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The endgame in the decade-long debate over stock options is finally playing out. The Financial Accounting Standards Board has an expensing requirement ready to go, although it may delay implementation. The International Accounting Standards Board's standard on expensing goes into effect in January. And while efforts to derail expensing continue in Congress, resistance will most likely prove futile.
Yet even before the final standard is issued, the stock option controversy itself has dramatically affected compensation for CFOs and their finance departments. "Long-term incentive values have dropped in every study we've done," says Diane Doubleday, a principal at Mercer Human Resource Consulting, which conducted the latest edition of CFO's biennial compensation survey. Many companies are shifting from options to other forms of compensation, she says, but "restricted stock or performance shares aren't making up the difference. The total pie has shrunk."
Of course, that trend isn't confined to the finance department. Stock option grants are smaller throughout Corporate America, and have disappeared altogether for many rank-and-file employees. The good news for CFOs and their direct reports is that the Sarbanes-Oxley Act and shaky investor confidence have created a very competitive market for finance talent. "Large public companies are paying CFOs more," says Doubleday.
More Diversity
To be sure, options are not going away. But how companies will change the mix of long-term incentives — and for which executives — remains to be seen. After all, knowing exactly how options will be valued and accounted for will allow companies to better analyze the comparative cost of other forms of compensation. Doubleday argues that a shift is already under way, driven more by shareholder and market demands than by accounting proposals. "Whether FASB postpones this standard for a year or not," she says, "we are still in the middle of a trend away from options to a diversity of compensation vehicles."
That diversity is even evident among the rarefied ranks of the 20 highest-paid CFOs. While option exercises put Oracle's Jeff Henley atop the list, many of those options were granted early in his 13-year career. "I've held on to options fairly long," he explains. "That accounts for why I had a significant gain. It certainly had nothing to do with recent times."
Indeed, although options still constitute a significant chunk of the pay of the 20 best-paid CFOs, five executives made the list without exercising any options at all. One of the five, Bear Stearns CFO Samuel Molinaro Jr., came in third overall on the strength of a $12 million bonus ($5.3 million of which was cash).
Moreover, 9 of the top 20 received substantial restricted stock awards, including more than $5 million worth for John Hancock Financial Services's Thomas Moloney (eighth on the list). "We have seen a dramatic increase in the use of restricted stock over the last year," reports Mercer's Doubleday. Seymour Burchman, senior vice president at compensation advisory firm Sibson Consulting, agrees. "There is a shift from long-term incentive opportunities delivered through options to service-vested restricted stock," he says.
While most restricted stock awards doled out today vest based on length of service, says Doubleday, future awards are likely to be based on performance, as compensation committees pursue the perennial goal of tying compensation to performance. "We are still in a transition, and in an uncertain period on accounting treatment," Doubleday emphasizes.
Still Weighing Options
Nothing illustrates the difficulty of that transition better than the case of Oracle's Henley. Appointed chairman in January after 13 years as CFO, Henley ended his finance career as the highest-paid CFO in the United States, with $25.3 million in total compensation, despite receiving no bonus, restricted stock, or even a raise since 2001.
Although Henley's haul was almost entirely the result of a $24.5 million gain on option exercises, he has been among the most pragmatic of software company CFOs, arguing that stock-option expensing is inevitable. Although he has expressed concern about valuation techniques (like other Silicon Valley firms, Oracle does not expense options), he has generally eschewed his industry's vocal opposition.
In fact, he says, "I think some tech companies did too much of it [awarded too many options]. There was more dilution of their [shares] than probably was warranted." Henley believes this cumulative dilution, not the pending expensing requirement, is the strongest driver of what he sees as a trend among software firms to give out fewer options.
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