Baxter International Inc.

                                            One Baxter Parkway

                                            Deerfield, Illinois 60015

 

 

March 18, 2008

 

Dear Shareholder:

 

You are invited to attend our Annual Meeting of Shareholders on Tuesday, May 6, 2008, at 10:30 a.m., Central Time, at the Chicago Cultural Center, 78 East Washington Street, Chicago, Illinois. Registration will begin at 9:00 a.m., and refreshments will be served.

 

Details of the business to be conducted at the Annual Meeting are included in the attached Notice of Annual Meeting of Shareholders and Proxy Statement.

 

Whether or not you plan to attend in person, you can ensure that your shares are represented at the Annual Meeting by promptly voting and submitting your proxy by Internet or by telephone or by signing, dating and returning your proxy card in the enclosed envelope. If you attend the Annual Meeting, you may revoke your proxy and vote in person.

 

Very truly yours,

 

Robert L. Parkinson, Jr.

Chairman of the Board

and Chief Executive Officer

                                            Baxter International Inc.

                                            One Baxter Parkway

                                            Deerfield, Illinois 60015

 

 

March 18, 2008

 

Notice of Annual Meeting of Shareholders

 

The 2008 Annual Meeting of Shareholders of Baxter International Inc. will be held at the Chicago Cultural Center, 78 East Washington Street, Chicago, Illinois, on Tuesday, May 6, 2008 at 10:30 a.m., Central Time, for the following purposes:

 

 

The Board of Directors recommends a vote FOR Items 1 and 2. Shareholders of record at the close of business on March 7, 2008 will be entitled to vote at the meeting.

 

By order of the Board of Directors,

 

David P. Scharf

Corporate Secretary

 

IMPORTANT NOTICE REGARDING THE AVAILABILITY OF PROXY MATERIALS FOR THE ANNUAL MEETING OF SHAREHOLDERS
TO BE HELD ON MAY 6, 2008

 

The Proxy Statement related to our 2008 Annual Meeting of Shareholders, our Annual Report to Shareholders for the year ended December 31, 2007 and our Annual Report on Form 10-K for the year ended December 31, 2007 are available on our website at http://www.baxter.com/annualreport.

 

Proxy Statement

 

The accompanying proxy is solicited on behalf of the Board of Directors for use at the Annual Meeting of Shareholders to be held on Tuesday, May 6, 2008. This Proxy Statement and accompanying proxy card are being mailed to shareholders on or about March 18, 2008.

 

 

 

 

 

 

 

If you are a current or former Baxter employee with shares credited to your account in the Incentive Investment Plan or Puerto Rico Savings and Investment Plan, then your proxy card (or vote via the Internet or by telephone) will serve as voting instructions to the plan trustee. The trustee will vote your shares as you direct, except as may be required by the Employee Retirement Income Security Act (ERISA). If you fail to give instructions to the plan trustee, the trustee may vote your shares at its discretion. To allow sufficient time for voting by the plan trustee, your voting instructions must be received by April 28, 2008.

 

 

Proposal 1 — Election of Directors

 

Baxter’s Board of Directors currently consists of thirteen members and is divided into three classes. The directors in each class serve three-year terms. The Board has nominated the five current directors of Baxter whose terms expire at the 2008 Annual Meeting for re-election as directors.

 

Baxter’s Bylaws require each director to be elected by the majority of the votes cast with respect to such director in uncontested elections; that is, the number of shares voted “for” a director must exceed the number of votes cast “against” that director. In a contested election (a situation in which the number of nominees exceeds the number of directors to be elected), the standard for election of directors will be a plurality of the shares represented in person or by proxy at any such meeting and entitled to vote on the election of directors. If a nominee who is serving as a director is not elected at an annual meeting, under Delaware law the director would continue to serve on the Board as a “holdover director.” However, under our Bylaws, any incumbent director who fails to be elected must offer his or her resignation to the Board. The Corporate Governance Committee would then make a recommendation to the Board whether to accept or reject the resignation, or whether other action should be taken. The Board would act on the Corporate Governance Committee’s recommendation and publicly disclose its decision and the rationale behind it within 90 days from the date the election results are certified. The director who offers his or her resignation would not participate in the Board’s decision.

 

All of the nominees have indicated their willingness to serve if elected, but if any should be unable or unwilling to stand for election, proxies may be voted for a substitute nominee designated by the Board of Directors. The Board of Directors appointed Wayne T. Hockmeyer, Ph.D. to serve as a director effective as of September 2007. Dr. Hockmeyer was recommended to the Corporate Governance Committee by an independent search firm. No nominations for directors were received from shareholders, and no other candidates are eligible for election as directors at the 2008 Annual Meeting. Unless proxy cards are otherwise marked, the persons named as proxies intend to vote the shares represented by proxy in favor of all of the Board’s nominees.

 

Set forth below is information concerning the nominees for election as well as information concerning the current directors in each class continuing after the Annual Meeting of Shareholders. The Board of Directors recommends a vote FOR the election of each of the director nominees.

 

Nominees for Election as Directors (Term Expires 2011)

 

 

Directors Continuing in Office (Term Expires 2009)

 

 

Directors Continuing in Office (Term Expires 2010)

 

 

Board of Directors

 

Baxter’s Board of Directors currently consists of thirteen members. The Board has determined that each of the following twelve current directors satisfies Baxter’s independence standards and the New York Stock Exchange’s listing standards: Walter E. Boomer, Blake E. Devitt, John D. Forsyth, Gail D. Fosler, James R. Gavin III, M.D., Ph.D., Peter S. Hellman, Wayne T. Hockmeyer, Ph.D., Joseph B. Martin, M.D., Ph.D., Carole J. Shapazian, Thomas T. Stallkamp, K. J. Storm and Albert P.L. Stroucken. Please refer to the section entitled “Corporate Governance — Director Independence” on page 8 of this Proxy Statement for a discussion of Baxter’s independence standards.

 

During 2007, the Board held 9 meetings. All directors attended 84% or more of the aggregate meetings of the Board and Board committees on which they served and average attendance was in excess of 95%. In accordance with Baxter’s Corporate Governance Guidelines, which express the company’s expectation that directors attend the annual meeting of shareholders, all but one of the company’s directors attended the annual meeting of shareholders held on May 1, 2007.

 

Committees of the Board

 

The standing committees of the Board of Directors are the Audit Committee, Compensation Committee, Corporate Governance Committee, Finance Committee, and Public Policy Committee. Each committee consists solely of independent directors, as defined by the rules of the New York Stock Exchange, and is governed by a written charter. All committee charters are available on Baxter’s website at www.baxter.com under “Corporate Governance — Board of Directors — Committees of the Board” and in print upon request by writing to: Corporate Secretary, Baxter International Inc., One Baxter Parkway, Deerfield, Illinois 60015.

Audit Committee

 

The Audit Committee is currently composed of Thomas T. Stallkamp (Chair), Blake E. Devitt, Peter S. Hellman, K. J. Storm and Albert P.L. Stroucken, each of whom is independent under the rules of the New York Stock Exchange. The Board has determined that Messrs. Stallkamp, Devitt, Hellman, Storm and Stroucken each qualify as an “audit committee financial expert” as defined by the rules of the Securities and Exchange Commission. The Audit Committee is primarily concerned with the integrity of Baxter’s financial statements, system of internal accounting controls, the internal and external audit process, and the process for monitoring compliance with laws and regulations. Its duties include: (1) reviewing the adequacy and effectiveness of Baxter’s internal control over financial reporting with management and the independent and internal auditors, and reviewing with management Baxter’s disclosure controls and procedures; (2) retaining and evaluating the qualifications, independence and performance of the independent registered public accounting firm; (3) approving audit and permissible non-audit engagements to be undertaken by the independent registered public accounting firm; (4) reviewing the scope of the annual internal and external audits; (5) reviewing and discussing earnings press releases prior to their release; (6) holding separate executive sessions with the independent registered public accounting firm, the internal auditor and management; and (7) discussing guidelines and policies governing the process by which Baxter assesses and manages risk. The Audit Committee met 10 times in 2007. The Audit Committee Report appears on page 37.

