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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 2005 annual meeting of Eaton Corporation shareholders will be held
Wednesday, April 27, at 10:30 a.m. local time at Eaton Center, 1111 Superior
Avenue, Cleveland, Ohio, for the purpose of:
1. Electing directors;
2. Ratifying the appointment of independent auditors; and
3. 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 February 28, 2005. 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 18, 2005
Your Vote Is Important
You may vote your shares by using a toll-free telephone number or electronically
on the Internet, as described on the proxy form. We encourage you to file your
proxy using either of these options if they are available to you. Alternatively,
you may mark, sign, date and mail your proxy form in the postage-paid envelope
provided. 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................................ 8
Director Independence....................... 8
Board Committees ........................... 9
Committee Charters and Policies............. 10
Audit Committee Report...................... 11
Compensation of Directors .................. 12
Board of Directors Governance Policies...... 13
Executive Sessions of the Outside
Directors................................. 13
Security Holder Communications to the
Board..................................... 13
Director Attendance at Annual Meetings...... 13
Code of Ethics.............................. 13
Executive Compensation ..................... 14
Aggregated Option Exercises and Fiscal Year-
End Values................................ 16
Option Grants............................... 16
Long-Term Incentive Plan Awards............. 17
Stock Ownership Guidelines.................. 17
Compensation and Organization Committee
Report.................................... 17
Company Stock Performance................... 23
Retirement Plans............................ 24
Other Retirement and Compensation
Arrangements.............................. 25
Ratification of the Appointment of
Independent Auditors ..................... 26
Other Business ............................. 26
Share Ownership Tables...................... 27
Section 16(a) Beneficial Ownership Reporting
Compliance................................ 29
Future Shareholder Proposals ............... 29
APPENDICES
Appendix A:
Charter of Governance Committee and
Relevant Policies......................... 29
Appendix B:
Board of Directors Governance Policies ... 31
Appendix C:
Board of Directors Independence Criteria
and Board Policy on Directors' Use of
Company Planes ........................... 34
Appendix D:
Charter of Audit Committee ............... 36
Appendix E:
Charter of Compensation and Organization
Committee................................. 39
Appendix F:
Charter of Finance Committee.............. 40
Appendix G:
Code of Ethics ........................... 42
PROXY STATEMENT
EATON CORPORATION
Eaton Center
1111 Superior Avenue
Cleveland, Ohio 44114-2584
216-523-5000
----------------------------------------------
This proxy statement, the accompanying proxy form and Eaton's annual report for
the year ended December 31, 2004 are scheduled to be sent to shareholders on or
about March 18, 2005.
PROXY SOLICITATION
Eaton's Board of Directors solicits your proxy, in the form enclosed, for use at
the 2005 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, 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
$8,500, 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 February 28, 2005
is entitled to one vote for each share then held. On February 28, 151,229,096
Eaton common shares (par value, 50c each) were outstanding and entitled to vote.
At the 2005 annual meeting, the inspector of election appointed by the Board of
Directors for the meeting will determine the presence of a quorum and tabulate
the results of shareholder voting. As provided by Ohio law and Eaton's Amended
Regulations, Eaton shareholders present in person or by proxy at the meeting
will constitute a quorum. The inspector of election intends to treat as
"present" for these purposes shareholders who have submitted properly executed
or transmitted proxies that are marked "abstain." The inspector will also treat
as "present" shares held in "street name" by brokers that are voted on at least
one proposal to come before the meeting.
Director nominees receiving 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,
3
requesting cumulative voting, and if an announcement of that notice is made at
the beginning of the meeting by the Chairman or Secretary, or by or on behalf of
the shareholder who gave the notice. If cumulative voting is in effect with
respect to 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 four
directors will expire in April 2005, and those directors have been nominated for
re-election. Three of the nominees were elected at the 2002 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 form will have the authority to appoint
substitute nominees. Eaton's management, however, has no reason to believe that
this will occur.
Following is biographical information about each nominee and each director.
4
NOMINEES FOR ELECTION TO TERMS ENDING IN 2008 OR WHEN THEIR SUCCESSORS ARE
ELECTED AND HAVE QUALIFIED:
J. R. MILLER PHOTO G. R. PAGE PHOTO V. A. PELSON PHOTO
N. C. LAUTENBACH PHOTO
NED C. LAUTENBACH, 61, is a JOHN R. MILLER, 67, is a GREGORY R. PAGE, 53, is VICTOR A. PELSON, 67, is a
principal of Clayton, retired oil industry President and Chief Senior Advisor to UBS
Dubilier & Rice, Inc., a executive. Mr. Miller was Operating Officer of Securities LLC, investment
private equity investment President, Chief Operating Cargill, Incorporated, an bankers. Before becoming
firm specializing in Officer and a director of international marketer, associated with UBS
management buyouts. Before The Standard Oil Company processor and distributor of Securities and its
joining Clayton, Dubilier, from 1980 to 1986, also agricultural, food, predecessors in 1996, Mr.
Mr. Lautenbach was serving as a member of its financial and industrial Pelson was an employee of
associated with IBM from Management Committee, and products and services. He AT&T from 1959 to 1996,
1968 until his retirement in where he previously held a was Corporate Vice President where he held a number of
1998. At IBM, he held number of other executive & Sector President, executive positions,
several executive positions, positions, including that of Financial Markets and Red including Group Executive
including Senior Vice Vice President, Finance for Meat Group of Cargill in and President responsible
President and Group three years. He is currently 1998, Corporate Executive for the Communications
Executive - Sales and a director of Cambrex Vice President, Financial Services Group, Executive
Distribution, and was a Corporation and Graphic Markets and Red Meat Group Vice President and member of
member of IBM's Corporate Packaging Corporation. Mr. in 1999, and became the Management Executive
Executive Committee. From Miller was a member of the President and Chief Committee. At the time of
1999 to 2002, Mr. Lautenbach Board of the Federal Reserve Operating Officer in 2000. his retirement from AT&T,
served as Chief Executive Bank of Cleveland from 1986 Mr. Page is a director of Mr. Pelson was Chairman of
Officer of Acterna to 1993, serving as its Cargill, Incorporated. Global Operations and a
Corporation, a global Chairman during the last two DIRECTOR SINCE 2003 member of the Board of
provider of communications of those years. From 2000 to Directors. Mr. Pelson is a
test equipment, software and 2003 he was Chairman, director of Dun & Bradstreet
services, which filed and President and Chief and United Parcel Service.
had approved in 2003 a Executive Officer of DIRECTOR SINCE 1994
voluntary plan of Petroleum Partners, Inc., a
reorganization under Chapter provider of outsourcing
11. Mr. Lautenbach is a services to the petroleum
member of the Board of industry.
Trustees of Fidelity DIRECTOR SINCE 1985
Investments and a member of
the Council on Foreign
Relations.
DIRECTOR SINCE 1997
5
DIRECTORS WHOSE PRESENT TERMS CONTINUE UNTIL APRIL 2006:
G. L. TOOKER PHOTO D. L. McCOY PHOTO
A. M. CUTLER PHOTO
ALEXANDER M. CUTLER, 53, is GARY L. TOOKER, 65, is an DEBORAH L. MCCOY, 50, 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
6
DIRECTORS WHOSE PRESENT TERMS CONTINUE UNTIL APRIL 2007:
E. GREEN PHOTO K. M. PATEL PHOTO
M. J. CRITELLI PHOTO
MICHAEL J. CRITELLI, 56, is ERNIE GREEN, 66, is founder, KIRAN M. PATEL, 56, 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. Mr. Critelli is President of Florida Prior to joining Solectron
non-executive Chairman of Production Engineering, in 2001, he was associated
the National Urban League. Inc., a subsidiary of Ernie with Cummins Inc. for 27
DIRECTOR SINCE 1998 Green Industries. He is a years, where he served as
director of DP&L Inc. and Vice President and Chief
Pitney Bowes Inc., and Financial Officer from 1996
non-executive Chairman of to 2000. In 2000-2001, Mr.
the Foundation Board of Patel was the Chief
Central State University. Financial Officer of
DIRECTOR SINCE 1995 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 Executives
Institute. He is a director
of Westport Innovations,
Inc.
DIRECTOR SINCE 2003
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. The Governance Committee's
current charter is available on the Company's website (www.eaton.com) under the
heading "Corporate Governance" and is included in this proxy statement as
Appendix A.
