of the Company or any of
its subsidiaries may be granted an award. The Committee (a) will designate
employees to whom grants are to be made, (b) will specify the number of options,
stock appreciation rights, performance shares, restricted shares or other
share-based awards subject to each grant, and (c) subject to Section 5(C), will
specify the price of the award. Non-employee directors are eligible to receive
stock options as provided under Section 5(B).
5. STOCK OPTIONS
(A) Employee Stock Options
Grants. The Committee may grant to eligible employees (i) options which are
intended to qualify as incentive stock options ("Incentive Stock Options") under
the Internal Revenue Code, or (ii) options which are not intended to qualify as
Incentive Stock Options. Each option will give the employee the right to
purchase a designated number of the Company's common shares with a par value of
50c each ("shares"). The aggregate fair market value (at the time of grant) of
shares for Incentive Stock Options under all plans of the Company which become
initially exercisable by an employee during any calendar year shall not exceed
$100,000 (or such other amount as may be provided by the Internal Revenue Code
or regulations thereunder).
Exercise. Each option shall be exercisable on such date or dates, during such
period and for such number of shares, as shall be determined by the Committee as
of the date of grant, although grants to employees subject to Section 16(b) of
the Securities Exchange Act of 1934 ("Section 16b") shall not be exercisable for
at least six months after those options are granted. The Committee may, in its
sole discretion, accelerate the times when an option may be exercised and the
Management Compensation Committee (comprised of Company officers) may do
likewise for employees who are not subject to Section 16b.
(B) Non-employee Director Stock Options
Grants. Subject to approval of the Plan by shareholders at the 2002 annual
meeting, each person who at that meeting or thereafter first becomes a
non-employee director automatically shall be granted an option for 10,000 shares
upon the date of his or her election. On each granting date that each
non-employee director continues to serve in that capacity, beginning in the year
after that director receives his or her initial grant, he or she shall
automatically be granted an option for a number of shares equal to the quotient
resulting from dividing (i) four times the annual retainer for each non-employee
director in effect on the granting date, by (ii) the closing price of an Eaton
common share on the New York Stock Exchange Composite Transactions on the last
business day immediately preceding the granting date. The granting date is the
Tuesday immediately before the fourth Wednesday of each January. Notwithstanding
anything to the contrary herein, no non-employee director shall receive an
initial grant or a continuing grant for a particular year if that director
receives such a grant under any other stock plan of the Company.
Term. The term of each option shall expire ten years from the date of grant.
Exercise. An option shall become fully exercisable six months following the
date of grant.
(C) Price
Each employee option and each non-employee director option shall state the
number of shares to which it pertains and the option price. The option price
shall be the fair market value of the shares subject to the option on the date
of grant. The fair market value shall be the mean of the high and low prices as
quoted on the New York Stock Exchange Composite Transactions.
48
(D) Payment
The price at which shares may be purchased upon exercise of an employee option
or non-employee director option shall be paid in cash, or, if permitted by the
terms of the option, by means of tendering shares or other consideration valued
at fair market value on the date of exercise, or any combination thereof. The
appropriate committee shall determine acceptable methods of tendering shares or
other consideration. Delivery of shares by the Company to the option holder upon
exercise of an option may be deferred, as authorized by the appropriate
committee.
6. PERFORMANCE SHARES
The Committee may grant performance shares to any eligible employee for no cash
consideration, if permitted by applicable law, or for such consideration as may
be determined by the Committee and specified in the grant. The Committee shall
establish award periods and shall establish the number of performance shares to
be earned if Company performance objectives are met. The performance objectives
shall be stated in terms of cash flow return on gross capital employed in the
Company's business ("CFR"). CFR equals the total of net income plus depreciation
and after-tax net interest divided by the total of capital plus accumulated
depreciation (minus goodwill and short-term investments). After performance
shares have been awarded and performance objectives have been established, the
Committee may not increase the number of performance shares that may be earned
by any employee upon attainment of those performance objectives within a
performance period. The actual levels of CFR to be achieved, and the length of
the performance period and, subject to the requirements of Section 3, other
terms and conditions of the performance shares, shall be determined by the
Committee. To the extent performance shares are forfeited or the grant of
performance shares has expired or is surrendered, canceled or terminated, the
shares subject to the grant shall be available for future grants if within other
Plan limitations.