 

Compensation Committee

 

The Compensation Committee is currently composed of John D. Forsyth (Chair), Walter E. Boomer, Carole J. Shapazian and Thomas T. Stallkamp. The Compensation Committee exercises the authority of the Board relating to employee benefit plans and is responsible for recommending to the Board compensation for the Chief Executive Officer and for determining the compensation of the other executive officers. The Compensation Committee may delegate its authority to subcommittees when appropriate. Its duties include: (1) making recommendations for consideration by the Board, in executive session, concerning the compensation of the Chief Executive Officer; (2) determining the compensation of executive officers (other than the Chief Executive Officer) and advising the Board of such determination; (3) making recommendations to the Board with respect to incentive compensation plans and equity-based plans and exercising the authority of the Board concerning benefit plans; (4) serving as the administration committee of the company’s equity plans; and (5) making recommendations to the Board concerning director compensation. The Corporate Governance and Compensation Committees work together to establish a link between Mr. Parkinson’s performance and decisions regarding his compensation. All compensation actions relating to Mr. Parkinson are subject to the approval of the independent directors of the Board. The Compensation Committee met 4 times in 2007. The Compensation Committee Report begins on page 34.

 

The Compensation Committee has directly engaged George B. Paulin, Chairman and Chief Executive Officer of Frederick W. Cook & Co., Inc., as its compensation consultant. Additionally, Hewitt Associates assists the Committee with the compilation of market data from time to time. Mr. Paulin reports directly and exclusively to the Committee and his firm provides no other services to Baxter except advising on executive and Board compensation matters. He provides analyses and recommendations that inform the Committee’s decisions, but he does not decide or approve any compensation actions. During 2007, he advised the Committee Chairman on setting agenda items for Committee meetings; reviewed management proposals presented to the Committee; evaluated market data compiled by Hewitt Associates; and conducted a review of the structure and level of compensation for non-employee directors.

 

Corporate Governance Committee

 

The Corporate Governance Committee is currently composed of Walter E. Boomer (Chair), Blake E. Devitt, John D. Forsyth and Joseph B. Martin, M.D., Ph.D. The Corporate Governance Committee assists and advises the Board on director nominations, corporate governance and general Board organization and planning matters. Its duties include: (1) developing criteria, subject to approval by the Board, for use in evaluating and selecting candidates for election or re-election to the Board and assisting the Board in identifying and attracting qualified director candidates; (2) selecting and recommending that the Board approve the director nominees for the next annual meeting of shareholders and recommending persons to fill any vacancy on the Board; (3) determining Board committee structure and membership; (4) reviewing at least annually the adequacy of Baxter’s Corporate

Governance Guidelines; (5) overseeing the succession planning process for management, including the Chief Executive Officer; (6) developing and implementing an annual process for evaluating the performance of the Chief Executive Officer; and (7) developing and implementing an annual process for evaluating Board and committee performance. The Corporate Governance Committee met 4 times in 2007.

 

Finance Committee

 

The Finance Committee is currently composed of K. J. Storm (Chair), Gail D. Fosler, James R. Gavin, M.D., Ph.D., Peter S. Hellman, Wayne T. Hockmeyer, Ph.D. and Albert P.L. Stroucken. The Finance Committee assists the Board in fulfilling its responsibilities in connection with the company’s financial affairs. The Finance Committee reviews and, subject to the limits specified in its charter, approves or makes recommendations or reports to the Board regarding: (1) proposed financing transactions, capital expenditures, acquisitions, divestitures and other transactions; (2) dividends; (3) results of the management of pension assets; and (4) risk management relating to the company’s hedging activities, use of derivative instruments and insurance coverage. The Finance Committee met 6 times in 2007.

 

Public Policy Committee

 

The Public Policy Committee is currently composed of Gail D. Fosler (Chair), James R. Gavin III, M.D., Ph.D., Joseph B. Martin M.D., Ph.D. and Carole J. Shapazian. The Public Policy Committee is primarily concerned with the review of the policies and practices of Baxter to ensure that they are consistent with its social responsibility to act with integrity as a global corporate citizen to employees, customers and society. Its duties include: (1) addressing the company’s responsibilities with respect to the health and safety of employees, consumers and the environment; (2) overseeing, reviewing and making recommendations to the Corporate Responsibility Office as set forth in the company’s Global Business Practice Standards; (3) reviewing and making recommendations regarding Baxter’s Quality and Regulatory programs and performance; and (4) reviewing and making recommendations on the company’s Government Affairs Program, including the company’s positions with respect to pending legislative and other initiatives. The Public Policy Committee met 4 times in 2007.

 

Corporate Governance

 

Director Independence

 

To be considered independent, the Board must affirmatively determine that a director does not have any direct or indirect material relationship with Baxter (either directly or as a partner, shareholder or officer of an organization that has a relationship with Baxter). Baxter’s Corporate Governance Guidelines require that the Board be composed of a majority of directors who meet the criteria for “independence” established by rules of the New York Stock Exchange.

 

In making its independence determinations, the Board considers transactions, relationships and arrangements between Baxter and entities with which directors are associated as executive officers, directors and trustees. When these transactions, relationships and arrangements exist, they are in the ordinary course of business and are of a type customary for a global diversified company such as Baxter. More specifically, with respect to each of the three most recent fiscal years, the Board evaluated for each of directors Fosler and Stroucken, the annual amount of purchases from the company where he or she serves as an executive officer by Baxter, and determined that the amount of purchases in each fiscal year was below two percent of the consolidated gross revenues of each of those companies during the companies’ last completed fiscal year. In addition, with respect to director Gavin, the Board considered the amount of Baxter’s payments to a tax exempt organization where he serves as an executive officer, and determined that Baxter’s payments constituted less than two percent of the organization’s annual consolidated gross revenues during the organization’s last completed fiscal year.

 

Corporate Governance Guidelines

 

Baxter’s Board of Directors has long adhered to corporate governance principles designed to ensure effective corporate governance. Since 1995, the Board of Directors has had in place a set of corporate governance guidelines

reflecting these principles. Baxter’s current Corporate Governance Guidelines cover topics including, but not limited to, director qualification standards, director responsibilities, director access to management and independent advisors, director compensation, director orientation and continuing education, succession planning and the annual evaluations of the Board and its committees. Baxter’s Corporate Governance Guidelines are available on Baxter’s website at www.baxter.com under “Corporate Governance — Guidelines” and in print upon request by writing to: Corporate Secretary, Baxter International Inc., One Baxter Parkway, Deerfield, Illinois 60015.

 

Global Business Practice Standards

 

Baxter has adopted a code of business conduct and ethics, called the Global Business Practice Standards, that applies to all members of Baxter’s Board of Directors and all employees of the company, including the Chief Executive Officer, Chief Financial Officer, Controller and other senior financial officers. Any amendment to, or waiver from, a provision of its Global Business Practice Standards that applies to Baxter’s Chief Executive Officer, Chief Financial Officer, Controller or persons performing similar functions will be disclosed on the company’s website, at www.baxter.com under “Corporate Governance.” Baxter’s Global Business Practice Standards are available on Baxter’s website at www.baxter.com under “Corporate Governance — Business Practices” and in print upon request by writing to: Business Practices, Baxter International Inc., One Baxter Parkway, Deerfield, Illinois 60015.