Any director candidates recommended by the Company's security holders are given
consideration by the Governance Committee, consistent with the process used for
all candidates. Security holders may submit recommendations in the manner
described on this page under the heading "Security Holder Recommendations of
Director Candidates."
All potential director candidates are reviewed by the Governance Committee in
consultation with the Chairman and Chief Executive Officer, typically with the
assistance of a professional search firm retained by the Committee. The
Committee decides whether to recommend one or more candidates to the Board of
Directors for nomination. Candidates who are ultimately nominated by the Board
stand for election by the shareholders at the annual meeting. (Between annual
meetings, in rare cases, 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: 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.
The Board of Directors Governance Policies are available on the Company's
website (www.eaton.com) under the heading "Corporate Governance" and are
included in this proxy statement as Appendix B. Printed copies will also be
provided free of charge upon request. Requests for printed copies should be
directed to the Company's Investor Relations Office, Eaton Corporation, 1111
Superior Avenue, Cleveland, Ohio 44114-2584.
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 2006 should send a signed
letter of recommendation, to be received before November 4, 2005, 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, which are
available on the Company's website (www.eaton.com) under the heading "Corporate
Governance" and are 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.
8
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. These criteria are also available on
the Company's website (www.eaton.com) under the heading "Corporate Governance"
and are 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. This policy is also available on the
Company's website and is 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 other than Mr. Cutler has a material relationship with the Company and
that each of the following directors qualifies as independent under the Board's
independence criteria and the New York Stock Exchange criteria: Michael J.
Critelli, Ernie Green, Ned C. Lautenbach, Deborah L. McCoy, John R. Miller,
Gregory R. Page, Kiran M. Patel, Victor A. Pelson and Gary L. Tooker. The Board
has also affirmatively determined 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 functions of the Audit Committee include assisting the
Board in overseeing the integrity of the Company's financial statements and its
systems of internal accounting and financial controls; the independence,
qualifications and performance of 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 and pre-approves all
auditing services and permitted non-audit services to be performed for the
Company by the independent auditor. Among its other responsibilities, the
Committee meets regularly with the Company's chief financial officer,
Director-Audits, independent auditor and Director-Global Ethics 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.
Each Committee member meets the independence requirements, and all Committee
members collectively meet the other requirements, of the New York Stock
Exchange, the Sarbanes-Oxley Act of 2002, and rules adopted thereunder by the
Securities and Exchange Commission. Further, Committee members are prohibited
from serving on more than two other public company audit committees. The Board
of Directors has determined that each member of the Audit Committee is
financially literate, that at least one member has accounting or related
financial management expertise and that two members, John R. Miller and Kiran M.
Patel, qualify as audit committee financial experts, as defined in Item 401(h)
of Regulation S-K under the Securities Exchange Act of 1934. The Audit Committee
held eight meetings in 2004. 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; recommending the
individual to assume the position of Chief Executive Officer if that position
becomes vacant; and reviewing the Company's practices for the recruitment and
development of a diverse talent pool. The Committee is also responsible for
determining the salary of each elected officer of the Company, subject to
discussion by the Board
9
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 short-term and long-term incentive
compensation plans; annually reviewing awards to elected officers 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 2004. 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 did not meet during 2004. 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 three meetings in 2004. 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 Board committee. The Governance Committee, in consultation with the
Chief Executive Officer, identifies and recommends to the Board candidates for
Board membership, reviews the nomination of directors for re-election; oversees
the orientation of new directors and the ongoing education of the Board;
recommends to the Board compensation of non-employee directors; administers the
Board's policy on director retirements and resignations; administers the
directors' stock ownership guidelines; and recommends to the Board guidelines
and procedures to be used by the directors to evaluate the Board's performance.
The responsibilities of the Governance Committee also include providing
oversight regarding significant public policy issues with respect to 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 2004. 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, the Compensation and Organization Committee and the
Governance
10
Committee most recently in February 2005, and the charter of the Finance
Committee in January 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. These charters also are available on the Company's
website (www.eaton.com) under the heading "Corporate Governance." Printed copies
will also be provided free of charge upon request. Requests for printed copies
should be directed to the Company's Investor Relations Office, Eaton
Corporation, 1111 Superior Avenue, Cleveland, Ohio 44114-2584.
In addition to the Board of Directors Governance Policies, certain other
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 eleven meetings in 2004. All directors attended at
least 75% of the meetings of the Board and its committees. The average rate of
attendance for all directors was 95%.
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
auditor, and to pre-approve all audit services and other services to be provided
to the Company by the independent auditor. The Committee is comprised of 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 February
23, 2005. 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 2004 audited financial
statements.
The Committee has discussed with Ernst & Young LLP, the Company's independent
auditor, 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 2003 and 2004, Ernst & Young's fees for various types of services to the
Company were as shown below:
2004 2003
------------- ------------
Audit Fees............. $14.5 million $7.3 million
Includes
Sarbanes-Oxley Section
404 attest services
Audit-Related Fees..... 1.5 million 1.3 million
Includes employee
benefit plan audits
and business
acquisitions and
divestitures
Tax Fees............... 6.8 million 5.4 million
Tax compliance
services 4.5 million 3.5 million
Tax advisory services 2.3 million 1.9 million
All Other Fees 0.4 million 0.1 million
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: services are pre-approved from time to time by the Committee or by the
Committee Chair on its behalf. As to any services approved by the Committee
Chair, the approval is made in writing and is reported to
11
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 2004 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.
Respectfully submitted to the Company's shareholders by the Audit Committee of
the Board of Directors.
Victor A. Pelson, Chair
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 Chair of the Finance Committee receives an annual retainer of
$5,000; the Chair of the Compensation and Organization Committee and the Chair
of the Governance Committee each receives an annual retainer of $7,500; and the
Chair 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 the annual meeting following a director's 68th birthday and is
higher than prevailing market rates. Under a separate 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
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
termination of service in the context of a change in control of the Company and,
with respect to amounts deferred prior to January 1, 2005 under certain of these
arrangements, upon a failure by the Company to pay.
Under the Company's Stock Plans, as approved by the shareholders, each
newly-elected 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. Options granted to
non-employee directors have an exercise price equal to the fair market value of
the shares on the date of the grant, vest in six months, and have an exercise
period of ten years.
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.
12
BOARD OF DIRECTORS GOVERNANCE POLICIES -- The Board of Directors revised the
Board of Directors Governance Policies most recently in February 2005, 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 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 -- Chair of the Compensation and
Organization Committee
February -- Chair of the Audit Committee
April -- Chair of the Governance
Committee
July -- Chair of the Finance Committee
September -- Chair of the Audit Committee
October -- Chair 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 and other interested parties
to send communications to the Board or the non-management directors:
Security holders and other interested parties 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 Chair of the Governance Committee. The Governance Committee Chair in turn
determines whether the communications should be forwarded to other members of
the Board and, if so, forwards them accordingly. However, for communications
addressed to a particular member of the Board (e.g., the director who will chair
a particular Executive Session), the Chair of a particular Board Committee or
the non-management directors as a group, the Vice President and Secretary
forwards those communications directly to the Board member or members 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 2004 Annual Meeting, held
April 28, 2004, all ten members of the Board were in attendance.
CODE OF ETHICS -- The Company has a Code of Ethics that was approved by the
Board of Directors. The Company provides training globally for all employees on
its Code of Ethics. Eaton requires that all directors, officers and employees of
Eaton, its subsidiaries and affiliates abide by the Company's Code of Ethics,
which is attached as Appendix G to this proxy statement. The Code of Ethics is
also available on the Company's website (www.eaton.com) under the heading
"Global Ethics." Printed copies will also be provided free of charge upon
request. Requests for printed copies should be directed to the Company's
Investor Relations Office, Eaton Corporation, 1111 Superior Avenue, Cleveland,
Ohio 44114-2584.
13
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 2004. The table also
summarizes compensation of the named executive officers for fiscal years 2003
and 2002.
