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Executives' contracts are attracting a tremendous amount of scrutiny in today's regulatory environment.
Kate O'Sullivan, CFO Magazine
April 1, 2005
After mortgage lender Fannie Mae found itself embroiled in an accounting scandal last year, former CEO Franklin Raines walked out the door with a $1 millionplus annual pension payment. Retiring CFO Timothy Howard was right behind him with a tidy package of his own: $400,000 plus medical benefits every year for life.
The employment contract that made possible such a severance provision for Howard—a type of agreement that was once the provenance of only the best-known CEOs—has become standard fare for most finance executives.
Contracts like Howard's bring good news and bad news for CFOs, however. While the increased visibility of the top finance job and the accompanying rewards are gratifying, executives' contracts are attracting a tremendous amount of scrutiny in today's regulatory environment. All this attention is making some companies reconsider once-common provisions.
Lavish perks, for one, have largely fallen from favor as boards try to avoid headlines. "Boards are careful to not let benefits pile up," says Mary Ann Jorgenson, a partner at Squire, Sanders & Dempsey LLP, in Cleveland, specifically noting that fewer companies are making provisions to "gross up" executives' severance packages to shield them from tax consequences. Adds Mark D. Pomfret, a partner with law firm Kirkpatrick & Lockhart Nicholson Graham LLP, in Boston: "As a management-side attorney, I'm getting pressure from my clients to push back hard on things like club benefits; even relocation packages are being scaled back slightly." Basically, says David Farber, former CFO of Kirker Enterprises, "the days of fighting for a car just don't exist anymore."
Eliminate Gray Areas
Companies aren't the only ones treading cautiously. CFOs are also approaching employment contracts with care, looking to both protect themselves financially from future problems and avoid a public outcry about excessive pay. While a typical contract still generally comprises salary, bonus, and other long- and short-term incentives, as well as a termination clause and a provision for officers' insurance, CFOs are conducting exhaustive due diligence before committing anything to paper.
Jay Zager, the new CFO at Gerber Scientific Inc., a $517 million industrial manufacturer in South Windsor, Connecticut, dug deeper into the background of his future employer than he would have in the past, reviewing Securities and Exchange Commission filings and discussing the business with an industrial consultant and Gerber's outside auditor. He also wanted to make sure he understood how the company viewed the CFO, and had several meetings with the CEO to discuss his role. He spoke with the chairman of the board and the chairman of the audit committee as well.
When it came time to sign a contract, gray areas in how pay was calculated had to be eliminated, says Zager. "In the past, I often found that compensation and bonuses were much more subjective," says the CFO, who closely examined how the two main elements of his new bonus structure—earnings before interest and taxes and cash flow from operations—were weighed.
John Courtney, a former finance chief who is now the CEO of the nonprofit Academic Health Centers Clinical Research Forum, agrees that bonuses need to be clearly spelled out and closely linked to specific targets. "It used to be that effort would lead to performance incentives," he says. "Now it's much more tied to outcomes."
The outcome most finance executives want from their contracts is more cash in hand. Consequently, it's not surprising that while not everyone is giving up his or her stock options, "there is demand for more-predictable compensation," says Linda Doyle, a partner with McDermott Will & Emery in Chicago. That means more restricted stock grants, stock appreciation rights, and deferred-compensation elements rather than stock options alone.
These days, CFOs are much more interested in protecting what is owed them. Change-of-control provisions are foremost in the minds of finance executives who know they may not outlast a future merger or the arrival of a new boss. CFOs are also seeking careful descriptions of the grounds for dismissal or for reductions in pay, like a recall of a bonus in the event of a restatement due to wrongdoing. "You want to be explicit in terms of the cancelability of the contract both for cause and not for cause," says Courtney.
For another layer of protection, finance chiefs are requesting liability coverage should things go wrong, says Pomfret. "As recently as five years ago, the indemnification provision did not exist or was given very short shrift," he says. "Now, savvy CFOs are insisting that there be some representation that the company maintains directors' and officers' insurance, and that they're eligible for it."
What's not in the contract, though, may be as important as what is. For example, during their preemployment negotiations, some finance heads are requesting operational responsibilities and seats on important internal committees. And given the heavy regulatory demands on finance, many CFOs want to be sure they have a strong supporting staff. While it may not end up in writing, a CFO may request "three more people in internal audit, and then, when the board agrees, they know they can hire people," says Jorgenson.
Of course, at public companies, CFOs should be prepared for the details of their contracts to attract attention—as Tim Howard's did—should things go south. Yet another reason to proceed with caution.