 

Executive Sessions

 

The non-employee directors of the Board met in executive session without management at every regularly scheduled meeting during 2007 pursuant to Baxter’s Corporate Governance Guidelines. The Audit Committee is required by its charter to hold separate sessions during at least five committee meetings with each of the internal auditor, the independent auditor and management. The Corporate Governance and Compensation Committees also meet in executive session as deemed appropriate.

 

Lead Director

 

Baxter’s lead director is currently Thomas T. Stallkamp. Pursuant to Baxter’s Corporate Governance Guidelines, Mr. Stallkamp presides at all executive sessions of the Board and acts as the liaison between the non-management directors and the Chairman of the Board. In addition, the lead director serves as the contact person to facilitate communications by Baxter employees and shareholders directly with the non-management members of the Board. The Corporate Governance Committee recommends a lead director to the full Board for approval on an annual basis.

 

Communicating with the Board of Directors

 

Shareholders and other interested parties may contact any of Baxter’s directors, including the lead director or the non-management directors as a group, by writing a letter to Baxter Director c/o Corporate Secretary, Baxter International Inc., One Baxter Parkway, Deerfield, Illinois 60015 or by sending an e-mail to boardofdirectors@baxter.com. Baxter’s Corporate Secretary will forward communications directly to the lead director, unless a different director is specified.

 

Nomination of Directors

 

It is the policy of the Corporate Governance Committee to consider candidates for director recommended by shareholders, members of the Board and management. The Corporate Governance Committee also considers directors recommended by the independent search firm retained by the Board to help identify and evaluate potential director nominees. The Corporate Governance Committee evaluates all candidates for director in the same manner regardless of the source of the recommendation. Shareholder recommendations for candidates for director should include the information required by Baxter’s Bylaws and be sent to the Corporate Governance Committee, c/o Corporate Secretary, Baxter International Inc., One Baxter Parkway, Deerfield, Illinois 60015.

Pursuant to Baxter’s Corporate Governance Guidelines, nominees for director must:

 

 

The Corporate Governance Guidelines also provide that directors are selected on the basis of talent and experience. Diversity of background, including diversity of gender, race, ethnic or national origin, age, and experience in business, government and education and in healthcare, science, technology and other areas relevant to the company’s activities are factors in the selection process. As a majority of the Board must consist of individuals who are independent, a nominee’s ability to meet the independence criteria established by the New York Stock Exchange is also a factor in the nominee selection process.

 

Once a candidate has been identified, the Corporate Governance Committee may collect and review publicly available information regarding the person to assess whether the person should be considered further. If the Corporate Governance Committee or its Chair determines that the candidate warrants further consideration, the Corporate Governance Committee and the external search firm retained by the Committee will engage in a process that includes a thorough investigation of the candidate, an examination of his or her business background and education, research on the individual’s accomplishments and qualifications, an in-person interview and reference checking. If this process generates a positive indication, the lead director, the members of the Committee and the Chairman of the Board will meet separately with the candidate and then confer with each other regarding their respective impressions of the candidate. If the individual was positively received, the Committee will then recommend the individual to the full Board for election. If the full Board agrees, the Chairman of the Board is then authorized to extend an offer to the individual candidate.

 

Baxter’s Stock Ownership Guidelines for Executive Officers and Directors

 

Baxter’s stock ownership guidelines provide that the Chief Executive Officer is required to achieve ownership of Baxter common stock valued at six times annual base salary and each of the other executive officers is required to achieve ownership of Baxter common stock valued at four times annual base salary, in each case within five years of becoming an executive officer. As of December 31, 2007, each named executive officer has satisfied his or her stock ownership requirement, except for Mr. Davis who was appointed to his position in May 2006 and is expected to meet his stock ownership requirement within the applicable five-year period.

 

Baxter’s Corporate Governance Guidelines require that after five years of Board service, each director is to hold common stock equal to five times the annual cash retainer provided to directors. As of December 31, 2007, all of Baxter’s directors hold at least the required amount of common stock, except for Dr. Hockmeyer who was elected to the Board in September 2007 and is expected to satisfy the stock ownership requirement within the next year.

Executive Compensation

 

Compensation Discussion and Analysis

 

The Compensation Committee has designed a compensation program that is straightforward and driven by a few key principles and objectives, with pay for performance being the most significant structural element of the program. The compensation package awarded to each named executive officer consists of a base salary, cash bonus and equity awards. Baxter also makes available limited perquisites, certain retirement and other benefits, and arrangements for post-termination compensation if appropriate.

 

Year in Review

 

Baxter reported net income for 2007 of $1.7 billion, or $2.61 per diluted share, an increase of 22% and 23%, respectively, over 2006. Due to the strong cash flow generated from the company’s operations in 2007, the company was able to invest $760 million in research and development and accelerate its business development activities. Baxter’s share price improved 27% during 2007 relative to the Standard and Poor’s 500 Health Care Index which rose 7% during the same period. This strong financial performance translated into enhanced compensation under our pay for performance program.

 

Mr. Parkinson received total compensation of $17.6 million for his service as Baxter’s Chief Executive Officer and Chairman of the Board in 2007, primarily driven by strong company and individual performance in 2007 and 2006 (as some awards were made in early 2007 based, in part, on 2006 performance). Mr. Parkinson’s 2007 compensation also reflects the Board’s annual review of competitive market data as well as a $2.29 million increase in his accumulated pension benefits largely because he was credited with two additional years of service in 2007 pursuant to his employment agreement. Mr. Parkinson’s compensation reflects the role he has played in the turnaround of the company since his arrival in 2004. As Chairman and Chief Executive Officer, he has been responsible for assembling a management team to address the challenges the company faced at the time of his arrival as well as the challenges that arise in the day-to-day operations of a company as large and diverse as Baxter.

 

Each of our other named executive officers received total compensation for his or her 2007 performance as follows: Mr. Davis, $2,816,972; Ms. Amundson, $4,676,268; Mr. Gatling, $4,316,872; and Mr. Greisch, $5,110,184. The compensation received by Ms. Amundson and Mr. Greisch reflects the strong performances of the segments of the business for which these officers were responsible during 2007. The amount of compensation received by Mr. Davis for his 2007 service as Chief Financial Officer was driven by Mr. Davis’s individual performance in 2007 and the Committee’s desire to move his compensation towards compensation commensurate with that which is paid to chief financial officers at companies in our peer group as he had completed a full year as Baxter’s Chief Financial Officer in May 2007. Mr. Gatling appears for the first time as a named executive officer in 2007, primarily due to the accelerated compensation cost recognized by the company related to his equity awards as he was retirement eligible at the time he received his 2006 and 2007 equity awards.

 

Consistent with past years, the most significant component of the total compensation paid to the named executive officers in 2007 was in the form of equity. The grant date fair value of the equity awards granted to Mr. Parkinson and the other named executive officers in 2007 represented approximately 65% of their overall compensation. We describe these grants below.

 

Compensation Philosophy

 

Baxter’s compensation program is designed to:

 

 

The objective of the program is to compensate our executive officers in a manner that is consistent with these principles, works to align the interests of management and shareholders, drives sustained and superior performance relative to our peers and motivates, retains and attracts executive talent.

Structure of Compensation Program

 

Pay for Performance

 

Pay for performance is the most significant structural element of Baxter’s compensation program. Annual performance against financial targets (earnings per share, sales and return on invested capital) drives the payout of cash bonuses. Baxter’s three-year growth in shareholder value relative to our peer group (as defined below) determines the payout under 50% of our equity awards, which are granted in the form of performance share units. Baxter’s common stock’s overall performance determines the value of the remainder, which is granted in the form of stock options. The Committee’s assessment (or the Board’s in the case of Mr. Parkinson) of how each officer performs his or her job impacts earned cash bonuses and equity awards.