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 2004 $979,334 $2,167,440 $122,552 $1,593,000 242,000 $4,517,381 $ 20,806
Chairman, 2003 950,004 1,504,807 106,726 931,665 242,000 1,826,660 19,266
Chief Executive Officer 2002 950,004 1,745,633 100,720 944,790 224,000 918,496 18,151
and President
C. Arnold 2004 $431,060 $ 716,958 $ 963 $ 0 44,000 $1,309,049 $ 11,128
Senior Vice President 2003 411,750 445,372 0 175,125 44,000 602,763 9,303
and Group Executive-- 2002 399,125 456,934 0 204,500 44,000 326,552 8,928
Fluid Power
R. W. Carson 2004 $439,740 $ 696,549 $ 12,124 $ 0 44,000 $1,309,049 $ 13,629
Senior Vice President 2003 437,588 452,125 4,526 175,125 44,000 822,483 13,681
and Group Executive-- 2002 418,614 515,456 14,495 204,500 44,000 363,468 52,358
Electrical
R. H. Fearon 2004 $456,770 $ 761,298 $ 0 $ 295,000 44,000 $1,028,563 $ 11,064
Executive Vice 2003 439,184 476,110 0 175,125 44,000 407,289 12,900
President-- 2002 301,045 507,616 45,874 422,900 44,000 73,909 171,891
Chief Financial and
Planning Officer
J. E. Sweetnam 2004 $406,440 $ 658,619 $ 12,776 $ 0 44,000 $1,207,428 $ 87,063
Senior Vice President 2003 390,702 404,881 18,567 175,125 44,000 469,350 27,896
and Group Executive-- 2002 373,344 438,589 0 204,500 44,000 264,079 11,056
Truck
-------------------------------------------------------------------------------------------------------------
(1) Reported in this column is annual compensation representing (i) amounts
reimbursed by the Company for the payment of income taxes on personal
benefits and (ii) $99,202 in executive perquisites received by Mr. Cutler in
2004, including $45,600 which represents the incremental cost for personal
use of the Company-owned aircraft. Due to concerns for 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) The restricted stock awards shown in the table for 2004 vest as follows: A.
M. Cutler, 20% after 24 months, an additional 20% after 36 months, an
additional 30% after 48 months, and the remaining 30% after 60 months; R. H.
Fearon, 20% after 12 months, an additional 20% after 24 months, an
additional 20% after 36 months, and the remaining 40% after 48 months.
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. At year-end 2004 the number and value
of unvested restricted shares held by each of the named executive officers
were as follows: C. Arnold, 43,222, $3,127,544; R. W. Carson, 10,000,
$723,600; A. M. Cutler, 75,460, $5,460,286; R. H. Fearon, 16,000,
$1,157,760; and J. E. Sweetnam, 8,000, $578,880. Value is calculated by
multiplying the closing price of an Eaton share on that date by the number
of restricted shares.
(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, subject to limits imposed
under the Internal Revenue Code. 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. The amounts the
Company contributed during 2004 for the named executive officers were as
follows: C. Arnold, $8,200; R. W. Carson, $7,380; A. M. Cutler, $8,200; R.
H. Fearon, $7,544; and J. E. Sweetnam, $8,200. 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 2004 for each of
the named executive officers were as follows: C. Arnold, $0; R. W. Carson,
$0; A. M. Cutler, $3,125; R. H. Fearon, $0; and J. E. Sweetnam, $0. 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 2004 for each of the named executive
officers was as follows: C. Arnold, $2,928; R. W. Carson, $6,249; A. M.
Cutler, $9,481; R. H. Fearon, $3,520; and J. E. Sweetnam, $3,863. Each
executive officer is responsible for paying individual income taxes due with
respect to the Company's insurance program. This column also includes
relocation expenses beyond those generally available under the Company's
relocation policy for transferred salaried employees for Mr. Sweetnam of
$16,385 in 2003 and $75,000 in 2004, and for Mr. Carson of $39,571 in 2002.
In addition, this column includes relocation expenses for Mr. Fearon as a
newly hired, incentive-eligible employee of $164,433 in 2002 and $1,700 in
2003. Pursuant to the Company's relocation policy for incentive-eligible
employees, Cendant Mobility Services Corporation, the agency handling
relocation of Eaton's employees, purchased Mr. Fearon's California home for
an independent appraised value of $2.55 million. Under Eaton's contract with
Cendant, in 2003, Eaton paid Cendant $189,563 based on Cendant's carrying
costs and brokerage costs in connection with its sale of Mr. Fearon's home.
These amounts are excluded from the table, as they were paid to Cendant and
were not treated as compensation to Mr. Fearon.
15
AGGREGATED OPTION EXERCISES AND FISCAL YEAR-END VALUES -- The following table
provides information concerning the exercise of stock options during fiscal year
2004 and the value of unexercised stock options at the end of fiscal year 2004
with respect to the named executive officers.
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 124,768 $4,375,200 985,759 725,417 $38,057,202 $21,668,852
C. Arnold 0 0 83,760 88,440 2,919,338 2,178,656
R. W. Carson 88,218 2,351,213 204,650 88,440 7,409,831 2,178,656
R. H. Fearon 0 0 43,560 88,440 1,426,590 2,154,570
J. E. Sweetnam 0 0 75,510 134,908 2,611,513 3,659,126
---------------------------------------------------------------------------------------------------------
OPTION GRANTS -- The following table provides information concerning grants of
stock options made during fiscal year 2004 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 three separate
nationally recognized compensation consulting firms used for annual market
analysis and applying this average percentage to the average price for an Eaton
common share over a specified number of years. For 2004, 2003 and 2002, the
number of years utilized was five. 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. No stock appreciation rights
were granted during fiscal year 2004.
INDIVIDUAL GRANTS
------------------------------------------------
PERCENT OF
TOTAL
NUMBER OF OPTIONS POTENTIAL REALIZABLE VALUE AT ASSUMED
SECURITIES GRANTED TO ANNUAL RATES OF STOCK PRICE APPRECIATION
UNDERLYING EMPLOYEES EXERCISE FOR OPTION TERM
OPTIONS IN FISCAL OR BASE EXPIRATION -----------------------------------------
NAME GRANTED (#) YEAR(1) PRICE DATE 0% 5% 10%
-------------------------------------------------------------------------------------------------------------------
A. M. Cutler 242,000 10.29% $59.07 2/24/2014 $0 $ 9,005,812 $ 22,728,955
C. Arnold 44,000 1.87% 59.07 2/24/2014 0 1,637,420 4,132,537
R. W. Carson 44,000 1.87% 59.07 2/24/2014 0 1,637,420 4,132,537
R. H. Fearon 44,000 1.87% 59.07 2/24/2014 0 1,637,420 4,132,537
J. E. Sweetnam 44,000 1.87% 59.07 2/24/2014 0 1,637,420 4,132,537
All Shareholders(2) 0 5,708,443,398 14,407,023,814
-------------------------------------------------------------------------------------------------------------------
(1) Based on a total of 2,350,844 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, except for options granted to
Mr. Cutler, 20% of which become exercisable upon each of the first five
anniversaries 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 $59.07, the value of all 153,394,638 shares outstanding
on January 31, 2005 would increase by the amounts shown. There can be no
assurance that the market price of Eaton shares will increase in the future.
--------------------------------------------------------------------------------
16
LONG-TERM INCENTIVE PLAN AWARDS -- The following table provides information
regarding long-term incentive plan awards made during fiscal year 2004 to each
of the named executive officers.
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 31,100 4 years 15,550 31,100 62,200
C. Arnold 8,650 4 years 4,325 8,650 17,300
R. W. Carson 8,650 4 years 4,325 8,650 17,300
R. H. Fearon 9,500 4 years 4,750 9,500 19,000
J. E. Sweetnam 7,350 4 years 3,675 7,350 14,700
---------------------------------------------------------------------------------------------------
(1) These units were awarded during 2004 under the Company's long-term incentive
plan at a target price per unit of $57.95. 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 2004. The Committee's
comprehensive formal executive compensation philosophy, which has been discussed
with the Board of Directors, is consistent with the Company's long-standing
belief that executive compensation must to a large extent be at risk, depending
on achieving rigorous Company, business unit and individual performance
objectives designed to enhance shareholder value. The Committee's philosophy
requires that executive compensation be competitive to allow the Company to
attract, motivate and retain highly qualified executives, and to 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
this philosophy and is confirmed by periodic comprehensive studies of the
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 consulting firm's recommended
compensation committee practice standards. The report also noted that the
Company's executive total compensation programs generally met the consulting
firm's best practice evaluation criteria. As an outgrowth of these discussions,
in 2004 the Committee commissioned an additional Company study of executive
total compensation practices and of Eaton's
17
performance compared to the peer group of companies that the Company's senior
management and Board of Directors use annually for strategic planning purposes
and for incentive plan performance goal discussions. This peer group currently
consists of sixteen well-known diversified industrial manufacturers, most of
which compete directly in one or more of the Company's major product markets.
