In October 2007, Steven Crane aimed to align himself with shareholders in a big way. The CFO of ModusLink Global Solutions bought 10,000 shares of company stock at $13.80 a share. If the decision made him a better CFO, as management gurus would assert, he is certainly the poorer for it now. As of early January, the stock was trading at about $3.50 a share. On paper, the 75 percent drop in value drained $103,000 from Crane's net worth — about a quarter of his salary. That bad news came just as ModusLink suspended executive bonuses.
Crane is far from alone. Among public companies, about 135 finance chiefs have invested more than $100,000 in company stock in single transactions since September 2007. As 2009 began, about 100 of them faced real losses on those purchases, according to CFO magazine's analysis of data supplied by InsiderScore. American Express CFO Daniel Henry has lost $686,000 of the $1.1 million he put into company stock in November 2007, soon after becoming CFO. David Wolf, CFO of Berry Petroleum, bought five times in 2008, with an average paper loss of 43 percent on his $581,579 investment as of early January.
Might this prompt a reevaluation of the wisdom of executive stock ownership? Not according to most corporate-governance experts. Shared risk — especially on the downside — dodges the moral hazard of executives plumping up short-term results at the expense of long-term success, says Ira Kay, global director of compensation at Watson Wyatt Worldwide. Equity stakes encourage managers to behave like shareholders and maintain a keen focus on optimal total returns. Paul Hodgson, a senior corporate-governance research analyst at The Corporate Library, agrees. "The whole point of owning stock," he says, "is so that executives are exposed to the same losses as shareholders."
Even those who have suffered losses appear to be unshaken. In their view, risk goes with the turf and will ultimately prove beneficial. "In Steve [Crane]'s case, and in my case as well, we saw volatility as an opportunity," says Michael Mardy, a member of ModusLink's compensation committee and the CFO of luggage maker Tumi Inc. (At press time, Mardy was facing a 50 percent loss on the $6,100 worth of ModusLink shares he bought last October.) "If we're in it for the long term, the money will grow," he says.
A few CFOs have chalked up gains despite the widespread plunge in the market. Joseph D'Amico has seen his $445,000 investment in Apollo Group stock grow 92 percent since last April. First Bancorp CFO Fernando Scherrer has posted a 55 percent gain on a $144,000 investment made in November 2007. But in the wake of the stock market's worst year since 1931, they are among a small cadre of exceptions. All told, in the roster of large inside CFO buyers, losers outnumber winners three-to-one.
For corporate boards charged with retaining key executives, depressed stock prices pose a serious hurdle. Designed as much to attract and hold talented managers as to reward them, long-term stock incentives could backfire if prices stay down for a prolonged period. New job offers that carry incentives pegged to recently updated stock values may look much more appealing than a long uphill climb to break-even. As a result, Mardy's comments notwithstanding, some boards may be tempted to tinker with stock-related compensation.
Not a good idea, warns Charles Noski, a former CFO at AT&T who sits on board-level compensation committees at Air Products & Chemicals and ADP (and also holds board posts at Microsoft and Morgan Stanley). "I don't see how a board can show mercy on executives when shareholders and employees, in their 401(k)s, are bearing that same pain," Noski says.
Many directors see their reputations as shareholder advocates on the line. Much as they empathize with managers, says Kay, "the balance has shifted to shareholders." So much so that even when managers meet internal performance targets and qualify for previously agreed-upon incentives, they may not get them. One survey found that slightly more than one third of directors planned to exercise some discretion in honoring executive-compensation agreements, due to concerns that suffering shareholders would feel, again, that managers were being rewarded for subpar performance. "If the stock price is down 30 to 40 percent, even if it's a market issue and you're hitting internal targets," says compensation consultant Jim Heim at Pearl Meyer & Partners, "there's a perception of misalignment between shareholders and executives" if executives reap rewards.
The alignment between executives and shareholders that stock ownership is meant to embody generally assumes that both parties are taking at least a moderately long-term view, but often executives have to unload stock at a moment's notice. More than 70 executives, including eight CFOs, sold shares under duress to satisfy margin requirements last fall, according to InsiderScore. As one particularly painful example, Bernard Freibaum, the former CFO at General Growth Properties, invested heavily in the company's stock through much of 2008, before the price plunged. He sold $87 million in stock this past fall, at least in part to meet margin calls, even as shares of General Growth suffered a very specific decline, dropping from $20 to $7.75 during September alone. By early January the stock was trading at $1.35 a share.
Many companies already ban executives from trading stock so freely, imposing restrictions that are more severe than those delineated by the Securities and Exchange Commission. More bans are likely, says George Paulin, CEO of executive-compensation firm Frederic W. Cook.