7. OTHER AWARDS
In limited circumstances where the Committee determines that the use of stock
options is inadvisable for tax or other regulatory reasons, it may grant stock
appreciation rights to eligible employees. Stock appreciation rights entitle the
holder, upon exercise, to receive a number of shares or cash, as the Committee
may determine, equal to the increase in fair market value of a number of shares
designated by such rights from the date of grant to the date of exercise. The
number of shares subject to a stock appreciation right shall be counted against
the individual limit on the maximum number of shares that may be awarded to any
employee during any three consecutive calendar year period, and against the
maximum number of shares which may be delivered under the Plan.
Subject to Section 3, the Committee may grant other share-based awards to any
eligible employee for no cash consideration, if permitted by applicable law, or
for such consideration as may be determined by the Committee and specified in
the grant. Such grants may include restricted shares. The Committee may specify
such criteria or periods for payment as it shall determine, and the extent to
which such criteria or periods have been met shall be conclusively determined by
the Committee. Other share-based grants may be paid in shares or other
consideration related to shares, as specified by the grant, and, subject to the
requirements of Section 3, shall have such terms and conditions as shall be
determined by the Committee.
8. TRANSFERS
Except as otherwise provided by the appropriate committee, awards under the Plan
are not transferable other than by will or the laws of descent and distribution.
A transferred award may be exercised by the transferee only to the extent that
the grantee would have been entitled had the award not been transferred.
Notwithstanding anything herein to the contrary, the transfer of Incentive Stock
Options shall be limited as required by the Internal Revenue Code and applicable
regulations.
49
9. ADJUSTMENTS
In the event of a reorganization, merger, consolidation, reclassification,
recapitalization, combination or exchange of shares, stock split, stock
dividend, rights offering or similar event affecting shares of the Company, the
following shall be equitably adjusted by the appropriate committee: (a) the
number and class of shares (i) reserved under the Plan, (ii) for which awards
may be granted to an individual, and (iii) covered by outstanding awards
denominated in shares or share units, (b) the prices relating to outstanding
awards, and (c) the appropriate fair market value and other price determinations
for such awards.
10. GENERAL PROVISIONS
The Company shall have the right to deduct from any cash payment made under the
Plan any taxes required by law to be withheld. It shall be a condition to the
obligation of the Company to deliver shares that the participant pay the Company
such amount as it may request for the purpose of satisfying any such tax
liability. Any award under the Plan may provide that the participant may elect,
in accordance with any regulations issued by the appropriate committee, to pay
the amount of such withholding taxes in shares.
No person, estate or other entity shall have any of the rights of a shareholder
with reference to shares subject to an award until a certificate or certificates
for the shares have been delivered to that person, estate or other entity. The
Plan shall not confer upon any non-employee director or employee any right to
continue in that capacity. The laws of Ohio shall govern the Plan and all
determinations made and actions taken pursuant hereto, to the extent not
governed by the laws of the United States.
11. AMENDMENT
The Board of Directors of the Company may alter, amend or terminate the Plan
from time to time, except that the Plan may not be amended without shareholder
approval to (i) materially increase the aggregate number of shares which may be
issued, (ii) increase the maximum number of shares which may be granted to any
employee, (iii) grant options or stock appreciation rights at a purchase price
below fair market value on date of grant, or (iv) materially modify the
requirements as to eligibility for participation in the Plan, or in any respect
as to which shareholder approval is required under the rules of the New York
Stock Exchange, provided that the Company is subject to such rules at the time
of the amendment. The provisions of the Plan pertaining to the awards to
non-employee directors may not be amended more than once every six months, other
than to comport with changes in the Internal Revenue Code, the Employee
Retirement Income Security Act, or the rules thereunder.