This study provided a comprehensive, multiple-year look at Eaton and peer
company actual results across a range of performance metrics along with the
resulting actual compensation provided to senior executives as reported in the
proxy statements' summary compensation tables for Eaton and these same firms.
The results of this study, which were reviewed and endorsed by a second
independent compensation consultant chosen by the Committee, concluded that
Eaton's total compensation awards over the last three years fell at or below the
median for the peer group although the Company's performance for most critical
measures was at or above the peer group median performance. In addition, in 2003
and again in 2004, the Committee commissioned this second independent
compensation consultant to conduct separate detailed studies of evolving market
practices involving long-term incentive compensation plans with a special focus
on stock-based programs. These studies confirmed that the Company's targeted
long-term incentive compensation values align well with mainstream competitive
practice and, further, that its long-standing practice of providing a balanced
portfolio of long-term incentive elements aligns favorably with emerging market
trends that are marked by the more disciplined use of options, a higher emphasis
on performance-contingent incentives and an increase in the use of equity
programs in forms other than stock options. This consultant further recommended
that the Company's present approach to long-term incentives again be used for
the Company's 2005 grants.
Eighty-four percent of the 2004 aggregate cash compensation of the executive
officers named in the summary compensation table was based directly on specific
financial performance objectives. Consistent with the Company's past practices,
in 2004, the Committee targeted base salaries at approximately the median range
of compensation paid by comparably-sized industrial companies that are included
in the survey databases of three separate nationally recognized compensation
consulting firms. There are no compensation surveys available that track the
companies included in the S&P 1500 Industrial Machinery Index utilized in the
stock performance graph on page 23. Accordingly, the Committee's consultants
believe that the three databases used, when combined, provide the best metrics
for setting the compensation of the Company's elected officers. The Committee
also established short-term and long-term incentive opportunities and stock
option grants at approximately the median range as reported in these same
surveys, 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, and accomplishment of other objectives. The
Committee also considers factors such as initiative and leadership, 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. As has been the practice in recent years,
in 2004, Mr. Cutler requested only moderate base salary adjustments for certain
elected officers. Following a review and discussion, the Committee approved base
salary adjustments for certain elected officers as proposed by the Chairman.
Short-Term Incentives -- Annual performance awards for 2004 for elected officers
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") and earnings per share ("EPS"), and individual and business
unit performance. A philosophical cornerstone of
18
short-term incentive compensation is the belief that CFR and EPS 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. If the
Company achieves the predetermined minimum levels of CFR, but does not achieve
the predetermined minimum levels of EPS, no incentive payments above plan
minimum level can be made. 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 2004 incentive awards. Actual
awards are also determined by individual performance ratings and Committee
discretion. 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 to any given individual incentive participant provided,
however, that the total aggregate awards to all eligible incentive plan
participants cannot exceed 100% of the CFR and EPS performance adjusted
incentive fund. 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 -- In 2004, the Committee continued its long-standing
practice of paying targeted long-term incentive compensation in two components:
approximately 50% in a four-year performance-based incentive compensation plan
with any earned awards paid in cash, and the remaining 50% in stock options. The
performance-based cash portion of long-term incentives is made under the
Company's Executive Strategic Incentive Plan. Grants under this plan are made
annually and cover four-year performance periods. Final awards to participants
under the plan are based on the Company's success in achieving aggressive CFR
and growth in EPS goals and include a discretionary assessment of each
participant's 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 reported
for the top quartile of its diversified industrial peer group and also based
upon the Company's strategic objectives and annual business plans. Incentive
targets are expressed as phantom share units, and final awards are paid in cash,
instead of shares. In light of the significant adverse changes in the global
economy, the Committee determined in 2002 that the original performance
objectives for award periods that were then 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 award periods
ending 2002, 2003 and 2004, respectively. For the award period ending in 2004,
the Company's performance exceeded the performance objectives necessary to earn
a maximum award. Aggregate awards were capped at 150%, 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.
Equity Compensation -- As noted above, approximately 50% of the executive's
total long-term incentive compensation consists of stock options. Stock options
align the interests of the Company's elected 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
19
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 three separate 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. The Committee
annually reviews progress of individual elected officers toward these ownership
goals. Options have an exercise price equal to the fair market value of the
shares on the date of the grant, vest in equal installments over a minimum of
three years and, to further encourage a long-term perspective, have an exercise
period of ten years. The Company does not re-price 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.
In limited circumstances, the Company grants restricted stock to selected
elected officers or other executives. Such grants are typically made for special
retention purposes. They generally vest over four or more years and, when added
to the other basic compensation elements, may result in total compensation that
is somewhat above the median. Under the 2002 Stock Plan, no more than 10% of the
total number of shares authorized for delivery may be granted as restricted
shares, performance shares, stock appreciation rights or share awards (other
than stock options). In addition, no more than 5% of the total number of shares
authorized for delivery under the 2002 Stock Plan may be granted as restricted
shares, performance shares, stock appreciation rights or other share-based
awards (other than stock options) that 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 the 2002 Stock Plan, the vesting period must exceed one
year, with no more than one-third of those shares vesting at the end of each of
the twelve-month periods following the date of grant. While the 10% limit noted
above was appropriate for the 2002 Stock Plan, as approved by the shareholders
at the 2002 Annual Meeting, circumstances had changed by the time of the 2004
Annual Meeting, when the shareholders, at the recommendation of the Board of
Directors, approved the 2004 Stock Plan. Instead of a 10% limit, the 2004 Stock
Plan contained a 40% limit on the total number of shares authorized by the Plan
which could be used for grants of restricted shares, performance shares, stock
appreciation rights or other share awards (other than stock options). The
Committee supported the use of more shares for these other forms of equity
grants because their use was in line with the long-term incentive compensation
strategy that the Committee had then adopted. This long-term strategy, developed
in 2003 with the assistance of a special Committee-retained consultant, was
reviewed and reconfirmed in 2004 based upon an updated market analysis conducted
by the same consultant. Under this strategy, the Committee will continue to
drive executive performance while being sensitive to executive retention risks
by using a balanced portfolio of long-term incentive compensation components. In
addition, the Committee will continue to monitor the competitive environment in
executive compensation which is expected to continue to evolve during the life
of the 2004 Stock Plan as the result of a number of factors including the recent
ruling by the Financial Accounting Standards Board that mandates accounting for
stock options. This action will largely equalize the treatment of stock options
when compared to other potential incentive and equity elements that could be
used in executive incentive programs. It is important in this environment that
the Committee have the
20
flexibility to consider 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 that meet competitive
practice.
Chief Executive Officer Compensation -- The 2004 compensation for Mr. Cutler was
earned pursuant to the arrangements described above. Prior to approving an
annual total compensation plan for Mr. Cutler, each year the Committee conducts
a comprehensive Chief Executive Officer performance evaluation. This overall
performance evaluation is a primary component used by the Committee when
developing and approving annual compensation adjustments, awards and grants for
the Chief Executive Officer. This process is supported by an independent outside
consultant who is chosen by the Committee and who, independent of management,
collects and compiles input from each non-employee Director. After reviewing a
comprehensive annual goal report and self-evaluation provided by Mr. Cutler,
each Director provides his or her independent rating recommendations, comments
and performance improvement suggestions in performance areas including: Company
operations and financial results, long-term strategy development and progress,
success in building organizational depth, capability and diversity, personal
leadership style, community and industry involvement, Board support and the
development and execution of corporate governance practices. The Directors'
inputs on these performance areas, along with any narrative commentary, are
compiled anonymously by the independent outside consultant who prepares a draft
consensus evaluation for final review and approval by the Committee. This final
evaluation is also reviewed in an Executive Session of the Board of Directors
and shared with Mr. Cutler prior to a formal performance evaluation discussion
with the Chairman of the Committee.
In the process of constructing the 2004 annual total compensation plan for the
Chairman and Chief Executive Officer, the Committee began with a careful
evaluation of the median compensation values for each compensation element as
reported for comparably-sized industrial companies in the survey databases of
the three national compensation consulting firms used by the Committee for its
annual market analysis. The reported survey data captured the actual annual cash
compensation (base salary and bonus award) and the value of the most recent
long-term incentive grants provided to the chief executive officers reported by
participating survey companies in mid-year 2003.
