If you believe traditional stock options align management's interests with those of shareholders, then CFOs increasingly are on the same page as their ultimate paymasters.
So finds the biennial CFO Compensation Survey, undertaken by the consulting firm of Towers Perrin.According to the survey of 630 companies (a significant majority of which have at least $500 million in sales), fully 53 percent — or $600,000 — of their CFOs'median total compensation in 1999 came in the form of long-term incentives, primarily stock options. The proportion of total pay represented by long-term compensation is up from 39 percent in 1995, according to Towers Perrin. All told, the survey shows that CFOs' median total pay last year was $1,124,400, almost double the $649,730 they received four years earlier. Of the total last year, roughly $344,900 was cash and $201,200 was bonus money.
As a result of this growing reliance on stock options, of course, the personal fortunes of finance executives are now increasingly tied to the vagaries of the equity marketplace. "Top management pay in the U.S. is, in effect, decided mainly by the stock market, not by the compensation committee or by the company's performance against internally set goals," observes Richard Ericson, a consultant in the Minneapolis office of Towers Perrin.
The reason is clear enough. With the bull market producing spectacular stock- price gains for high-tech companies, and with the boom in Internet start-ups boosting demand for managerial talent, options are increasingly seen as the easiest way to attract, motivate, and retain key employees. No less clear is the result, at least in personal terms, for the CFOs who made the list of the 25 highest-paid traditional-economy finance executives, among companies with at least $1 billion in revenues. The No. 1 earner on the list, James H. Hance Jr., of Bank of America Corp., for instance, received a whopping $26.8 million in options last year. The second most highly paid CFO, Lehman Brothers Holdings Inc.'s John Cecil, also did well by options, winning a grant worth $10.8 million. That's based on the value of those options at the time they were granted, using the Black-Scholes option pricing model.
Of course, linking pay to stock prices can eviscerate wealth as rapidly as it can produce it. Witness the carnage inflicted by the technology sector's recent nosedive. Yahoo Inc.'s soon-to-retire Gary Valenzuela, for example, was holding options worth more than $1.6 billion at the peak of Yahoo's stock on January 3. Their value had been cut in half by the time this issue went to press, even after he took 75,000 off the table. Warren Jenson of Amazon.com Inc. has also experienced a market-driven meltdown in net worth. His options' market value has fallen from $85 million at Amazon's peak last December 10 to around $43 million on May 1.
Even so, most recipients defend the use of options on the grounds that they instill a greater incentive to maximize shareholder value than does cash compensation. But critics contend that while options reward management and shareholders alike when stock prices rise, the risk is borne exclusively by the latter, because shareholders alone experience actual losses if the price of the underlying stock falls and the options expire worthless. And that risk, though not apparent in income statements, is growing apace, thus threatening to undermine the very value that options are supposed to help create.
That has left some CFOs scratching their heads. Just how far should a company go with option grants? "It's a question we've discussed here" without being able to answer definitively, admits Mike Van Handel, CFO of Manpower Inc., a $12 billion (in sales) supplier of staffing services, based in Milwaukee. "While our goal is to be competitive in the marketplace," Van Handel explains, "from an overall corporate standpoint, [option grants] really are a hidden cost."
In response, a few companies have altered their approach to long-term incentives. American Home Products, Boeing, John Deere, Hewlett-Packard, and Super Valu, for example, have linked the vesting of restricted stock grants — those of stock that cannot be sold for a specified period — to specific performance targets. But their use of restricted stock is much more limited than their stock option grants, and those remain only loosely linked to performance.
Among major publicly traded companies, in fact, only Broomfield, Colorado-based Level 3 Communications has actually tied option grants to performance — taking the radical step of adopting indexed options, which link grants to the degree to which the company's stock price outperforms the S&P 500 index. Level 3 is likely to remain a minority of one when it comes to options, however, unless its program succeeds in motivating and retaining top talent. Otherwise, the vast majority of firms are likely to stick to traditional grants, if only out of fear that they cannot otherwise compete for talent. "There is a tidal wave of great ideas, but a limited number of people available to execute them," says Larry Best, CFO of Boston Scientific Corp., a $2.8 billion medical-device maker based in Natick, Massachusetts.
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