 

Financial Targets

 

For both 2007 and 2006, the Committee selected earnings per share, sales and return on invested capital as the financial measures on which to assess the company’s performance for purposes of funding the cash bonus pool. The relative weight assigned to each of these measures was 50%, 25%, and 25%, respectively, for both 2007 and 2006. If each financial measure is met in a given year, then the cash bonus pool is funded at two times the target cash bonus for each executive officer covered by the bonus pool.

 

The Committee selected adjusted earnings per share (EPS) and sales, as these are of immediate interest to shareholders and are the primary two measures as to which Baxter regularly provides guidance to the market. Adjusted EPS is the most heavily weighted measure, as the Committee believes it is a straightforward measure of the company’s current ability to generate value that is well understood by shareholders. The table below provides our adjusted EPS and sales targets for 2007 and 2006 as well as our actual results in these years.

 

 

 

 

The adjustments made to EPS for special items in 2007 and 2006 were the same adjustments made when Baxter publicly announced its 2007 results — that is, the company used the same adjusted EPS measure for compensation that was used in announcing financial results. Net sales is adjusted by removing the impact of foreign currency fluctuations using budgeted exchange rates for the same reason that Baxter announces results against sales guidance excluding the impact of foreign currency fluctuations — that is, it provides a better perspective on underlying sales growth. The use of budgeted exchange rates allows Baxter to evaluate final performance on the same foreign currency basis that was used for setting the target.

 

Return on invested capital (ROIC) is the internal cash earnings measure that the company uses to assess how effectively it is allocating and utilizing capital in its operations. ROIC is calculated by dividing cash flows from operations (excluding the impact of interest expense) by average invested capital. Baxter does not provide guidance on ROIC nor does it disclose ROIC in its public filings; however, for years 2007 and 2006, Baxter achieved 104.7% and 114.7% of its respective ROIC targets. The Committee selected ROIC as the third measure in order to balance the more immediate EPS and sales goals, helping to ensure a focus on efficient and value-maximizing investment and appropriate long-term management of capital. Improving ROIC requires disciplined management of working

capital and is inherently challenging because of the measure’s focus on cash flows as opposed to book earnings. As the company becomes more profitable it becomes more difficult to show significant ROIC improvement due to the impact of increases in retained earnings on the denominator of the measure — that is, as the denominator grows the company is required to generate more cash flows from operations than in the prior year to improve its ROIC. As discussed above under “Year in Review”, Baxter reported net income for 2007 of $1.7 billion, an increase of 22% over 2006.

 

The historical data below on company performance and cash bonus funding percentages during the past five years provides additional perspective as to how difficult the financial targets are to achieve overall and how appropriately these targets measure the company’s overall performance. Set forth below is a graph showing the bonuses paid to named executive officers (taken as a group) as a percentage of the cash bonus targets for such named executive officers during each of the past five years.

 

 

The following graph compares the change in Baxter’s cumulative total shareholder return (including reinvested dividends) on Baxter’s common stock with the Standard & Poor’s 500 Composite Index and the Standard and Poor’s 500 Health Care Index during each of the past five years.

 

 

Performance Against Our Peers

 

As a healthcare company, Baxter operates in an ever-changing environment. Accordingly, encouraging our officers to focus on the long-term performance of the company is particularly important to Baxter. The performance share units that were awarded to named executive officers in March 2007 were designed to reward strong long-term performance by the company against the healthcare companies in our peer group (as defined below). These grants focus on the healthcare companies in our peer group, as these are the primary companies with which Baxter competes for talent, investor capital and market position.

 

The payout of shares of Baxter common stock resulting from the vesting of the performance share units granted in 2007 will be based on Baxter’s change in total shareholder value versus the change in total shareholder value of the healthcare companies included in Baxter’s peer group during the three-year performance period commencing

with the year in which the performance share units are awarded (January 1, 2007 — December 31, 2009). Growth in shareholder value will be measured based on the following formula:

 

 

The performance share units will pay out in shares of Baxter common stock in a range of 0% to 200% of the number of performance share units awarded. The table set forth below shows how the company’s growth in shareholder value against peers correlates with the 0% to 200% range of payouts.

 

 

The performance share units will pay out linearly between each set of data points above the 25^th percentile and below the 85^th percentile. For example, if Baxter performs at a 40^th percentile rank, each named executive officer would receive the number of shares equal to 57% of his or her award of performance share units. As it is possible that there will be no payout under the performance share units, these awards are completely “at-risk” compensation. Further, in order to pay out at the 100% target level, Baxter must outperform its peers at the 60^th percentile.

 

Performance of Baxter Common Stock

 

The performance of Baxter common stock determines the value of the stock options and restricted stock units that have been granted to the named executive officers.

 

Individual Performance

 

The Committee (or the full Board in the case of Mr. Parkinson) assesses the individual performance of each executive officer in making compensation decisions related to cash bonuses and equity awards. The assessment of individual performance is inherently subjective. Essentially the Committee (or the Board in the case of Mr. Parkinson) assesses how well an officer fulfilled his or her obligations in the past year. This assessment includes consideration of how well the operations for which an officer is responsible performed during the year. One factor that the Committee (or the Board in the case of Mr. Parkinson) evaluates in making assessments of individual performance is how well an officer performed against the performance goals set for such officer for the relevant year. Consideration is given in these discussions for not only whether an objective was met but also how the objective was met and at what cost the objective was met relative to the officer’s other responsibilities. Mr. Parkinson’s goals and his self-evaluation are reviewed with the Committee and the full Board. Mr. Parkinson reviews the performance goals and self-evaluations of each of the other executive officers and shares his insights and recommendations with the Committee. The goals set for each named executive officer for 2007 reflected the diversity of the company’s business and the wide range of responsibilities that are attributed to each of these officers. For example, Mr. Parkinson had 60 performance goals for 2007 covering the following areas: financial performance, organizational development/human resources, corporate strategy/business development, innovation/R&D, quality/regulatory, operational excellence, board relations/governance, constituent relations and leadership. The adjustments that are made to such officer’s compensation based on his or her performance are not directly correlated to the number of goals that an officer has achieved. The Committee believes that this type of rigid correlation could motivate an officer to focus on achieving his or her performance goals rather than on fulfilling his or her job responsibilities in a manner that is in the best interest of the company and its shareholders.

Instead the Committee (or the Board in the case of Mr. Parkinson) uses this information to facilitate a discussion of each officer’s performance and then makes adjustments to cash bonuses and equity grants on a discretionary basis.

 

Our Peer Group and Use of Peer Group Data

 

Use of survey data from Baxter’s peers plays a significant role in the structure of the compensation program as it is a primary input in setting target levels for base salaries, cash bonuses and equity awards and helps us to ensure that the compensation is market competitive in order to retain and attract talent. We use data from companies that the Committee has selected as comparable companies (collectively, our “peer group”) to help identify a reasonable starting point for base salaries, cash bonuses and equity awards and then analyze company and individual performance to determine whether it is appropriate to move away from this baseline. Peer group data also plays a role in what non-cash compensation is paid to the named executive officers as the market data we obtained regarding companies in our peer group helps determine what types and amounts of non-cash compensation are appropriate for competitive purposes. If survey data is not available for a particular officer’s position at the company, such as Mr. Gatling’s position, the Committee sets an officer’s compensation targets at levels that are competitive with other officers at Baxter based on the Committee’s view of where such officer should fall within the hierarchy of the organization.

 

Baxter’s use of peer group data is consistent among the named executive officers in that the baseline (i.e. percentile target) that is set for an element of compensation applies to all officers regardless of position. However, differences in the compensation paid to comparable officers at companies in our peer group do result in higher target amounts for officers depending on their position. For example, the compensation targets set for Mr. Parkinson based on peer group data are significantly higher than those set for any of the other named executive officers despite being set using the same methodology. In general, Mr. Parkinson’s compensation is significantly higher than the compensation we pay to any of the other executive officers as his responsibilities and obligations at Baxter are significantly greater than those of any of the other named executive officers.