While the Committee uses median survey data as the initial basis for considering
and establishing the base salary and short and long-term incentive targets for
the Chief Executive Officer and other executives, final awards actually earned
under the Company's incentive plans reflect both the Company's financial
performance against pre-established goals and the Committee's assessment of the
individual executive's performance and value-added contributions.
After being held constant for the prior three years, Mr. Cutler's base salary
was modestly adjusted in 2004 to reflect his consistent effective performance as
Chairman and Chief Executive Officer and to properly position his salary in
relation to current market practice. After this 2004 adjustment, Mr. Cutler's
base salary positioned him just above the median salary level as reported in the
lowest of the three national consulting survey databases used by the Committee.
Mr. Cutler's short-term incentive target opportunity approved by the Committee
for 2004 positioned him at approximately the median incentive level as reported
in the lowest of the three survey databases used by the Committee. Mr. Cutler's
2004 short-term incentive payout was based on the Company's financial
performance, as measured by CFR and EPS compared to the targets set by the
Committee for 2004. Consistent with the incentive 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 continued leadership in expanding and driving the use of the Eaton
Business System throughout the Company; exceeding 2004 profit plan and EPS
goals; exceeding the goals set for strengthening the balance sheet;
significantly outgrowing the end markets in the Company's major business
21
segments; continuing to implement effective cost reduction measures including
those related to the integration of recent acquisitions and expanding the
Company's initiatives in moving toward a lower capital intensity business model;
successfully closing four acquisitions and reaching agreement on one additional
acquisition; successfully closing one joint venture and executing letters of
intent on two other joint ventures that offer significant potential for growth
in Asia; 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; beginning
the rollout of the Company's next phase of its high performance workplace
initiative; generating consistent improvement across the organization in the
response rate for its annual global employee engagement survey process that has
firmly established Eaton as a "industry benchmark company" for such surveys; and
effectively driving and communicating the Company's vision and commitment to be
a sustained top quartile performer within its diversified industrial peer group.
Finally, the Committee took note of the Company's success in generating a total
shareholder return of just over 36% in 2004 which built upon a 41% all in return
to the shareholders in 2003.
In 2004, the Committee approved a target long-term incentive cash opportunity
for the 2004 -- 2007 award period under the Executive Strategic Incentive Plan
which, together with his Committee-approved 2004 stock option grant, positioned
the value of Mr. Cutler's total long-term incentive compensation elements just
above the median long-term incentive compensation value reported for the lowest
of the three survey databases. The 2004 stock option grant approved for Mr.
Cutler will vest in equal amounts over 5 years. Mr. Cutler's earned payouts from
the long-term incentive plan for the award period ending in 2004 were based upon
the Company's CFR and cumulative earnings per share performance as described
above, and upon Mr. Cutler's personal performance over that period.
Mr. Cutler's 2004 base salary, annual incentive compensation plan target
opportunity, long-term incentive cash performance plan target opportunity and
stock option grant compared appropriately with the median of base salaries,
short-term and long-term incentive grants made to chief executive officers as
reported in the survey databases of the three nationally recognized compensation
consulting firms used by the Committee. In addition to these median level
compensation adjustments and grants, the Committee also approved a restricted
stock grant for Mr. Cutler in 2004 in order to provide an additional level of
retention value in his total compensation package.
Tax Deduction -- Any non-deferred annual compensation of more than $1 million
for the Chief Executive Officer and each of the 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.
Respectfully submitted to the Company's shareholders by the Compensation and
Organization Committee of the Board of Directors,
Michael J. Critelli, Chair
Ernie Green
Ned C. Lautenbach
Gregory R. Page
Gary L. Tooker
22
COMPANY STOCK PERFORMANCE -- The following graph compares the cumulative total
shareholder return for the five years ending December 31, 2004 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 shares on December 31, 1999.
EATON S&P 500 S&P 1500 IND MACH
----- ------- -----------------
1999 100.00 100.00 100.00
2000 106.12 90.90 94.19
2001 123.96 80.10 101.75
2002 133.29 62.41 94.87
2003 188.33 80.30 129.88
2004 256.91 89.03 153.73
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.
PURSUANT TO STANDARD SINGLE LIFE ANNUITY OPTION FOR YEARS OF CREDITED SERVICE INDICATED
FINAL -----------------------------------------------------------------------------------------
COMPENSATION 15 YEARS 20 YEARS 25 YEARS 30 YEARS 35 YEARS 40 YEARS
========================================================================================================
500,000 109,372 145,829 182,286 218,743 255,200 291,658
600,000 131,872 175,829 219,786 263,743 307,700 351,658
700,000 154,372 205,829 257,286 308,743 360,200 411,658
800,000 176,872 235,829 294,786 353,743 412,700 471,658
900,000 199,372 265,829 332,286 398,743 465,200 531,658
1,000,000 221,872 295,829 369,786 443,743 517,700 591,658
1,100,000 244,372 325,829 407,286 488,743 570,200 651,658
1,200,000 266,872 355,829 444,786 533,743 622,700 711,658
1,300,000 289,372 385,829 482,286 578,743 675,200 771,658
1,400,000 311,872 415,829 519,786 623,743 727,700 831,658
1,500,000 334,372 445,829 557,286 668,743 780,200 891,658
1,600,000 356,872 475,829 594,786 713,743 832,700 951,658
1,700,000 379,372 505,829 632,286 758,743 885,200 1,011,658
1,800,000 401,872 535,829 669,786 803,743 937,700 1,071,658
1,900,000 424,372 565,829 707,286 848,743 990,200 1,131,658
2,000,000 446,872 595,829 744,786 893,743 1,042,700 1,191,658
2,100,000 469,372 625,829 782,286 938,743 1,095,200 1,251,658
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 ($41,712 for 2004 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 (consisting of salary plus 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, 2005, 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 as follows: A. M. Cutler, 29.4; C.
Arnold, 4.3; R. W. Carson, 6.0; and J. E. Sweetnam, 7.2.
Eaton Personal Pension Account Formula -- Under this benefit formula, a
participant's single
24
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
(consisting of salary plus 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 $215,361.
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, 2005, the number of years of service for Mr.
Fearon was 2.8 years.
OTHER RETIREMENT AND COMPENSATION ARRANGEMENTS -- 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 accrued prior to
January 1, 2005 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 plans which provide supplemental annual
retirement income to certain executives who do not have the opportunity to
accumulate significant credited service with Eaton, provided that they either
retire at age 55 or older and have at least ten years of service with Eaton or
retire at age 65 or older regardless of the years of service. The amount of the
annual supplement is generally equal to the amount by which a percentage
(described below) of the executive's average final annual compensation exceeds
his or her earned retirement income (which includes amounts receivable pursuant
to the retirement plans described above). The percentage of average final annual
compensation used for this purpose depends upon an executive's age and years of
service at retirement. The percentage ranges from 25% (for retirements at age 55
with less than 15 years of service) to 50% (for retirements at age 62 or older
with 15 years or more of service). Benefits under the plans generally are paid
in one of the forms available under the Company's qualified pension plans as
elected by the participant, except that the present value of the benefit will be
paid in a single installment upon a change of control of the Company. Currently,
it is expected that fifteen officers would receive a benefit under the plans,
including C. Arnold, R. W. Carson, R. H. Fearon and J. E. Sweetnam, who are
named in the Summary Compensation Table on page 15. The estimated annual
benefits payable under the plans are $190,665 to Mr. Arnold, $265,346 to Mr.
Carson, $443,927 to Mr. Fearon, and $202,854 to Mr. Sweetnam, based on the
assumptions that they retire at age 65 and that their base salary plus target
bonus increase at 4% per annum.
The Company has entered into agreements with its officers, including those named
in the Summary Compensation Table on page 15,
25
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 $2.2
million of marketable securities and 898,788 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. 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 2005. 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.
3. 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.
26
SHARE OWNERSHIP TABLES -- 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.
NUMBER OF
NAME AND ADDRESS OF COMMON PERCENT
BENEFICIAL OWNER SHARES OF CLASS
--------------------------------------------------
Lord, Abbett & Co. LLC 9,263,598(1) 6.10%
90 Hudson Street
Jersey City, NJ 07302
--------------------------------------------------
(1) Lord, Abbett & Co. LLC has filed with the Securities and Exchange Commission
a Schedule 13G dated February 14, 2005, which reports the beneficial
ownership of 9,263,598 common shares by it and certain affiliated entities
and individuals. As reported in the Schedule 13G, Lord, Abbett & Co. LLC and
such affiliated entities and individuals have sole voting power with respect
to 9,263,598 shares and have sole power to dispose or to direct the
disposition of 9,263,598 common shares.
