"I'm willing to lay it all on the line in terms of performance." Four years ago, that was what WorldCom's Scott Sullivan — at the time the highest-paid CFO in our compensation survey — told us when he chose a cash bonus over a base-pay increase. Two years later, our biennial survey showed that CFOs were enjoying the fruits of new, CEO-style compensation packages laden with stock options, but also that the booming stock market was rewarding leaders and laggards alike.
How times change. Both Sullivan, now under indictment for securities fraud, and the market have since gone seriously awry. Thanks to the havoc wreaked by both, corporate boards are once again pursuing the elusive goal of tying executive pay more closely to individual company performance. Much of the consequent reshuffling of CFO pay packages will likely involve rethinking the use of stock options, which have become a singular focus of reform efforts.
Much of the consequent reshuffling of CFO pay packages will likely involve rethinking the use of stock options, which have become a singular focus of reform efforts. But CFOs have already felt the pain of the bear market in their short-term pay, according to the 2002 compensation survey, conducted by Mercer Human Resource Consulting. Total CFO cash compensation (salary and paid bonuses) stayed flat this year, averaging $432,400. The lack of growth — a sharp contrast with the 9.6 percent increase the previous year — is testament to frozen salaries and lower or unpaid bonuses, even as other finance functions saw their pay go up. And as the stock market has gone south, "options have also shown significant erosion in value to executives," says Mercer analyst Lee McCullough.
To Have and to Hold
It isn't just the market that is eroding the value of options. The features that made them so wildly popular — grants don't affect earnings, and companies get a tax deduction when they're exercised — are under heavy fire. Many companies have already opted to expense them under FAS 123, and the Financial Accounting Standards Board (FASB) now may have the moral clout to win a rematch with Congress, which killed its 1995 effort to require expensing of options. And should expensing become mandatory, options will lose a key advantage over other forms of incentive-based compensation.
None of this suggests that options are going away. Indeed, the survey shows that a slightly higher percentage of CFOs were eligible for stock options this year than last. Options have the benefit of being exempt from Section 162(m) of the Internal Revenue Code, which limits the tax deductibility of cash compensation over $1 million. And serious issues still stand in the way of a universal expensing requirement. In October, FASB issued a draft of rules meant to clarify the process for companies making a transition to expensing from footnote disclosure. But that's an administrative fix that ignores, or at least lags, growing questions among businesses about the accounting problems inherent in expensing options. Without a provision for truing up the estimated "fair-value" expense of options with the actual expense when they are exercised, option expensing in a down economy could ultimately skew the bottom line in much the same way pension gains did during the boom.
Until the accounting and tax-treatment changes, options still carry hefty advantages over stock and cash, argues Jack Dolmat-Connell, vice president of Clark/Bardes Consulting, an executive compensation and benefits consulting firm based in North Barrington, Illinois. And although they are no longer perceived to have unlimited upside, options doled out in a bear market have room to grow. "People say options are dead, cash is king," he says. "That's bunk. Companies aren't in the position these days to give lots of cash."
But turning options into cash may get harder for CFOs. Already it is nominally more expensive. Until the Securities and Exchange Commission clarifies the rules for the Sarbanes-Oxley Act prohibition on corporate loans to executives, most companies have suspended cashless exercise programs, forcing executives to pay the strike price out of pocket or seek financing.
And reforms aimed at the perceived failure of options to act as long-term incentives could also hit CFOs in the wallet. A report on executive compensation released by The Conference Board's Commission on Public Trust and Private Enterprise suggested "substantial minimum holding periods for equity received as compensation." Similarly, a cross-industry study of 100 proxy statements by Clark/Bardes found strong correlations between "real" beneficial ownership — that is, actual shares held by executives — and five-year total shareholder return. "The inverse held as well: companies whose executives held the most options were the lowest performers," says Dolmat-Connell.
Clark/Bardes now recommends requiring executives to hold some multiple of their salary in actual stock. Since stock grants have to be expensed, and option grants — so far — don't, the end result is likely to be that finance chiefs exercising options will have to hold at least a portion of any stock bought with options.
The Risk/Reward Ratio
All types of executive pay — but particularly compensation for CEOs — were headline news this fall, from the excesses of Tyco International CEO L. Dennis Koslowski to the retirement perks of former General Electric CEO Jack Welch. Just days before The Conference Board released its findings in September, Federal Reserve Bank of New York CEO William J. McDonough blasted excessive pay, calling for corporations to voluntarily reduce executive compensation "to more reasonable and justifiable levels truly related to the benefit of shareholders and other stakeholders such as workers and the community."