 

Since October 2006, our peer group has included other companies of similar size and selected healthcare peers. These selected healthcare peers include all of the companies in the Standard & Poor’s 500 Health Care Index for which data is available, except for distribution companies, insurance providers, hospitals, nursing homes and consultants and pure drug discovery and development companies. The target peer group is comprised of approximately 120 companies (of which approximately 35 are healthcare companies). The actual number of companies in our peer group fluctuates from year to year based on the number of companies for which information is available to Hewitt Associates.

 

As discussed above under “Pay for Performance — Performance Against Our Peers”, payouts under the performance share units granted in 2007 will be determined based on Baxter’s change in total shareholder value versus the change in total shareholder value of the healthcare companies included in our peer group. As of December 31, 2007, the healthcare companies that will be used to determine the payout under the performance share units granted in 2007 are set forth below.

 

Elements of Executive Compensation

 

Base Salaries

 

Base salaries are paid in order to provide a fixed component of compensation for the named executive officers. For 2007 and 2006, base salary target levels for all named executive officers were set within a range that is competitive with the 50^th percentile of salaries paid to comparable officers at companies in our peer group. The Committee selected the 50^th percentile as the positioning for base salaries because, as they are the only fixed component of compensation, they are less appropriately used to motivate performance and thus, the Committee determined to set them at a reasonably competitive mid-point.

 

The Committee sets actual individual base salaries higher or lower than targeted base salaries for any reason that the Committee deems relevant. Factors that the Committee considered for 2007 and 2006 base salaries included how long an officer has been at Baxter and in his or her current role, the impact of his or her position on the company’s results and how such officer’s role fits within the hierarchy of the organization. The Committee used its discretion to set Mr. Davis’s 2006 base salary at a level lower than what was competitive with the 50^th percentile of our peer group as he was new to both his role and Baxter, having been appointed to serve as Chief Financial Officer in May 2006 after having joined Baxter as Treasurer in November 2004. Accordingly, the increase in his base salary in 2007 over 2006 was made to move his base salary towards compensation commensurate with the compensation paid to similarly situated officers at peer companies. Base salaries for all of the other named executive officers were at, or modestly below, the 50^th percentile of salaries paid to comparable officers in our peer group.

 

Cash Bonuses

 

Cash bonuses are intended to reward company and individual performance by providing officers with an opportunity to receive additional cash compensation based on both the company’s performance relative to the financial targets described above and the Committee’s assessment of how well an officer performed his or her role during the applicable year.

 

Target Setting

 

For 2007 and 2006, cash bonus targets for all named executive officers (other than Mr. Davis) were set within a range that is competitive with the 60^th percentile of cash bonuses paid to comparable officers at companies in our peer group. As the ultimate payout of a cash bonus is driven primarily by achievement of financial targets, the Committee sets the target amounts at the 60^th percentile to further motivate officers to meet the financial targets. The Committee has the discretion to adjust each officer’s target as it deems appropriate. Typical reasons for adjusting cash bonus targets are how long an officer has been in his or her current role, how the officer’s role fits within the hierarchy of the organization and how the officer’s base salary has increased historically. The last factor is relevant as our peer group data is in the form of a multiple of an officer’s base salary. If an officer received a significant increase in his or her base salary that was above the 50^th percentile target, such officer would then receive a more significant cash bonus target which would effectively be higher than the 60^th percentile bonus target. The Committee used its discretion to set Mr. Davis’s target cash bonus at 80% of his salary, which was less than the 90% that would have been competitive with the 60^th percentile, given that he had been newly promoted to Chief Financial Officer in May 2006. Cash bonus targets for all of the other named executive officers were at the 60^th percentile of cash bonuses paid to comparable officers in our peer group.

 

Determination of 2007 Payouts

 

As the company met each of its financial targets for its 2007 performance, the bonus pool was funded at two times the target cash bonus for each executive officer covered by the bonus pool. The Committee then used “negative discretion” to determine the actual cash bonus amount that was paid to each named executive officer. The “negative discretion” that was used took into account the Committee’s view of how well each officer performed his or her responsibilities during 2007. More specifically, each officer’s cash bonus was adjusted to 145% of target based on how the company performed against each of its 2007 financial targets and the relative weighting of these targets. Based on the Committee’s assessment of each officer’s performance, each officer’s cash bonus target was adjusted further upward in a range of 115% to 140%. Mr. Greisch was at the high end of this range with a 140% upward adjustment due to his strong performance overseeing our international operations during a year in which more than 55% of our

revenues were generated outside of the United States. Ms. Amundson was at the high end of this range with a 140% upward adjustment due to her performance as President of BioScience, the company’s highest-performing segment in 2007. Mr. Davis received an upward adjustment of 130% due to his contributions to the company’s strong financial performance in 2007. Mr. Gatling received an upward adjustment of 115% to reflect his 2007 performance as Corporate Vice President, Global Manufacturing and Supply Chain, a function that is responsible for the manufacturing operations of our Medication Delivery and Renal segments, both of which performed well in 2007 but not at the level of the BioScience segment. Mr. Parkinson was paid a cash bonus of $3,000,000, which included an upward adjustment of 117%. This amount was determined taking into account the company’s strong financial performance in 2007, Mr. Parkinson’s contributions to this performance as well as his other leadership contributions (as discussed above under “Year in Review”), and the limitations on the tax-deductibility of compensation paid by the company under Section 162(m) of the Internal Revenue Code of 1986, as amended. For more information on how performance was assessed, see “Pay for Performance — Financial Targets and — Individual Performance” above. The Committee believes that the methodology it uses in paying cash bonuses is consistent with providing compensation that reflects how an officer is valued within the company and the market place.

 

Equity Awards

 

Equity awards are the most significant components of each named executive officer’s compensation package. We emphasize equity awards to motivate our named executive officers to drive the long-term performance of the company and to align their interests with those of our shareholders. This emphasis is appropriate as these officers have the greatest role in establishing the company’s direction and should have the greatest proportion of their compensation aligned with the long-term interests of shareholders. We further this alignment by requiring officers to satisfy the stock ownership guidelines discussed above under “Corporate Governance — Baxter’s Stock Ownership Guidelines for Officers and Directors.”

 

Structure of Equity Compensation Program

 

In February 2007, the Committee restructured the equity compensation program. The Committee decided that the annual equity grants to executive officers would be made up of performance share units and stock options as opposed to restricted stock units and stock options. The proportion of stock options was also reduced from 70% to 50%. The replacement of restricted stock units with performance share units was driven by the Committee’s belief that as the recipients of these awards have the most responsibility for Baxter’s performance, the payout of a portion of their equity awards should be completely “at-risk.” As there are factors beyond the control of the officers that affect the company’s performance as measured against its peers, the Committee did retain stock options as an annual grant to recognize that it is in the best interest of the company to provide a certain amount of equity to officers that will vest as long as the officer continues to serve at Baxter, and will only have value as long as Baxter’s value continues to increase from the date of grant. The reduction in stock options in 2007 was influenced by market data that showed that companies are shifting away from stock options in favor of alternative performance-based awards and the Committee’s judgment regarding the appropriate balance between absolute and relative shareholder value in our executive officers’ total rewards.

 

2007 Equity Grants

 

In order to determine the size of equity grants to be awarded to each named executive officer during the 2007 annual grant process, the Committee reviewed market data on how much equity similarly situated officers were receiving at companies in our peer group. This review focused on how much equity should be granted to each officer in order to be competitive with the 60^th percentile of equity awards provided to officers at companies in our peer group. The Committee (or the Board in the case of Mr. Parkinson) set targets that were above the median to motivate officers to outperform the other healthcare companies in our peer group and to reflect the significant at-risk component of this element. In determining the actual amounts of the grants, the Committee (or the Board in the case of Mr. Parkinson) then used its discretion to increase each named executive officer’s 2007 target grant by 20% (or 10% in the case of Mr. Gatling). The adjustments primarily reflected the Committee’s expectations of such officer’s future contributions to the company and assessment of such officer’s individual performance. Mr. Gatling’s adjustment reflects the relationship of his role to the Medication Delivery and Renal segments of the business, both of which performed well in 2006 but did not perform as well as the BioScience segment.