12. EFFECTIVE AND TERMINATION DATES
The Plan will become effective if and when approved by shareholders holding a
majority of the Company's outstanding common shares entitled to vote at the 2004
annual meeting of shareholders.
No awards shall be granted under the Plan after December 31, 2013. Awards
granted before that date shall remain valid thereafter in accordance with their
terms.
50
(EATON LOGO)
EATON CORPORATION
EATON CENTER
CLEVELAND, OHIO 44114-2584
PROXY
The undersigned hereby appoints A. M. Cutler, J. R. Horst and E. R. Franklin as
proxies, each with the power to appoint his substitute, and hereby authorizes
them to represent and to vote, as designated on the reverse side of this card,
all of the Eaton common shares, including reinvestment shares, if any, held by
the undersigned on March 1, 2004, at the annual meeting of shareholders to be
held at The Forum Conference and Education Center, One Cleveland Center, 1375
East Ninth Street, Cleveland, Ohio, on April 28, 2004, at 10:30 a.m. local time
and at any adjournments thereof.
Election of Directors:
(01) M. J. Critelli, (02) E. Green, (03) K. M. Patel
THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS. WHEN PROPERLY
EXECUTED, IT WILL BE VOTED FOR ITEMS 1, 2 AND 3 UNLESS CONTRARY INSTRUCTIONS ARE
INDICATED ON THE REVERSE SIDE.
PLEASE MARK, SIGN, DATE AND RETURN PROMPTLY IN THE ENCLOSED ENVELOPE.
HAS YOUR ADDRESS CHANGED? DO YOU HAVE ANY COMMENTS?
___________________________________ _____________________________________
___________________________________ _____________________________________
___________________________________ _____________________________________
EATON CORPORATION
C/O EQUISERVE TRUST COMPANY N.A.
P.O. BOX 8694
EDISON, NJ 08818-8694
YOUR VOTE IS IMPORTANT. PLEASE VOTE IMMEDIATELY.
VOTE-BY-INTERNET
LOG ON TO THE INTERNET AND GO TO THE WEB (COMPUTER GRAPHIC)
SITE HTTP://WWW.EPROXYVOTE.COM/ETN.
OR
VOTE-BY-TELEPHONE
CALL TOLL-FREE (TELEPHONE GRAPHIC)
1-877-779-8683 OR 1-877-PRX-VOTE.
IF YOU VOTE OVER THE INTERNET OR BY TELEPHONE, PLEASE DO NOT MAIL YOUR CARD.
________________________________________________________________________________
FOLD AND DETACH HERE
PLEASE MARK
[x] YOUR VOTES AS
IN THIS EXAMPLE.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" ITEMS 1, 2 AND 3.
EATON CORPORATION
1. Election of Directors
(Please see reverse) FOR WITHHELD
ALL FROM ALL
NOMINEES NOMINEES
/ / / /
/ / FOR, EXCEPT VOTE WITHHELD FROM THE FOLLOWING NOMINEE(S):
_______________________________________________________
FOR AGAINST ABSTAIN
2. Approval of 2004 Stock Plan / / / / / /
FOR AGAINST ABSTAIN
3. Ratification of appointment of Independent
Auditors / / / / / /
4. IN THEIR DISCRETION, THE PROXIES ARE AUTHORIZED TO VOTE UPON SUCH OTHER
BUSINESS AS MAY PROPERLY COME BEFORE THE MEETING.
Please sign exactly as name appears hereon. Joint owners should each sign. When
signing as attorney, executor, administrator, trustee or guardian, please give
full title as such.
