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CFO compensation made headway last year, but the sailing may not be so smooth in 2011.
Russ Banham, CFO Magazine
October 1, 2011
While 2010 may have been the year of say-on-pay, bonus clawbacks, and other efforts to shine more light on — if not actually reduce — executive compensation, none of that seemed to put CFOs' mortgage payments in jeopardy. In fact, while it comes as little surprise that pay moved up in 2010 versus a dismal 2009, the extent of the rebound seems remarkable under the circumstances. According to research firm Equilar, the median total compensation for CFOs working for companies in the S&P 500 was a robust $3 million, up 26% from the $2.4 million that S&P 500 CFOs took home the year before.
A nearly identical increase was enjoyed by CFOs at midsize (S&P 400) and smaller (S&P 600) companies, up 25.7% (with median total pay of $1.6 million) and 20.2% ($924,848), respectively. In many cases, the drivers were stock awards and cash bonuses, the latter jumping 30% year-over-year for S&P 500 CFOs. Base salaries also made a modest comeback, inching up 3.7% year-over-year for large-cap company finance chiefs.
Despite various calls for reform, executive compensation is far less a cause célèbre today than it was in 2008, when the financial crisis sparked widespread anger over the compensation packages lavished on senior executives at bailed-out financial institutions. That ire has faded not only because the smoke has cleared and time has passed, but also because changes to compensation schemes have begun to take root.
For instance, stock options, a key factor in the big take-homes of previous years, are a somewhat smaller piece of the pie today, according to Aaron Boyd, Equilar's director of research. "We're continuing to see their decline in prevalence as an overall part of CFO pay, down from 74% in 2009 to 71% in 2010." Increasing in popularity, he says, are performance shares and restricted stock awards, which grew to 57% and 66%, respectively, over the same period.
Stock options represented 17% of total CFO compensation in 2010, down from 22% in 2009. CFO compensation reviews by three other research organizations (Kenexa Compensation, the Association for Financial Professionals, and Financial Executives Research Foundation) are generally in tune with Equilar's findings, even though these organizations use somewhat different methodologies to track different company universes. (Kenexa draws data from Russell 3000 companies; AFP gauges CFO pay at member companies in the $20 billion or less annual revenue range; and FERF studies pay at both public and private companies.)
Bonuses were a major reason why CFOs enjoyed notable increases in compensation virtually across the board. "We've definitely seen the return of discretionary cash bonuses, which are awarded based on specific, achievable goals and targets, versus the slap-on-the-back, 'Nice job, Bob' sort of bonus we used to see," says Deb Nielsen, director of data operations and executive compensation at Kenexa. "For CFOs in the Russell 3000, nondiscretionary bonuses are up 38%, while overall pay is up 17%."
AFP also cited an increased focus on performance targets as the main driver behind 2010's bigger bonuses. "We calculated the top drivers as hitting operating income or EBITDA targets, which accounted for 55% of bonuses, followed by the completion of specific projects, at 53%," says Karen L. Melia, AFP survey research specialist. (For a more detailed look, see "What Drives Your Bonus?" among the compensation charts.)
Bonuses may have increased, but there is no doubt that it was the rebounding of the stock market in 2010 that propelled much of the increase in CFO pay, particularly at larger companies. Given the events of recent weeks, that calls into question not only whether CFOs will suffer a reversal of fortune this year, but whether such a reversal is merited. Rewarding senior executives with stock-based compensation was supposed to be a way to create a "pay-
for-performance" system, but the recent volatility calls the wisdom of that assumption into question.
The Long and Short of It
In positing a cure for the current economic malaise, many economists are now advising companies to take a longer-term view and not hitch their stars to the next quarter's results. But what will that mean for compensation programs that are designed to reward consistent quarter-over-quarter improvements? According to George Paulin, chairman and CEO of compensation consultancy Frederic W. Cook & Co., "The solution is to have less compensation tied to short-term performance, and more tied to salary and long-term equity incentives with stock ownership and retention requirements."
Such a shift is now occurring at banks and financial-services firms as they dust off from the beatings of 2008, but other industries have not followed suit. Why? Paulin chalks it up to the "difficult trade-off of more-immediate cash and pay liquidity versus betting [compensation] on the future." Another wrinkle, Paulin adds, is that "one of the ideal ways to deliver long-term equity — stock options — is challenged by bad accounting treatment, valuation complexities, and opposition from proxy advisers who fail to understand the long-term pay-for-performance linkage."