In addition to the annual grants described above, each of the named executive officers (other than Mr. Parkinson) received a one-time transitional award of restricted stock units as a result of restructuring the equity program in 2007. Under the former program, equity grants would have reflected the performance of Baxter against its peers in the immediately preceding year as measured by its total shareholder return against the total shareholder return of the Standard and Poor’s 500 Health Care Index. With the new design, the payouts under the equity awards that replaced restricted stock units (performance share units) are impacted by the future performance of the company as measured by Baxter’s growth in shareholder value as compared to the growth in shareholder value of the healthcare companies in our peer group. The Committee granted these transitional awards to reward the named executive officers for the company’s strong 2006 performance (which would not have otherwise been captured in the company’s equity award design while the company transitioned to the new plan design in 2007). The number of restricted stock units in this transitional award was determined by estimating the value of the additional equity awards that the officers would have received under the former program and then dividing this value in half.

 

Perquisites

 

Baxter provides a very limited range of perquisites to our named executive officers. Baxter permits personal travel on company aircraft due to the potential efficiencies associated with such use. All personal aircraft usage must be pre-approved by the Chief Executive Officer and any such aircraft usage is reviewed annually by the Committee. Baxter also pays for an annual physical exam for executive officers and believes this practice to be in the best interest of the company and its shareholders as the health of an officer is critical to an officer’s performance. In 2007, no named executive officer had perquisites in excess of $5,000.

 

Retirement and Other Benefits

 

Baxter allows the named executive officers to participate in a pension program and deferred compensation plan in order to provide compensation that is reflective of such officers’ value in the market as well as to facilitate retirement savings as part of the total compensation program in a cost- and tax-effective way for the company.

 

As of April 2007, Mr. Parkinson had been employed by Baxter for three years, and as a result he received an additional two years of service (five years in total) under the pension program based on the terms of his employment agreement. The employment agreement further specifies that if Mr. Parkinson remains employed by Baxter for five years, he will receive two additional years of service (nine years in total). This additional service is credited under the supplemental pension plan. Mr. Parkinson’s employment agreement also provides that he is eligible for unreduced early retirement upon vesting with a normal offset for benefits received under the pension program. This additional service credited in 2007 accounted for approximately 78% of the change in Mr. Parkinson’s accumulated pension value between December 31, 2006 and 2007. The other named executive officers participate in the pension program to the same extent and on the same terms as any other eligible Baxter employee. The distinction between the pension benefits available to Mr. Parkinson versus the other named executive officers is consistent with his level of responsibility within the company and how his position is valued in the market as determined at the time his agreement was negotiated. A more detailed discussion of the pension program is provided under the caption “Pension Benefits” on page 27 of this Proxy Statement. Each of the named executive officers also is eligible to participate in Baxter’s deferred compensation plan (which permits the officer to defer the receipt of covered compensation and receive a 3% company match, which will increase to 3.5% in 2008), the terms of which are more fully described under the caption “Nonqualified Deferred Compensation” on page 29 of this Proxy Statement.

 

Post-Termination Compensation

 

Named executive officers may receive certain payments in the event that Baxter undergoes a change of control and the officer ceases to be employed by the company — that is, subject to a “double trigger.” Mr. Parkinson would receive payments under his employment agreement and the other named executive officers would receive payments under their severance agreements. Providing for payments in a change of control situation is consistent with market practice and helps ensure that if a change of control is in the best interest of the shareholders, the officers have appropriate incentives to remain focused on their responsibilities before, during and after the transaction without undue concern for their personal circumstances. In addition to change of control payments, Mr. Parkinson would receive certain payments in the event he is terminated for any reason (other than for cause). We believe that

compensating Mr. Parkinson in these additional circumstances is appropriate in light of the value of his position in the market place, including as reflected in the negotiations accompanying our hiring of Mr. Parkinson pursuant to his employment agreement. In consideration for these benefits, Mr. Parkinson and the named executive officers have agreed not to compete, directly or indirectly, with the company for two years from the date of his or her termination. The named executive officers’ severance benefits were not a significant factor in determining their other compensation elements because the Committee did not believe that such benefits, as provided, exceeded market practices of peer companies in a way that justified a reduction in any other elements or vice versa. For a more detailed discussion of these agreements, including the estimated amounts that would be payable assuming a termination date of December 31, 2007, please refer to the information under the caption “Potential Payments Upon Termination Following A Change-in-Control” on page 29 of this Proxy Statement.

Summary Compensation Table

 

The following table shows for the years ended December 31, 2007 and 2006 the compensation provided by Baxter and its subsidiaries to its Chief Executive Officer, Chief Financial Officer and the three next most highly compensated executive officers. The five individuals identified in the Summary Compensation Table are referred to as the “named executive officers” throughout this Proxy Statement.

 

 

 

 

 

 

 

 

 

Grants Of Plan-Based Awards

 

 

 

 

Description of Certain Awards Granted in 2007

 

Performance Share Units.  Each named executive officer received a performance share unit grant in March 2007. The threshold, target and maximum payouts that each officer could receive under his or her award is disclosed under the Estimated Future Payouts Under Equity Incentive Plan column in the Grants of Plan-Based Awards table above. The payout amounts under these awards will be earned based on Baxter’s growth in shareholder value relative to the growth in shareholder value of the healthcare peers included in Baxter’s peer group during the three-year performance period commencing on January 1, 2007. The payout of shares of Baxter common stock will range

from 0% to 200% of the number of performance share units awarded. If an officer ceases to be employed at Baxter during the performance period (other than due to death, disability or retirement), such officer will forfeit any payout under his or her performance share units. However, if an officer who is “retirement eligible” (meaning he or she is at least 65 years of age, or at least 55 years of age with at least 10 years of service) retires after December 31, 2007, then his or her performance share units will remain eligible for payout at the end of the performance period. Mr. Gatling is the only named executive officer who was retirement eligible on the grant date associated with his performance share units. Officers have no rights of a shareholder with respect to the performance share units until the performance period is complete, other than the right to receive cash payments equal to dividends paid on shares of Baxter common stock to the same extent as if each performance share unit was a share of common stock. For more information about these awards see “Compensation Discussion and Analysis — Structure of Compensation Program — Pay for Performance — Performance Against Our Peers” on page 13 of this Proxy Statement. These grants are reflected in the Estimated Future Payouts Under Equity Incentive Plan Awards columns in the Grants of Plan-Based Awards table above.

 

Stock Options.  Each named executive officer received a stock option grant in March 2007. These stock options vest one-third per year over a three-year period. The exercise price of each stock option awarded by Baxter to its executive officers under our incentive compensation programs is the closing price of our common stock on the date of grant, which is the date when the Compensation Committee acts to approve equity awards for senior executives. Generally, if an officer ceases to be employed at Baxter before his or her stock options vest, these options will expire on the date such officer’s employment is terminated unless such termination is due to death, disability or retirement. However, if an officer who is retirement eligible (as defined above) retires after December 31, 2007, then his or her stock options will continue to vest based upon their original vesting schedule. Mr. Gatling is the only named executive officer who was retirement eligible on the date his stock options were granted to him. Each of these options expires on the ten-year anniversary of the grant date. These grants are reflected in the All Other Option Awards column in the Grants of Plan-Based Awards table above.