27
The following table shows the beneficial ownership, reported to the Company as
of January 31, 2005, of Company common shares by each director, each executive
officer named in the Summary Compensation Table on page 15 and all directors and
executive officers as a group, and also sets forth the number of share units
held under various deferred compensation plans.
NAME OF NUMBER OF PERCENT TOTAL NUMBER OF
BENEFICIAL COMMON SHARES OF DEFERRED COMMON SHARES AND
OWNER OWNED(1, 2) CLASS(3) SHARE UNITS(4) DEFERRED SHARE UNITS
-------------------------------------------------------------------------------------------------
C. Arnold 181,994(5) 33,285 215,280
R. W. Carson 264,239(5) 56,399 320,638
M. J. Critelli 40,784 0 40,784
A. M. Cutler 1,369,761(5,
6) 282,210 1,651,971
R. H. Fearon 91,281 23,644 114,925
E. Green 48,378 5,482 53,860
N. C. Lautenbach 46,900 15,185 62,085
D. L. McCoy 33,834 9,974 43,808
J. R. Miller 44,760 0 44,760
G. R. Page 14,866 1,093 15,959
K. M. Patel 15,366 863 16,229
V. A. Pelson 37,436 10,235 47,671
J. E. Sweetnam 145,737(5) 10,481 156,219
G. L. Tooker 39,288(6) 6,216 45,504
All Directors and Executive
Officers as a Group 3,576,244 2.3% 675,309 4,251,553
-------------------------------------------------------------------------------------------------
(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, 2005 upon the exercise of outstanding stock options as
follows: C. Arnold, 127,760; R. W. Carson, 248,650; A. M. Cutler, 1,190,179;
R. H. Fearon, 72,600; J. E. Sweetnam, 119,510; and all directors and
executive officers as a group, 3,061,362 shares.
(3) Each of the individuals listed holds less than 1% of outstanding common
shares.
(4) For a description of these units, see pages 12 (under "Compensation of
Directors") and 19 (under "Long-Term Incentives").
(5) Includes shares held under the Eaton Savings Plan as of January 31, 2005.
(6) Includes shares held jointly or in other capacities, such as by trust.
28
Employee benefit plans of the Company and its subsidiaries on January 31, 2005
held 11,098,752 common shares for the benefit of participating employees, or
approximately 7.2% of common shares outstanding.
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 2004.
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 2006 annual meeting, proposals must relate to proper subjects and must be
received by the Corporate Secretary, Eaton Corporation, Eaton Center, Cleveland,
Ohio 44114-2584, by November 18, 2005.
By order of the Board of Directors
/s/ EARL R. FRANKLIN
Earl R. Franklin
Vice President and
Secretary
March 18, 2005
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 Chair of the Committee, and
annually submit to the Board candidates to be appointed members and Chair 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 and such other
criteria as the Committee may deem appropriate.
5. Recommend to the Board individuals to be nominated for election or
re-election to the Board, taking into account input from all Directors. For
re-election of Directors, the input shall include a self-evaluation by each
such Director and input from the Chair of each Board Committee on which the
Director serves.
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
29
to continuing education, the Committee will recommend seminars, provide
guidance and monitor the process.
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. Establish guidelines, procedures and minimum requirements to be used by the
Directors to evaluate the performance of the Board, the Audit Committee,
Compensation and Organization Committee, Finance Committee and Governance
Committee.
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
Chair 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 January 2005 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.
30
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 Chair
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 who are Chief Executive Officers
of publicly-held companies may serve on a maximum of three public company
Boards, including the Company's Board. Other Directors may serve on a maximum of
six public company Boards, including 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 Chair 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.
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
31
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 or her
assessment of each officer's performance and his or her 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 key executives
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 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
32
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 for additions or changes in 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 or her 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 Board and as members or Chairs of
Board Committees) and consistent with the Directors' independence from the
Company and its management.
33
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 2005 Non-Employee Director Fee Deferral Plan to defer
Director fees for payment following retirement from the Board, in the form of
shares, the cash equivalent, or a combination of shares and cash, as previously
elected by the Director.
D. Stock Options. When each outside Director is first elected to the Board, the
Director receives an initial grant of stock options, 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, an
employee of Eaton Corporation or any of its subsidiaries or affiliates. No
member of the Director's immediate family(1) is, or has been within the
previous three years, 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(1) has
received, during any twelve-month period within the previous three years,
more than $100,000 in direct compensation from Eaton Corporation or any of
its subsidiaries or affiliates (including, without limitation, any
consulting, advisory or other compensatory fees) except (a) fees which
Eaton Corporation pays to its Directors for their services as members of
the Board and members or Chairs of Board Committees and (b) fixed amounts
of deferred compensation for prior service, which are not contingent in any
way on continued service; provided that compensation paid to an immediate
family(1) member for service as an employee other than an executive officer
will not be considered in determining the Director's independence.
3. The Director is not a partner or an employee with a firm that is the
internal or external auditor for Eaton Corporation or any of its
subsidiaries or affiliates; nor is any member of the Director's immediate
family(1) a partner with such a firm or an employee who participates in the
firm's audit, assurance or tax compliance practice (excluding its tax
planning practice); nor has the Director or any member of the Director's
immediate family(1) within the previous three years been a
---------------
(1) "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.
34
partner or employee with such a firm who within that time has personally
worked on the audit of Eaton Corporation or any of its subsidiaries or
affiliates.
4. Neither the Director nor any member of his or her immediate family(1) is
employed, or has been employed within the previous three years, as an
executive officer of any company whose compensation committee at the same
time included an individual who currently serves as an executive officer of
Eaton Corporation or any of its subsidiaries or affiliates.
5. The Director is not an employee, nor is any member of his or her immediate
family(1) an executive officer, of another company as to 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 exceeded the greater of $1 million or 2% of the
other company's consolidated gross revenues, in any of the other company's
past three fiscal years.
6. The Board of Directors has affirmatively determined that the Director has
no material (2) 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 tax exempt organization, that has a relationship with Eaton
Corporation or any of its subsidiaries or affiliates. Eaton Corporation
will publicly disclose in its proxy statement any contributions it has made
to any tax exempt organization in which an independent Eaton Director
serves as an executive officer, if within the preceding three years such
contributions in any single fiscal year have exceeded the greater of $1
million or 2% of the tax exempt 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 (a)
fees which Eaton Corporation pays to its Directors for their services as
members of the Board and members or Chairs of Board Committees and (b)
fixed amounts of deferred compensation for prior service, which is not
contingent in any way on continued service.
2. The Committee member is not an affiliate of Eaton Corporation (i.e., not
controlling, controlled by, or under common control with, Eaton
Corporation), 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 Chair for guidance.
---------------
---------------
(1) "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.
(2) "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.
35
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.
36
The Audit Committee shall have the authority to retain and terminate special
legal, accounting or 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, as
determined by the Committee, to compensate the auditors and any advisors to the
Committee, in addition to funding the ordinary administrative expenses of 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. Non-audit engagements with the independent auditor
shall exclude in any event non-audit services prohibited by law.
3. Resolve any disagreements between the independent auditor and the Company's
management.
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. Meet to review and discuss with management and the independent auditor the
Company's annual audited financial statements prior to the filing of each
Form 10-K report. This review shall include a discussion of major issues
regarding accounting principles, financial statement presentations or the
adequacy of internal controls that could significantly affect the financial
statements. This review also shall include a discussion of the type of
37
information to be disclosed in the Company's annual earnings press release
and a discussion of the specific 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. The Committee shall then
recommend to the Board whether the financial statements should be included
in the annual report to shareholders and the annual report on Form 10-K.
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. Meet to review and discuss 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 quarterly earnings press
release and a discussion of the specific 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. Receive quarterly reports by the Director -- Global Ethics of any issues
relating to the Company's accounting, financial reporting, financial
integrity or similar matters.
18. Review and approve the Company's annual internal audit plan.
19. Annually review the Company's assessment of the effectiveness of the
Company's internal control structure and procedures, including the
attestation of the independent auditor concerning that assessment.