Signature: _____________ Date: _________ Signature:______________ Date: _______
________________________________________________________________________________
FOLD AND DETACH HERE
PROXY
CONFIDENTIAL VOTING INSTRUCTIONS
To Fidelity Management Trust Company, Trustee for the Plans listed below
(the "Trustee"):
The undersigned, as a participant in the (a) Eaton Savings Plan or (b) Eaton
Personal Investment Plan ((a) and (b) being collectively called the "Plans"),
hereby directs the Trustee to vote in person or by proxy all common shares of
Eaton Corporation credited to the undersigned's account under the Plans on the
record date at the annual meeting of shareholders of Eaton Corporation to be
held at The Forum Conference and Education Center, One Cleveland Center, 1375
East Ninth Street, Cleveland, Ohio, on April 28, 2004, at 10:30 a.m. local time
and at any adjournments thereof. The Trustee is hereby instructed to vote FOR
items 1, 2 and 3 unless the undersigned indicates proper voting instructions to
the contrary. Under each of the Plans, if the Trustee does not receive proper
voting instructions by April 23, 2004 telling the Trustee how to vote the Eaton
shares in the account of the undersigned, the Trustee will vote those shares in
the same proportion, on each issue, as it votes other Eaton shares according to
instructions from other Plan participants.
Election of Directors:
(01) M. J. Critelli, (02) E. Green, (03) K. M. Patel
THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS. WHEN
PROPERLY EXECUTED, IT WILL BE VOTED FOR ITEMS 1, 2 AND 3 UNLESS
CONTRARY INSTRUCTIONS ARE INDICATED ON THE REVERSE SIDE.
SEE REVERSE
SIDE
EATON CORPORATION
C/O EQUISERVE TRUST COMPANY N.A.
P.O. BOX 8694
EDISON, NJ 08818-8694
YOUR VOTE IS IMPORTANT. PLEASE VOTE IMMEDIATELY.
VOTE-BY-INTERNET
LOG ON TO THE INTERNET AND GO TO THE WEB (COMPUTER GRAPHIC)
SITE HTTP://WWW.EPROXYVOTE.COM/ETN.
OR
VOTE-BY-TELEPHONE
CALL TOLL-FREE (TELEPHONE GRAPHIC)
1-877-779-8683 OR 1-877-PRX-VOTE.
IF YOU VOTE OVER THE INTERNET OR BY TELEPHONE, PLEASE DO NOT MAIL YOUR CARD.
________________________________________________________________________________
FOLD AND DETACH HERE
[X] PLEASE MARK
YOUR VOTES
AS IN THIS
EXAMPLE.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" ITEMS 1, 2 AND 3.
EATON CORPORATION
1. Election of Directors
(Please see reverse) FOR WITHHELD
ALL FROM ALL
NOMINEES NOMINEES
/ / / /
/ / FOR, EXCEPT VOTE WITHHELD FROM THE FOLLOWING NOMINEE(S):
_______________________________________________________
FOR AGAINST ABSTAIN
2. Approval of 2004 Stock Plan / / / / / /
FOR AGAINST ABSTAIN
3. Ratification of appointment of Independent
Auditors / / / / / /
4. IN THEIR DISCRETION, THE PROXIES ARE AUTHORIZED TO VOTE UPON SUCH OTHER
BUSINESS AS MAY PROPERLY COME BEFORE THE MEETING.
Please sign exactly as name appears hereon. Joint owners should each sign. When
signing as attorney, executor, administrator, trustee or guardian, please give
full title as such.
Signature: _____________ Date: _________ Signature:______________ Date: _______
PUERTO RICO
EATON ELECTRICAL DE PUERTO RICO, INC.
RETIREMENT SAVINGS PLAN
Dear Participant:
As a participant in the Eaton Electrical de Puerto Rico, Inc. Retirement Savings
Plan, you have the right to direct KeyBank National Association, as trustee of
the Plan, on how to vote the Eaton Corporation common shares credited to your
account under the Plan. The enclosed proxy card may be used for this purpose.
Your directions to KeyBank will be kept confidential.
If EquiServe Trust Company, N.A., which is acting as the tabulating agent,
receives your proxy card by April 23, 2004, KeyBank will vote the shares in your
account as instructed.
If EquiServe does not receive your proxy card by that date, KeyBank will vote
the shares in your account in the same proportion on each issue as it votes
those shares for which it has received voting directions from the other
participants.