 

Restricted Stock Units.  Each named executive officer (other than Mr. Parkinson) received a one-time transitional award of restricted stock units in March 2007 as a result of the restructuring of Baxter’s equity compensation program in 2007. These restricted stock units vest one-third per year over a three-year period. Officers have no rights of a shareholder with respect to the shares underlying the restricted stock units prior to vesting, other than the right to receive cash payments equal to dividends paid on shares of Baxter common stock to the same extent as if each restricted stock unit was a share of common stock. If an officer ceases to be employed at Baxter during the vesting period (other than due to death, disability or retirement), such officer will forfeit his or her restricted stock units. However, if an officer who is retirement eligible (as defined above) retires after December 31, 2007, then his or her restricted stock units will continue to vest based upon their original vesting schedule. Mr. Gatling is the only named executive officer who was retirement eligible on the date his restricted stock units were granted to him. These grants are reflected in the All Other Stock Awards column in the Grants of Plan-Based Awards table above.

 

Employment Agreement with Chairman and Chief Executive Officer

 

Baxter and Robert L. Parkinson, Jr. entered into an employment agreement on April 19, 2004 in connection with Mr. Parkinson’s appointment as Chairman and Chief Executive Officer of Baxter. There are no other employment agreements between Baxter and its named executive officers.

 

Pursuant to an automatic day-to-day extension, the agreement has a two-year term (subject to earlier termination as described below). Mr. Parkinson is to receive an annual base salary of not less than $1,100,000, subject to possible increase by the independent directors of the Board. He is eligible to participate in Baxter’s officer bonus and long-term incentive programs at a level commensurate with his position as Chief Executive Officer as determined by the independent directors of the Board, and to receive benefits to the same extent and on the same terms as those benefits provided by the company to its other senior executives including, but not limited to, health, disability, insurance and retirement benefits. In addition to these benefits, the agreement provides that if Mr. Parkinson remains employed for at least three years (which he achieved in 2007), his pension benefit will be determined as if he had completed five years of service, and if he remains employed for at least five years, his

pension benefit will be determined as if he had completed nine years of service (an additional four years credited, including the additional two year credited in 2007). This additional service is credited under the supplemental pension plan. The agreement also provides that if Mr. Parkinson retires after his pension benefit is vested but before he is eligible for an unreduced early retirement benefit, he will receive payments under the supplemental pension plan equal to the difference between an unreduced pension benefit and his actual benefits received under the pension plan.

 

In consideration for his employment at Baxter, Mr. Parkinson will not compete with the company, directly or indirectly, for a period of two years after the termination of his employment. Mr. Parkinson has also agreed not to solicit or attempt to solicit any customer or supplier of the company nor solicit, persuade or induce any individual who is employed by the company or its subsidiaries to terminate such employment or enter into an employment relationship with another entity.

 

The agreement provides for certain payments in the event of Mr. Parkinson’s death, permanent disability, termination for cause, constructive discharge or termination following a change in control or non-renewal of his agreement. For more information about these payments, please see “Potential Payments Upon Termination Following A Change-in-Control — Our Chairman and Chief Executive Officer” on page 29 of this Proxy Statement.

Outstanding Equity Awards At Fiscal-Year End

 

 

 

 

Option Exercises and Stock Vested

 

 

 

 

Pension Benefits

 

 

 

 

 

Baxter’s tax-qualified pension plan is a broad-based retirement income plan. The normal retirement (age 65) benefit equals (i) 1.75 percent of a participant’s “Final Average Pay” multiplied by the participant’s number of years of pension plan participation, minus (ii) 1.75 percent of a participant’s estimated primary social security benefit, multiplied by the participant’s years of pension plan participation. “Final Average Pay” is equal to the average of a participant’s five highest consecutive calendar years of earnings out of his or her last ten calendar years of earnings. In general, the compensation considered in determining the pension payable to the named executive officer includes salary and cash bonuses awarded under the officer bonus program. Although age 65 is the normal retirement age under the pension plan, the pension plan has early retirement provisions based on a point system. Under the point system, each participant is awarded one point for each year of pension plan participation and one point for each year of age. Participants who terminate employment after accumulating at least 65 points, and who wait to begin receiving their pension plan benefits until they have 85 points, receive an unreduced pension plan benefit regardless of their actual age when they begin receiving their pension plan benefits.

 

Baxter’s supplemental pension plan is offered to provide a benefit for the amount of eligible compensation that is disallowed as pensionable earnings under the pension plan pursuant to provisions of the Internal Revenue Code of 1986, as amended, that limit the benefit available to highly compensated employees under qualified pension plans. Accordingly, this plan is available to all employees eligible to participate in the pension plan whose benefit under the pension plan is limited by the Internal Revenue Code of 1986, as amended. Benefits under the supplemental pension plan will be paid at the same time and in the same form as benefits under the pension plan for participants whose pension commences by December 31, 2008. Effective January 1, 2009, new tax regulations will require that the supplemental plan be amended to provide a time and form of payment that is independent of the pension plan. Deferred salary and bonus amounts that may not be included under the pension plan are included in the supplemental plan. In addition, individual employment agreements may provide for additional pension benefits to be paid through the supplemental pension plan, such as those paid under Mr. Parkinson’s employment agreement.

 

Participation in the pension and supplemental pension plans was frozen as of December 31, 2006. Any employees hired or rehired after that date will not be eligible to participate in the pension plan or supplemental pension plan, but instead will receive an additional employer contribution equal to 3% of his or her compensation in Baxter’s tax-qualified section 401(k) profit sharing plan (and nonqualified deferred compensation plan if his or her compensation exceeds the compensation that can be taken into account under Baxter’s 401(k) plan). Employees who were hired prior to December 31, 2006, but who did not have a vested interest in the pension plan, were eligible to elect to cease accruing benefits in the pension plan (and supplemental plan, if applicable), and instead receive the additional employer contribution.

Nonqualified Deferred Compensation

 

 

 

 

A participant in Baxter’s deferred compensation plan may elect to defer a portion of his or her eligible compensation (up to 50% of base salary and up to 100% of eligible bonus) during the calendar year as long as the participant makes such election prior to the beginning of the calendar year. For named executive officers, eligible compensation under the deferred compensation plan includes a participant’s base salary and any cash bonus. Participants in the deferred compensation plan may select a subset of investment elections available to all eligible employees under Baxter’s tax-qualified section 401(k) profit sharing plan. Amounts in a participant’s account are adjusted on a daily basis upward or downward to reflect the investment return that would have been realized had such amounts been invested in the investments selected by the participant. Participants may elect to change their investment elections once each calendar month. Baxter is also required to match contributions to the deferred compensation plan dollar-for-dollar up to 3% of a participant’s eligible compensation. In 2008, the maximum match will increase to 3.5% of eligible compensation in conjunction with a change in the maximum matching contribution under Baxter’s tax qualified 401(k) profit sharing plan. In addition, a participant who either was hired after December 31, 2006, or who elected not to continue to accrue benefits in the pension plan, will receive a company contribution equal to 3% of his eligible compensation in excess of the compensation that is recognized in the tax qualified 401(k) profit sharing plan. Deferrals under the plan are not recognized as eligible compensation for the qualified pension plan (but are recognized in the supplemental pension plan) or in calculating benefit pay under Baxter’s welfare benefit plan and result in lower compensation recognized for company matching under Baxter’s tax-qualified section 401(k) profit sharing plan.

 

Participants may elect to be paid distributions either in a lump sum payment or in annual installment payments over two to fifteen years. Distributions will be paid in the first quarter of the plan year following such participant’s termination of employment unless such participant is a “key employee” as defined in Section 409A of the Internal Revenue Code of 1986, as amended. No distributions will be paid in connection with the termination of a key employee until at least six months following such termination and any amounts that would have otherwise been paid during such six month period shall be accumulated and paid in a lump sum, without interest, at the expiration of such period.