Yet some compensation experts argue that if there's a silver lining under the tarnish that Sullivan and other now-infamous finance chiefs brought to the CFO role, it is that the new risks posed by the criminal provisions of the Sarbanes-Oxley Act may ultimately require commensurate rewards. Certainly, there is a perception that the bear market and sweeping regulatory changes are dealing a one-two punch to finance executives.
"CFOs have the toughest job today," GE CEO Jeffrey Immelt told CFO recently. And one former automotive-industry CFO, now a board member, recalls his first reaction to Sarbanes-Oxley was "that all CFO positions should [now] come with a government health warning." He adds, "There is a risk/reward ratio in a capitalist society. Overall compensation packages for CFOs and independent board members are going to have to be moved up."
That's a view shared by some compensation experts. "If auditor fees and [directors' and officers'] liability are going up, we are kidding ourselves if we don't think board pay, CEO pay, and CFO pay are going up," says Brent Longnecker, president of Spring, Texas-based Resources Consulting Group, which specializes in corporate-pay and board-governance issues.
But not everyone thinks CFO pay should rise. Dolmat-Connell likens the scrutiny of corporate finance to the focus on IT executives during the Y2K crisis, which did result in higher pay for chief information officers. "But doggone it," he declares, "we shouldn't be paying CFOs more for jobs they should be doing in the first place."
"If the parameters for that risk are defined, I don't need to be paid more," agrees Valmont Industries CFO Terry McClain. "Management already gets paid for the responsibility and liability they take on." He says any CFO should be willing to attest that financial statements are materially correct, and indeed would prefer that language to the current "to the best of my knowledge" phrase. Some critics have suggested the latter phrase provides CFOs with a lot of wiggle room, but McClain dislikes the fuzzy language for the opposite reason: it could be construed to hold CFOs liable for immaterial misdeeds committed at low levels in the organization. "I'm willing to sign a 'Go to jail free' card,'" he says, "but I have to know what the circumstances are under which I will pay a fine or go freely to jail."
While the jury is out on whether corporate reforms will boost CFO pay, this year's survey does show extraordinary hikes for other finance-related positions. Even as CFO pay remained stagnant, pay was up 6.2 percent for the top accounting position and 7.8 percent for the top tax job. Pay for top audit executives rose 7.5 percent, compared with 4.7 percent in 2001, while senior auditors' pay increased 7.0 percent, compared with 2.9 percent the year before.
Better Than CEO, Anyway
As those numbers suggest, finance is more important than ever — but it's tough at the top. The survey shows that controller and treasurer pay also stayed relatively flat. "Those core finance functions are closely aligned with the financial performance of the organization," notes Mercer's McCullough. "At least the numbers haven't gone down."
And at least CFOs generally have some portion of their compensation based on internal metrics. According to a survey conducted by the Todd Organization of 2,047 companies with revenues of more than $250 million, 23.3 percent did not pay their CFO a bonus, but 30.9 percent declined to reward their CEO, whose pay is typically tied almost exclusively to market performance.
Moreover, CEOs, who averaged $1.2 million in total cash compensation this year, are under much heavier scrutiny for excessive compensation than CFOs, whose average pay is about one-third (34.6 percent) of that amount. Four years ago, our survey showed CFO pay as a percent of CEO pay had slipped steadily, from 42.4 percent in 1993 to 34.5 percent in 1998. Since then, it has stabilized. Apart from a one-time low of 31.8 percent in 2000, CFOs have consistently taken home about 34 to 35 percent of their CEO's total cash compensation in the past four years.
Going forward, say experts, CFOs can expect diversification in their formerly option-heavy compensation packages. Our survey shows that the number of CFOs eligible for restricted stock fell from 21 percent last year to 12 percent this year. Yet experts say restricted stock, sometimes derided as "pay for attendance," may make a comeback as companies seek ways to diversify long-term incentives. "Long-term incentives will move from just options to options, performance unit plans, and restricted stock awards," predicts Longnecker.
Likewise, use of phantom stock — stock awards held by the company to save executives the tax hit — may grow if more companies adopt holding requirements for executives. "It's very expensive from a tax point of view to exercise [options] and hold," says Dave Johnson, who leads the executive compensation practice at Ernst & Young. "Companies want CFOs to have skin in the game, but will help them do it on a tax-deferred basis."
