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."
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