Equilar's Boyd is sanguine that a solution will emerge. "Obviously, long-term success may sometimes require short-term pain, but companies can be thoughtful in their pay design to address these exact issues," he says. "One method is to identify specific short-term goals that fit in with the long-term strategy of the firm. Another is to combine the differing time periods — short-term and long-term — by adding holding periods or deferring payouts to short-term awards to align it with the longer-term results of the company."
As an example, Boyd notes that many major financial institutions have added a holding period to the stock awards being given out as part of the annual bonus. AFP's Melia offers a similar long-term pay solution. "Hypothetically, an organization could structure the bonus payout or salary increase incrementally over a 5-year or 10-year span," she says. "For example, if the stock market is at X level or above on December 31, 2011, the pay can be structured so an executive receives 5% of the value at that time, 5% the following year, and so on. Or you could provide 10% on December 31, 2011, and 5% annually thereafter, forcing the organization to focus on both right now and the future."
Obviously, the gap between hypothetical solutions and practices that companies will actually embrace is sizable. As Boyd says, "There is no golden formula for pay-for-performance. Companies must, on a case-by-case basis, have a pay plan in place that reflects their culture, values, and goals. On the bright side, they are making a more concerted effort to make sure pay plans are well designed and effectively match the pay of executives to the performance of the company."
A 2010 survey by Mercer supports this contention, noting that 65% of 260 corporate respondents said they had either introduced new financial performance measures in their annual incentive programs in 2010 or plan to introduce them in 2011. In addition, roughly half the respondents said they had either introduced new nonfinancial metrics in their annual incentive plans in 2010 or expect to do so in 2011.
Some of those actions may be motivated by the momentum behind "say-on-pay" shareholder initiatives, but to date those efforts have sent mixed messages. The cries for such measures grew loud enough over the past few years to be incorporated into the Dodd-Frank Act, but so far shareholders have voted overwhelmingly with management, not against it. According to Equilar, a mere 1.5% of shareholder votes on company pay packages resulted in a thumbs down. That certainly seems to suggest, Boyd says, that "the majority of companies successfully linked pay to performance for their executives in 2010. It will be interesting to see if that changes in next year's votes."
Kenexa reviewed proxy statements through August 2011, and found a roughly similar percentage of "no" votes for the Russell 3000. But a win may not be a win if the percentage of shareholders approving current pay practices doesn't amount to a substantial majority. Kenexa noted that 35 companies, including Amgen, Headwaters, and Photronics, received between 50% and 60% shareholder support for their compensation packages. "It is generally agreed that if you get below 80% approval, you should seriously consider what you need to change for next year," says Nielsen, who criticizes the lack of detail in the current say-on-pay process. "It's just a 'yes' or 'no' deal; there are no votes on individual components within the compensation package, which would give companies some guidance on what to change," she says.
Nevertheless, Nielsen maintains that say-on-pay votes, although nonbinding, still pack a punch in terms of a company's reputation, which can devolve into a "big PR mud pit" if a company gets less than 80% support and does nothing about it. "If people are getting big payouts, bonuses, golden parachutes, and tax gross-ups, and the company isn't doing so hot, there could be hell to pay."
Financial-services firms have continued to feel the heat, as have energy companies and individual companies in some other sectors, but often the outcry over executive compensation comes from workers and retirees; if shareholders are displeased, they have yet to channel that unhappiness into a clear response.
As for the clawbacks of bonuses that subsequently appeared to be undeserved, while Dodd-Frank does call for companies to take back three years' worth of paid compensation from executives in the event of a restatement, many companies had already put in clawback provisions prior to Dodd-Frank. "We're seeing some movement as far as companies amending their policies, but not nearly as strict or as broad reaching as Dodd-Frank" intends, says Boyd.
Gregg Passin, U.S. executive-compensation leader at consultancy Mercer, says that many companies that have not yet put clawbacks in place are waiting for regulatory guidance from the Securities and Exchange Commission. "They don't want to do this twice," he says; he expects the SEC to spell things out by the end of the year.