Taking Stock of Salaries
As Caterpillar Inc. executives learned in December, bad news about compensation does not end with the price of stock that executives may own. Hard times are putting salary levels in the crosshairs as well. After letting 800 employees go, the global construction-and-mining-equipment maker said that its executives "will earn as much as 50 percent less in 2009." Senior managers can look forward to paychecks that have been bulldozed by as much as 35 percent.
Pay cuts at other companies are likely. Half of the board members polled in fall 2008 by Pearl Meyer plan to decrease base executive salaries from a year earlier. Only 6 percent plan increases. Even income rooted in already established formulas may be up for reconsideration, warns Heim at Pearl Meyer. Meanwhile, Watson Wyatt found that reduced bonus pools loom for executives at nearly half of the companies it surveyed.
As in past recessions, a few prominent top executives have made news by agreeing to accept $1 salaries, a move that compensation consultant Graef Crystal dubs "a circus act." If their companies ultimately fare well, he says, these executives will reap handsome profits from lavish share grants. Other concessions by top executives are likely. "You're going to see a number of CEOs who voluntarily forgo bonuses this year, especially if there are layoffs," says Heim.
Ironically or logically, depending on your point of view, all this pressure on executive compensation may prompt executives to take a closer look at — you guessed it — company stock. Far from declining in 2008, executive stock purchases actually gained favor even as the market chalked up a disheartening series of declines. It could end up a smart move when the economy rebounds. "This is an opportunity for executives to be compensated well for getting their companies through this ridiculous mess we're in," says Tumi CFO Mardy.
Optimists — or bargain seekers — to the core, a record number of CFOs appear to share Mardy's bullish outlook. Even Steven Crane ponied up another $85,000 last year for ModusLink shares. The stock was "a good value" in July and September, says Crane, who adds that he expects to do well over time. In November alone, public-company CFOs logged 258 investments in company stock — a record pace, according to Ben Silverman at InsiderScore. "There's a fair amount of showing faith, with executives who strongly believe their stocks are undervalued trying to rally shareholders," Silverman says.
Surprisingly, most of the CFOs who made big buys do not appear to be buying to meet executive stock-holding guidelines. (About 90 percent of large companies have these in place, typically requiring CFOs to hold three times the value of their base salary in stock within three to five years of joining.) For one thing, not all CFOs who invested a large sum in company stock are at companies that have such guidelines. Also, many of the CFOs were relatively new to their companies and would have been within the grace period for meeting the quota.
In any case, although many executives will be out of compliance this year due to depressed stock prices, most boards are going to be "pretty understanding" and likely suspend any enforcement action, says Frederic W. Cook's Paulin, since the guidelines "are not intended to send people into the market to buy at a time like this" when bonuses are low.
A look at the 25 CFOs who have suffered the worst declines on investments of $100,000 or more since September 2007 (see the list here) reveals some interesting trends. Notably, all 25 are still with their companies, most still serving as CFOs, some having been promoted. Roderick Sherwood, who joined media conglomerate Westwood One in September 2008, bought shares worth $500,000 soon after his arrival. He became Westwood's president in October. CFOs Kenneth Hall at NexCen Brands and Martin Ellis at Agilysys have also become CEOs of their companies. Kirk Walters served as interim CEO of Sovereign Bancorp for several months and now holds both the CFO and chief administrative officer titles there. Despite their paper losses, several have continued to buy, averaging their losses if not recouping them.
They may all share something else in common: little time to contemplate the pain. Whatever the damage to their stock portfolios, they all have plenty of bigger things to worry about. "People understand this is a pretty extraordinary time, and there are bigger issues than pay for executives to focus on right now," says Noski. Even with the expectation that executive paychecks will take a haircut, he adds, "I have not heard a lot of whining."
The real question may hinge on what we hear, or don't hear, when the dust settles. Did shareholders benefit by having executives suffer along with them, or did alignment once again prove to be elusive?
Alix Stuart is a senior writer at CFO.
To see a list of the 25 CFOs who have suffered the worst declines on investments of $100,000 or more since September 2007, click here.
Some Like It Hot
Investing in their companies has burned quite a few CFOs lately, but a handful look like winners.
Not every insider stock purchase since September 2007 has triggered a reversal of fortune. At 40 public companies, CFOs who invested more than $100,000 in single transactions have posted net gains, including 35 whose gains exceeded 10 percent in early January 2009. All might agree that they snapped up cheap shares, but so would most losers. What did the winners know that eluded their peers? Many bought later rather than sooner in the market downdraft. CFOs at five of six well-known companies (Trex CFO James Cline bought earlier), for instance, bought shares last November and December after the worst of the carnage. — A.S.
|Corning||James Flaws||11/10/08||$1 million||6%|
|W.R. Grace||Andrew LaForce||12/4/08||221,500||52|
|Starwood Hotels||Vasant Prabhu||11/20/08||118,756||82|
*Filing date generally lags purchase date. +Gain based on 1/6/09 closing
price, compared with value of shares at purchase
Sources: InsiderScore and the companies