20. Review the report of the Director -- Audits on internal controls and
internal audit results.
21. Annually review and approve the compensation of the Company's
Director -- Audits.
38
22. Review and approve the appointment and any replacement of the Company's
Director -- Audits.
23. 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.
24. 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.
25. Discuss the types of information to be disclosed in earnings guidance to
analysts and others, and the type of presentation 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.
26. Meet several times per year with the Company's chief financial officer,
Director -- Audits, independent auditor and Director -- Global Ethics in
separate executive sessions.
27. Prepare the report required by the rules of the Securities and Exchange
Commission to be included in the Company's annual proxy statement.
28. Assure that performance evaluations of the Audit Committee are conducted
annually.
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.
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 position of Chairman and Chief Executive
Officer;
3. Conduct periodic reviews of the Company's processes, policies and practices
that support the recruitment and development of an appropriately diverse
pool of technical, professional, managerial and executive talent on a global
basis;
4. Recommend to the Board the individual who should assume the position of
Chairman and Chief Executive Officer if that position becomes vacant;
5. 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;
6. Establish performance objectives under the Company's short-term and
long-term incentive compensation plans and determine
39
the attainment of such performance objectives;
7. Annually determine the salary of each elected officer of the Company,
subject to discussion by the Board and endorsement by the independent
Directors;
8. Annually review the awards to be made to the elected officers under the
Executive Incentive Compensation Plan;
9. Annually review the awards to be made to the elected officers under the
Company's long-term incentive compensation plans;
10. Administer the Company's stock plans and periodically approve grants of
stock options and other equity-based awards to Company employees;
11. 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.
12. Review proposed organization or responsibility changes at the officer level;
13. 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;
14. 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;
15. 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;
16. 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;
17. Periodically report to the Board concerning the Committee's actions,
conclusions and recommendations; and
18. 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.
40
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 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.
41
APPENDIX G
CODE OF ETHICS
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.
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.
42
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).
43
------------------------------
VOTE BY TELEPHONE
------------------------------
[EATON LOGO] Have your proxy card available
c/o Corporate Election Services when you call the TOLL-FREE
P.O. Box 1150 NUMBER 1-800-542-1160 using a
Pittsburgh, PA 15230 touch-tone telephone and
------------------------------- follow the simple directions
that will be presented to you
to record your vote.
------------------------------
VOTE BY INTERNET
------------------------------
Have your proxy card available
when you access the website
http://www.votefast.com and
follow the simple directions
that will be presented to you
to record your vote.
------------------------------
VOTE BY MAIL
------------------------------
Please mark, sign and date
your proxy card and return it
in the POSTAGE-PAID ENVELOPE
provided or return it to:
Corporate Election Services,
P.O. Box 1150, Pittsburgh, PA
15230.
------------------------ ------------------------ ------------------------
VOTE BY TELEPHONE VOTE BY INTERNET VOTE BY MAIL
Call toll free using a Access the website and Return your proxy
touch-tone telephone: cast your vote: in the postage-paid
1-800-542-1160 http://www.votefast.com envelope provided
------------------------ ------------------------ ------------------------
VOTE 24 HOURS A DAY, 7 DAYS A WEEK!
YOUR TELEPHONE OR INTERNET VOTE MUST BE RECEIVED BY 11:59 P.M. EASTERN DAYLIGHT
TIME ON APRIL 26, 2005 IN ORDER TO BE COUNTED IN THE FINAL TABULATION.
===================================
-
===================================
- PLEASE FOLD AND DETACH CARD AT PERFORATION BEFORE MAILING. -
--------------------------------------------------------------------------------
[EATON LOGO]
THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS
FOR THE ANNUAL MEETING OF SHAREHOLDERS TO BE HELD ON APRIL 27, 2005.
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 indicated on the reverse side of this card,
all of the Eaton common shares held by the undersigned on February 28, 2005, at
the annual meeting of shareholders to be held at Eaton Center, 1111 Superior
Avenue, Cleveland, Ohio, on April 27, 2005, at 10:30 a.m. local time and at any
adjournments thereof.
----------------------------------------
Signature(s)
----------------------------------------
Signature(s)
Date: , 2005
-----------------------------
Please sign exactly as your name(s)
appear on this proxy. If shares are held
jointly, all joint owners should sign.
If signing as executor, administrator,
attorney, trustee or guardian, etc.,
please give your full title.
YOUR VOTE IS IMPORTANT!
IF YOU DO NOT VOTE BY TELEPHONE OR INTERNET, PLEASE SIGN AND
DATE THIS PROXY CARD AND RETURN IT PROMPTLY IN THE ENCLOSED
POSTAGE-PAID ENVELOPE TO CORPORATE ELECTION SERVICES, P.O.
BOX 1150, PITTSBURGH, PA 15230, SO THAT YOUR SHARES MAY BE
REPRESENTED AT EATON CORPORATION'S 2005 ANNUAL MEETING. IF
YOU VOTE BY TELEPHONE OR INTERNET, IT IS NOT NECESSARY TO
RETURN THIS PROXY CARD.
- PLEASE FOLD AND DETACH CARD AT PERFORATION BEFORE MAILING. -
--------------------------------------------------------------------------------
EATON CORPORATION PROXY
--------------------------------------------------------------------------------
THIS PROXY WHEN PROPERLY EXECUTED WILL BE VOTED AS DIRECTED. IF NO DIRECTION IS
INDICATED, THIS PROXY WILL BE VOTED FOR THE ELECTION OF THE FOLLOWING DIRECTOR
NOMINEES AND FOR PROPOSAL 2.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" THE LISTED NOMINEES.
1. Election of 4 Directors:
Nominees: (01) Ned C. Lautenbach (02) John R. Miller (03) Gregory R. Page (04) Victor A. Pelson
[ ] FOR all nominees listed above [ ] WITHHOLD authority to vote for
(except as marked to the contrary below) all nominees listed above
TO WITHHOLD AUTHORITY TO VOTE FOR ANY INDIVIDUAL NOMINEE, WRITE THAT NOMINEE'S NAME OR NUMBER ON THE LINE BELOW.
----------------------------------------------------------------------------------------------------------------
THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" PROPOSAL 2.
2. Ratification of the appointment of Ernst & Young LLP as independent auditors for 2005.
[ ] FOR [ ] AGAINST [ ] ABSTAIN
3. IN THEIR DISCRETION, THE PROXIES ARE AUTHORIZED TO VOTE UPON SUCH OTHER BUSINESS AS MAY PROPERLY COME BEFORE
THE MEETING.
PROXY TO BE SIGNED AND DATED ON THE REVERSE SIDE
------------------------------
VOTE BY TELEPHONE
[EATON LOGO] ------------------------------
c/o Corporate Election Services Have your voting instruction
P.O. Box 1150 form available when you call
Pittsburgh, PA 15230 the TOLL-FREE NUMBER
------------------------------- 1-800-542-1160 using a
touch-tone telephone and
follow the simple directions
that will be presented to you
to record your vote.
------------------------------
VOTE BY INTERNET
------------------------------
Have your voting instruction
form available when you access
the website
http://www.votefast.com and
follow the simple directions
that will be presented to you
to record your vote.
------------------------------
VOTE BY MAIL
------------------------------
Please mark, sign and date
your voting instruction form
and return it in the
POSTAGE-PAID ENVELOPE provided
or return it to: Corporate
Election Services, P.O. Box
1150, Pittsburgh, PA 15230.
----------------------- ----------------------- -----------------------------
VOTE BY TELEPHONE VOTE BY INTERNET VOTE BY MAIL
Call toll free using a Access the website and Return your voting instruction
touch-tone telephone: cast your vote: form in the postage-paid
1-800-542-1160 http://www.votefast.com envelope provided
----------------------- ----------------------- -----------------------------
VOTE 24 HOURS A DAY, 7 DAYS A WEEK!
YOUR TELEPHONE OR INTERNET VOTE MUST BE RECEIVED BY 11:59 P.M. EASTERN DAYLIGHT
TIME ON APRIL 24, 2005 IN ORDER TO BE COUNTED IN THE FINAL TABULATION.
===============================
-
===============================
- PLEASE FOLD AND DETACH CARD AT PERFORATION BEFORE MAILING. -
--------------------------------------------------------------------------------
[EATON LOGO]
THIS VOTING INSTRUCTION FORM IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS
FOR THE ANNUAL MEETING OF SHAREHOLDERS TO BE HELD ON APRIL 27, 2005.