Stock options remain popular as a recruitment and retention element in CFO pay packages, but they have lost a bit of steam. Why? "Heavy reliance on options is criticized for pushing senior executives to adopt overly risky strategies," says Nielsen. "For midlevel executives, options are often aligned with factors that they have no control over. Stock options also dilute the value of shares for shareholders."
But if stock options are on the decline, it's a mighty slow decline. FERF's data indicates that stock options as a component of stock-based compensation fell from 30.3% in 2009 to 29% in 2010.
Perhaps more telling might be the increased popularity of newer types of compensation, such as performance shares, which give executives an opportunity to earn a certain number of shares based on predefined performance goals. The better the performance of the company, the more shares an executive can earn, typically up to a defined cap.
Restricted stock usage is also gaining favor, given its perceived alignment with company performance. "A stock-option grant with a strike price of $100 has no value when the stock trades at $80," Boyd explains. Restricted stock carries certain prohibitions regarding when it can be sold, but maintains its fair-market value. According to FERF's survey, restricted stock was awarded at 27% of companies in 2010, up from 10% the year before.
As for the modest rise in base pay last year, as Tom Thompson, a research associate at FERF, points out, that represents some progress. "The pay freezes we saw during the financial crisis started to ease in 2010, with 57% of respondents to our survey stating they had received a salary increase, versus 34% in 2009," he says.
Mercer's Passin cites the same trends, and says, "We're back in line with what we saw in prerecession years."
For now, at least.
Russ Banham is a contributing editor of CFO.
And the Winners Are…
If you're a good friend of Apple CFO Peter Oppenheimer, now may be the time to hit him up for a loan. Oppenheimer took top honors for CFO compensation in 2010, earning a tidy $29,796,666. But a finance chief's hold on this honor is almost always contingent on his or her company having a banner year.
In fact, "there aren't many repeats on the list from 2009 to 2010," says Deb Nielsen, director of data operations and executive compensation at Kenexa Compensation, which compiles the annual list (see "The Top-25 Highest-Paid CFOs" among the compensation charts). "Only 6 CFOs from last year's top 25 are on this year's list [Google, Comcast, General Electric, Activision Blizzard, Exxon Mobil, and Morgan Stanley]."
She attributes that to the staggered nature of equity awards. "If you look at Apple's three-year history, it had big grants in 2008, no grants in 2009, and another big grant in 2010, which explains why Oppenheimer had such a big year; the year before, he took home a mere $1.6 million," Nielsen says. "We see a lot of flip-flopping year over year." For instance, last year's list-topper, Viacom CFO Thomas Dooley, did not make the list this year.
CFOs in certain industries also fared better than others. "Finance executives at businesses that didn't make the list the last couple of years — financial services, banks, securities firms, for instance — reentered the list," Nielsen notes. "CFOs at JPMorgan Chase, Fidelity, and Goldman Sachs, have rejoined the list. Whether or not they stay on, given the [market] events of late summer, is another question."
There is some consistency in the Kenexa findings, however. For instance, Google CFO Patrick Pichette was number two on the 2009 list ($24.7 million), and is number three on the 2010 list ($22.9 million). Says Nielsen, "I don't think he's leaving the list any time soon." — R.B.
Who's Gaining Ground?
For the second year in a row, the Association for Financial Professionals reported that treasurers received higher pay raises than CFOs. AFP chalked it up to the expansion of the traditional treasurer's role. "Treasurers are charged with keeping their companies highly liquid through the generation of cash," says Kevin Roth, AFP managing director of research. "They are also taking a greater leadership role in financial risk management, as their companies are subject to greater volatility in commodity pricing and foreign exchange."
CFOs need not fret about the pay-raise disparity. Another survey, by compensation consultancy Frederick W. Cook & Co., indicates that more CFOs are now the second-highest-paid executive at their companies. "The percentage of CFOs reported as their organizations' second-highest-paid executive now stands at 25%, up from about 20% five years ago," says George Paulin, Cook chairman and CEO. "The increase is at the expense of the chief operating officer."
More and more, Paulin says, companies are creating multiple COO positions — one in the U.S. and one for Europe or Asia, for example, and paying each one less. In addition, he says, "CFOs are increasingly the succession candidate for the CEO." — R.B.