And CFOs should expect the initial structure — as much as the ultimate payout — of compensation packages to reflect both internal and external company performance. The recent penchant for trying to give executives the top pay in their industries must be tempered by a company's relative performance within its industry, say critics. "All company executives cannot be in the top quartile of pay scales," The Conference Board report noted dryly. Predicts Johnson, "Compensation committees will be much less influenced by [compensation] benchmark data than they were historically. They'll look at peer group data, but as a guidepost. They're not going to solve it as an algebraic equation."
These efforts to tie compensation more closely to company performance, says Johnson, are likely to be "smoothed in" over time. And much depends on the fate of stock options, the evolving Sarbanes-Oxley rules, and even on whether more scandals lurk in the wings. Shortly before this article went to press, allegations arose that former Tyco CFO Mark Swartz, one of the top 10 earners in 2001, helped himself to unauthorized cash bonuses — the very form of compensation championed by many critics of stock options. Ultimately, only one thing is certain. "Going forward," says McCullough, "what is going to result in the biggest increase in compensation is if companies start performing again."
Tim Reason is a staff writer at CFO.
Plaudit for Audit
"Of all financial jobs in the company, internal audit has grown in stature, and expense, the most in the past year," says Gordon Grand, who leads the financial officers practice at executive-recruiting firm Russell Reynolds Associates. And the higher the reporting relationship, the higher the pay, adds Howard J. Johnson, senior vice president and director of auditing at JC Penney Co. Although most internal auditors still report to the CFO or controller, says Johnson, "the move is on to have more chief audit executives report either to the CEO or directly to the audit committee."
Johnson, who reports to JC Penney's general counsel, saw his own position elevated from vice president to senior vice president shortly after turnaround specialist Allen Questrom took over as CEO in 2000. His compensation got a nice bump, too: it's now roughly equivalent to that of a controller or treasurer, says Johnson, and includes a mix of base pay, bonus, and stock options. Ironically, the bonus is based in part on keeping audit-staff turnover below 15 percent — a potential challenge given their newfound status.
Johnson isn't worried, though. "We have far more ex-internal auditors running parts of JC Penney than we have in the audit department today," he admits, but poaching from outside the company is low. "Of the upper third of my staff, a lot make as much as chief auditors at other companies do," he says. In contrast to companies where just about every internal audit position is a 2-to-3-year stepping-stone assignment to controller or another finance position, Johnson's own staff averages 13 years of experience.
Longevity costs more, notes Johnson, but also results in higher-quality audits: "If you are in an internal audit shop and know that in three years you'll be someplace else in the company, how objective and independent are you going to be?" Many companies are now looking to "upgrade" their audit employees, suggests Johnson, explaining that some "are seeing that they don't have the caliber of staff necessary to do all the new things in terms of corporate governance and financial reporting." —T.R.
There's a wide range in every component of CFO pay.
Source: Mercer Human Resource Consulting
|Total Cash Compensation|
|Total Direct Compensation|
Where CFOs work — and what they make there. (Note: For items marked with an asterisk (*), we have insufficient data.)
Source: Mercer Human Resource Consulting
Total Cash Compensation
|Banking/ Financial Services|
|Computer/ Software Services|
|Hospitality/ Media/ Entertainment|
|Real Estate/ Construction|
The Bread Winners
The 14 top-paid CFOs of 2001.
Source: Mercer Human Resource Consulting
a. Incl. $573,442 in long-term incentive-plan payouts.
b. Incl. $15,199,440 in restricted stock grants.
c. Incl. $2,841,500 in restricted stock grants and $1,867,000 in long-term incentive-plan payouts.
d. Incl. $4,015,688 in restricted stock grants.
e. Incl. $5,540,625 in restricted stock grants.
f. Incl. $3,861,000 in long-term incentive plan payouts.
g. Incl. $740,480 in long-term incentive-plan payouts.
*Tyco has demanded arbitration against Swartz to recoup "misappropriated funds and other assets." Previous Tyco filings suggest these misappropriations took place in 1999 and 2000.
Total Annual Compen- sation
Gain on Option Exercise
Total Long-term Incentives
Direct Compen- sation
Change From 2000
|1. Michael E. Lehman,|
|2. Mark H. Swartz*,|
|3. Larry R. Carter,|
|4. Anthony S. Thornley,|
|5. James G. Stewart,|
|6. Dennis L. Winger,|
|7. M. Scot Kaufman,|
|8. David L. Shedlarz,|
|9. David A. Viniar,|
|10. John R. Joyce,|
|11. Wallace G. Haislip,|
|12. Theodore R. French,|
|13. Richard B. Kelson,|
|14. James H. Hance Jr.,|
Bank of America