 

Potential Payments Upon Termination Following A Change-in-Control

 

Our Chairman and Chief Executive Officer

 

Mr. Parkinson’s employment agreement provides for certain payments in the event of Mr. Parkinson’s death, permanent disability, termination without cause or due to constructive discharge, or termination following a change in control or non-renewal of his agreement. The following table shows Baxter’s potential payment and benefit

obligations to Mr. Parkinson upon his termination under each of these circumstances assuming such termination occurred on December 31, 2007.

 

 

 

 

In addition to the payments and obligations included in the table above, upon his termination for any reason, Mr. Parkinson would be entitled to any other payments or benefits due from the company in accordance with the terms of any employee benefit plans or arrangements generally available to all salaried employees, and any vested pension benefit earned upon his termination for any reason.

 

Other Named Executive Officers

 

In December 2006, each of the named executive officers (other than Mr. Parkinson) entered into a severance agreement with the company that provides for certain payments in the event Baxter undergoes a change of control and the officer is involuntarily terminated by the company or voluntarily terminates his or her employment with the company for good reason — that is, subject to a “double trigger”. These payments include:

 

 

 

The severance agreements also provide that if the total payments or benefits to which a named executive officer is entitled in connection with a change of control (including amounts paid under the severance agreements or any other such plan, arrangement or agreement with the company such as other equity compensation programs) exceed 110% of the largest amount that would result in no portion of the total payments being subject to any excise tax imposed under section 4999 of the Internal Revenue Code of 1986, as amended, the company will gross-up the severance payments to the officer to cover such excise tax. These amounts are reported in the “Tax Gross-Up” line of the table below.

 

The table set forth below shows Baxter’s potential payment and benefit obligations to each of the named executive officers (other than Mr. Parkinson) assuming that a change in control of the company has occurred and as a result the named executive officer either is terminated or terminates his or her employment for good reason on December 31, 2007. The accelerated vesting of equity awards that is included in the table below would occur as a result of the terms of the equity compensation programs governing these awards rather than the terms of the severance agreements.

 

 

 

 

In consideration for the benefits received under the severance agreements, each named executive officer has agreed to be bound for two years from the date of his or her termination to non-competition, non-solicitation and non-disparagement covenants. A condition for receiving any severance payments under the agreement is the execution by the named executive officer of a customary release of claims in a form reasonably acceptable to the company.

 

Director Compensation

 

Non-employee directors are compensated for their service under Baxter’s non-employee director compensation plan with cash compensation and equity awards of stock options and restricted stock units.

 

Cash Compensation

 

Each non-employee director is paid a $50,000 annual cash retainer (increased to $60,000 effective January 1, 2008) and a $1,500 fee for each Board and each committee meeting attended. Each non-employee director who acts as the chair of any committee meeting is paid an additional $1,500 for each meeting chaired by him or her. The lead director is paid an additional annual cash retainer of $25,000 (increased to $30,000 effective as of January 1, 2008). Non-employee directors are eligible to participate in a deferred compensation plan that allows for the deferral of all or any portion of cash payments until Board service ends and provides participants with a select sub-set of investment elections available to all eligible employees under Baxter’s tax-qualified section 401(k) profit sharing plan.

 

Stock Options

 

Each non-employee director is entitled to receive a grant of stock options annually on the date of the annual meeting of shareholders. Under Baxter’s director compensation plan, the annual stock option grant value to each non-employee director is $60,000 on the grant date, based on a Black-Scholes valuation of Baxter’s options as of that date. The stock options become exercisable on the date of the next annual meeting of shareholders, and may become exercisable earlier in the event of the death, disability, or a change in control of Baxter.

 

Restricted Stock Units

 

Each non-employee director also receives an annual grant of restricted stock units on the date of the annual meeting of shareholders. The number of restricted stock units equals the quotient of $60,000 divided by the closing sale price for a share of Baxter common stock on the date of the annual meeting. Directors have the option of deferring the receipt of the shares of stock underlying such restricted stock units until the earlier of three years from the grant date or termination from service as a director. The restricted stock units vest on the date of the next annual meeting of shareholders and may vest earlier in the event of the death, disability, or a change in control of Baxter. Directors are credited with dividend equivalents on the shares underlying the restricted stock units and such dividends equivalents are reinvested in additional restricted stock units. Directors have no other rights of a shareholder with respect to the shares underlying the restricted stock units prior to vesting.

 

Director Compensation Table

 

The following table provides information on 2007 compensation for non-employee directors who served during 2007.

 

 

Compensation Committee Report

 

The Compensation Committee is responsible for the oversight of Baxter’s compensation programs on behalf of the Board of Directors. In fulfilling its oversight responsibilities, the Compensation Committee has reviewed and discussed with management the Compensation Discussion and Analysis set forth in this Proxy Statement.

 

Based on the review and discussions referred to above, the Compensation Committee recommended to the Board of Directors that the Compensation Discussion and Analysis be included in Baxter’s Annual Report on Form 10-K for the fiscal year ended December 31, 2007 and Proxy Statement for the 2008 Annual Meeting of Shareholders, each of which will be filed with the Securities and Exchange Commission.

 

Compensation Committee
John D. Forsyth (Chair)
Walter E. Boomer
Carole J. Shapazian
Thomas T. Stallkamp

Security Ownership by Directors and Executive Officers

 

The following table sets forth information as of January 31, 2008 regarding beneficial ownership of Baxter common stock by executive officers, directors and director nominees.

 

 

 

Security Ownership by Certain Beneficial Owners

 

As of February 15, 2008, the following entity was the only person known to Baxter to be the beneficial owner of more than five percent of Baxter common stock:

 

 

 

 

Section 16(a) Beneficial Ownership Reporting Compliance

 

Section 16(a) of the Securities Exchange Act of 1934, as amended, requires our executive officers and directors and persons who own more than 10% of our common stock, as well as certain affiliates of such persons, to file initial reports of ownership and changes in ownership with the Securities and Exchange Commission. Based solely on our review of the reports that have been filed by or on behalf of such persons in this regard and written representations from them that no other reports were required, we believe that all persons filed the reports required by Section 16(a) of the Securities Exchange Act of 1934, as amended, on a timely basis during or with respect to 2007.

 

Certain Relationships and Related Transactions

 

The Board of Directors recognizes that related person transactions present a heightened risk of conflicts of interest. Accordingly, pursuant to Baxter’s Corporate Governance Guidelines, the Corporate Governance Committee has been charged with reviewing related person transactions regardless of whether the transactions are reportable pursuant to Item 404 of Regulation S-K under the Securities Exchange Act of 1934, as amended. For purposes of this policy, a “related person transaction” is any transaction in which the company was or is to be a participant and in which any related person has a direct or indirect material interest other than transactions that involve less than $50,000 when aggregated with all similar transactions. For any related person transaction to be consummated or to continue, the Corporate Governance Committee must approve or ratify the transaction. The Corporate Governance Committee will approve or ratify a transaction if the Committee determines that such transaction is in Baxter’s best interest. Related person transactions are reviewed as they arise and are reported to the Committee. The Committee also reviews materials prepared by the Corporate Secretary to determine whether any related person transactions have occurred that have not been reported. It is Baxter’s policy to disclose all related person transactions in the company’s applicable filings to the extent required by the Securities Act of 1933 and the Securities Exchange Act of 1934 and the rules and regulations thereunder.

Audit Committee Report

 

Management is responsible for the preparation, presentation and integrity of Baxter’s consolidated financial statements and Baxter’s internal control over financial reporting. The independent registered public accounting firm of PricewaterhouseCoopers LLP (PwC) is responsible for performing an independent integrated audit of Baxter’s consolidated financial statements and the effectiveness of Baxter’s internal control over financial reporting. The Audit Committee’s responsibility is to monitor and oversee these processes.

 

In this context, the Audit Committee reports as follows: