When it comes to compensating top CFOs, the game has changed — but the players have not.

Consider James Hance. In CFO magazine’s 1999 survey, based on information by Buck Consultants, the Bank of America finance chief and vice chairman topped our list of the 25 highest-paid old-economy CFOs. That year, Hance’s expected total direct compensation — defined as salary, bonus, restricted stock, and the value of options granted — was $52 million. Hance’s package included $27 million in option grants, as gauged by the Black-Scholes pricing model, along with $22 million in restricted stock.

Hance’s 1999 salary and bonus? A (relatively) puny $2.5 million.

In this year’s CFO.com special report on compensation, based on a survey conducted by Mercer Human Resources Consulting, Hance once again emerged as a top earner among finance chiefs at public corporations with $1 billion or more in revenues.

Times, however, have changed, and Hance’s pay package has clearly undergone a serious makeover. For example, the Black-Scholes value of the options granted to Hance in 2002 was just $2 million, according to Mercer’s calculation. And it’s not as if Bank of America’s performance was middling: The company’s net income grew from $6.8 billion to $9.2 billion in 2002.

In fact, BOA’s board compensation committee amply rewarded executives like Hance for the bank’s stellar 2002 performance. But in a marked shift from previous years, the board tipped the balance of executive pay toward restricted stock and away from stock options. Hance’s $11 million bonus — the biggest bonus in this year’s survey — consisted of $7 million in restricted shares, along with $4 million in cash.

BOA compensation committee members say they’re doling out more restricted stock grants because they want company executives to hold shares longer. Another reason, according to Hance, is the hue-and-cry over the expensing of stock options. Says Hance, “I think it’s a function of the times, when you think of some of the criticism companies have undergone [for their use of options].”

Proxy Music

The Bank of America finance chief wasn’t alone in seeing his pay package rejiggered last year. According to the survey, which was based on a sample of 250 CFOs at 350 large public companies that filed proxy statements between July 30, 2002, and April 4, 2003, the median bonus for finance chiefs rose by a hefty 17.5 percent in 2002. That’s the biggest such increase in four years.

Those mounting bonuses fueled a healthy boost in overall compensation for CFOs. While the median salary for the sample group increased 5.2 percent, their realized total direct compensation — salary, bonus, gains on options exercised, and other long-term incentive payouts — jumped a whopping 21.4 percent.

Granted, CFO bonuses may have surged because companies booked more profit last year. But the rise in short-term incentive pay could also mean that the interests of corporate executives and shareholders are finally synching up.

“Bonuses for CFOs need to be tied to company goals, not CFO goals, because you’re a senior officer of the company and you want [your] interests in alignment with shareholders,” argues Joseph Bronson, CFO of Applied Materials, a Santa Clara, California-based maker of semiconductor fabrication equipment. “You don’t get paid for effort, you get paid for results.”

Our survey seems to show that CFOs are starting to get paid for results — good or bad. In fact, bonuses and corporate performance seem to be marching almost in lockstep. Peter Oppermann, a senior compensation consultant with Mercer Human Resource Consulting, points out that the 17.5 percent rise in CFO bonuses in 2002 mirrored the 14.6 percent rise in median net income for the employers of the sample group.

Conversely, compensation committees at revenue-strapped industrial companies appear to be getting downright stingy with incentive pay. As a result of the long slump in the microchip industry, for instance, Applied Materials hasn’t paid bonuses for the last two years — and won’t be paying one this year. Explains Bronson, “We at least can’t be accused of paying bonuses [to executives] who don’t achieve results.”

Tainted Love

While Bronson did not receive a bonus, he did cash in about $2 million in stock options. In recent months, however, a number of companies have decided to stop awarding them to employees altogether. In the most prominent case, Microsoft CEO Steve Ballmer announced that the software maker will phase out its longstanding practice of granting options to workers. Reportedly, management at DaimlerChrysler might soon follow suit.

Whether this trend continues depends a lot on whether the Financial Accounting Standards Board votes to require public companies to expense options. Most observers believe FASB will go that route.

Either way, CFO compensation is likely to be less dependent on stock options in coming years — even if the stock market hits a good stretch. Recent financial scandals have tainted the granting of lavish stock options to senior managers, and powerful institutional investors are now demanding that companies devise different ways to provide incentives to managers.

Admittedly, a fair number of our survey CFOs found that revived share prices landed their options squarely in the money. Buttressed by a $10.1 million gain on the options he exercised, Apple Computer’s Fred Anderson returned to our list of top-paid CFOs in the number-two spot, after a one-year hiatus. Other big option winners last year included Navistar International’s Robert Lannert ($5.6 million from exercised options), AFLAC’s Kriss Cloninger ($5.5 million), and Merck’s Judy Lewent ($4.7 million).

But despite some respectable gains, the overall median value of stock options dished out to finance chiefs last year (calculated using a binomial model) dropped from 49.6 percent of expected total pay to 44.2 percent.

The drop-off in gains from exercised options is even more striking when you look at how some of the best-paid CFOs earned their keep.

Our number one, BOA’s Hance, did not cash any stock options in 2002, but he pocketed a $11 million bonus. Bear Stearns CFO Samuel Molinaro, who vaulted to number three on the list, did not cash any stock options, either; the lion’s share of Molinaro’s $8.2 million total direct compensation came from an $8 million bonus. Likewise, John Hancock Financial CFO Thomas Moloney, number four, did not make any money by exercising his stock-option grants. Instead, Moloney picked up $4.6 million in restricted stock, which pushed his total direct compensation to $7.7 million.

This stock-option shutout — for three of the four top-paid CFOs, mind you — is a real reversal of fortune from last year’s report. The leading earner in that survey, Sun Microsystems’ Michael Lehman, reeled in $36 million by exercising his options in 2001. Larry Carter, the recently retired CFO of Cisco Systems, cashed in to the tune of $29 million.

Notably, neither Lehman nor Carter earned a bonus in 2001, and both lacked big option paydays in 2002. Not surprisingly, both saw their TDC drop nearly 100 percent in this year’s survey.

Black-Scholes, Muddy Water

Options, of course, still have their supporters, especially among executives at startups and technology companies.

At such outfits, the end of option grants would hurt rank-and-file employees more than it would senior executives, says Stephen Giusto, CFO of Resources Connection, a professional services firm. If employers start issuing restricted stock rather than options to regular workers, adds Giusto, they would get fewer shares and enjoy less upside potential in their compensation.

But if FASB does require corporations to expense stock-option grants, CFOs at all publicly traded companies will be charged with calculating the worth of those options. And given the current CFO skepticism about the Black-Scholes pricing model, many finance chiefs may advise their boards to dump options rather than risk submitting inaccurate financial statements.

“The first thing we have to do for shareholders is produce predictable financial results,” asserts Bronson. “I have to be able to measure the expense, and if I can’t do that…I have to do something else.”

Finance chiefs themselves are also on the receiving end of grants — and like other employees who’ve seen the values of their once-promising options plunge underwater, they may have their doubts about Black-Scholes. Notes Oppermann: “People are saying, ‘I don’t think my options are worth the value you’re putting on them.’ “

Better Than CEOs

All of which may explain why many companies appear to be embracing more-tangible forms of payment. Our survey revealed that restricted stock, which holds at least some value even in a falling market, is making a comeback. Grants of restricted shares to CFOs grew by 8.1 percent in 2002 after falling 19.3 percent the year before.

And what about good old-fashioned raises? As a result of the sputtering economy, the tight labor market, and inflation, corporate strategists have sought to keep fixed costs low, says Oppermann. Unlike bonuses, which can vary from year to year according to corporate performance, executive salaries become a fixed cost once raises are awarded, he points out.

True enough, last year the median CFO salary rose a modest 5.2 percent, according to our survey. That’s a little south of the 6.9 percent increase in 2001, the 6.1 percent in 2000, and the 6.3 percent in 1999.

But to keep things in perspective, take a look at salaries for the CEO. Mercer’s Oppermann points out that last year, the median salary for chief executives barely moved the needle, rising just 2.2 percent. “CFOs are more in the spotlight” than CEOs, notes Oppermann, and they’re “becoming more and more important” as a result of Sarbanes-Oxley.

In reality, CFOs remain some of best-compensated executives in the world. As our survey underscored, finance chiefs have managed to keep their pay levels up even as options are disappearing. “Let’s face it,” says Giusto, “I’m not going to miss any meals this year.”

For the record, Giusto cashed no options last year; the Resources Connection CFO earned a salary of $270,000 and a bonus of $65,000.