The undersigned, as a participant in the (a) Eaton Savings Plan or (b) Eaton
Personal Investment Plan ((a) and (b) collectively called the "Plans"), hereby
directs the Trustee, Fidelity Management Trust Company, to vote all common
shares of Eaton Corporation credited to the account of the undersigned under the
Plans on February 28, 2005, in the manner indicated on the reverse side of this
form, at the annual meeting of shareholders to be held at Eaton Center, 1111
Superior Avenue, Cleveland, Ohio, on April 27, 2005, at 10:30 a.m. local time
and at any adjournments thereof. Under each of the Plans, if the Trustee does
not receive proper voting instructions by April 24, 2005 instructing 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.
----------------------------------
Signature
Date: , 2005
-----------------------
Please sign exactly as your name
appears to the left.
YOUR VOTE IS IMPORTANT!
IF YOU DO NOT VOTE BY TELEPHONE OR INTERNET, PLEASE SIGN AND
DATE THIS VOTING INSTRUCTION FORM AND RETURN IT BY APRIL 24,
2005 IN THE ENCLOSED POSTAGE-PAID ENVELOPE TO CORPORATE
ELECTION SERVICES, P.O. BOX 1150, PITTSBURGH, PA 15230, SO
THAT YOUR SHARES MAY BE REPRESENTED AT EATON CORPORATION'S
2005 ANNUAL MEETING. IF YOU VOTE BY TELEPHONE OR INTERNET,
IT IS NOT NECESSARY TO RETURN THIS VOTING INSTRUCTION FORM.
- PLEASE FOLD AND DETACH CARD AT PERFORATION BEFORE MAILING. -
--------------------------------------------------------------------------------
EATON CORPORATION VOTING INSTRUCTION FORM
--------------------------------------------------------------------------------
THIS VOTING INSTRUCTION FORM WHEN PROPERLY EXECUTED WILL CAUSE YOUR SHARES TO BE
VOTED AS DIRECTED. IF NO DIRECTION IS INDICATED ON YOUR EXECUTED FORM, YOUR
SHARES WILL BE VOTED FOR THE ELECTION OF THE FOLLOWING DIRECTOR NOMINEES AND FOR
PROPOSAL 2.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" THE LISTED NOMINEES.
1. Election of 4 Directors:
Nominees: (01) Ned C. Lautenbach (02) John R. Miller (03) Gregory R. Page (04) Victor A. Pelson
[ ] FOR all nominees listed above [ ] WITHHOLD authority to vote for
(except as marked to the contrary below) all nominees listed above
TO WITHHOLD AUTHORITY TO VOTE FOR ANY INDIVIDUAL NOMINEE, WRITE THAT NOMINEE'S NAME OR NUMBER
ON THE LINE BELOW.
---------------------------------------------------------------------------------------------
THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" PROPOSAL 2.
2. Ratification of the appointment of Ernst & Young LLP as independent auditors for 2005.
[ ] FOR [ ] AGAINST [ ] ABSTAIN
3. IN THEIR DISCRETION, THE PROXIES ARE AUTHORIZED TO VOTE UPON SUCH OTHER BUSINESS AS MAY PROPERLY COME
BEFORE THE MEETING.
FORM TO BE SIGNED AND DATED ON THE REVERSE SIDE
-------------------------------
VOTE BY TELEPHONE
[EATON LOGO] -------------------------------
c/o Corporate Election Services Have your voting instruction
P.O. Box 1150 form available when you call
Pittsburgh, PA 15230 the TOLL-FREE NUMBER
------------------------------ 1-800-542-1160 using a
touch-tone telephone and
follow the simple directions
that will be presented to you
to record your vote.
-------------------------------
VOTE BY INTERNET
-------------------------------
Have your voting instruction
form available when you access
the website
http://www.votefast.com and
follow the simple directions
that will be presented to you
to record your vote.
-------------------------------
VOTE BY MAIL
-------------------------------
Please mark, sign and date
your voting instruction form
and return it in the
POSTAGE-PAID ENVELOPE provided
or return it to: Corporate
Election Services, P.O. Box
1150, Pittsburgh, PA 15230.
----------------------- ----------------------- ------------------------------
VOTE BY TELEPHONE VOTE BY INTERNET VOTE BY MAIL
Call toll free using a Access the website and Return your voting instruction
touch-tone telephone: cast your vote: form in the postage-paid
1-800-542-1160 http://www.votefast.com envelope provided
----------------------- ----------------------- ------------------------------
VOTE 24 HOURS A DAY, 7 DAYS A WEEK!
YOUR TELEPHONE OR INTERNET VOTE MUST BE RECEIVED BY 11:59 P.M. EASTERN DAYLIGHT
TIME ON APRIL 24, 2005 IN ORDER TO BE COUNTED IN THE FINAL TABULATION.
=======================
-
=======================
- PLEASE FOLD AND DETACH CARD AT PERFORATION BEFORE MAILING. -
--------------------------------------------------------------------------------
[EATON LOGO]
THIS VOTING INSTRUCTION FORM IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS
FOR THE ANNUAL MEETING OF SHAREHOLDERS TO BE HELD ON APRIL 27, 2005.
The undersigned, as a participant in the Eaton Electrical de Puerto Rico, Inc.
Retirement Savings Plan, hereby directs the Trustee, KeyBank National
Association, to vote all common shares of Eaton Corporation credited to the
account of the undersigned under the Plan on February 28, 2005, in the manner
indicated on the reverse side of this form, at the annual meeting of
shareholders to be held at Eaton Center, 1111 Superior Avenue, Cleveland, Ohio,
on April 27, 2005, at 10:30 a.m. local time and at any adjournments thereof. If
the Trustee does not receive proper voting instructions by April 24, 2005
instructing 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.
----------------------------------
Signature
Date: , 2005
-----------------------
Please sign exactly as your name
appears to the left.
YOUR VOTE IS IMPORTANT!
IF YOU DO NOT VOTE BY TELEPHONE OR INTERNET, PLEASE SIGN AND
DATE THIS VOTING INSTRUCTION FORM AND RETURN IT BY APRIL 24,
2005 IN THE ENCLOSED POSTAGE-PAID ENVELOPE TO CORPORATE
ELECTION SERVICES, P.O. BOX 1150, PITTSBURGH, PA 15230, SO
THAT YOUR SHARES MAY BE REPRESENTED AT EATON CORPORATION'S
2005 ANNUAL MEETING. IF YOU VOTE BY TELEPHONE OR INTERNET,
IT IS NOT NECESSARY TO RETURN THIS VOTING INSTRUCTION FORM.
- PLEASE FOLD AND DETACH CARD AT PERFORATION BEFORE MAILING. -
--------------------------------------------------------------------------------
EATON CORPORATION VOTING INSTRUCTION FORM
--------------------------------------------------------------------------------
THIS VOTING INSTRUCTION FORM WHEN PROPERLY EXECUTED WILL CAUSE YOUR SHARES TO BE
VOTED AS DIRECTED. IF NO DIRECTION IS INDICATED ON YOUR EXECUTED FORM, YOUR
SHARES WILL BE VOTED FOR THE ELECTION OF THE FOLLOWING DIRECTOR NOMINEES AND FOR
PROPOSAL 2.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" THE LISTED NOMINEES.
1. Election of 4 Directors:
Nominees: (01) Ned C. Lautenbach (02) John R. Miller (03) Gregory R. Page (04) Victor A. Pelson
[ ] FOR all nominees listed above [ ] WITHHOLD authority to vote for
(except as marked to the contrary below) all nominees listed above
TO WITHHOLD AUTHORITY TO VOTE FOR ANY INDIVIDUAL NOMINEE, WRITE THAT NOMINEE'S NAME OR NUMBER ON THE
LINE BELOW.
----------------------------------------------------------------------------------------------------
THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" PROPOSAL 2.
2. Ratification of the appointment of Ernst & Young LLP as independent auditors for 2005.
[ ] FOR [ ] AGAINST [ ] ABSTAIN
3. IN THEIR DISCRETION, THE PROXIES ARE AUTHORIZED TO VOTE UPON SUCH OTHER BUSINESS AS MAY PROPERLY COME
BEFORE THE MEETING.
FORM TO BE SIGNED AND DATED ON THE REVERSE SIDE