In the next few months, the Securities and Exchange Commission will finalize new rules about what companies must reveal about executive pay. If the SEC hews to its January proposal, companies will have to add both more numbers and prose to their proxies starting in 2007. CFOs will have no secrets: their compensation, as well as that of their CEOs, will have to be disclosed regardless of its value relative to other executives’ pay.
The 370-page proposal calls for precise dollar values on executive perks, retirement benefits, and severance packages; a tally of total compensation for each executive that includes the grant-date value of stock options and pension gains; and a discussion and analysis section in lieu of the current compensation-committee report.
The new rules will force the disclosure of items that previously had to be calculated, such as pension benefits, severance, and change-in-control packages. For example, while most companies now disclose how many times annual salary an executive is due upon departure, in the past “you weren’t exactly sure what was being multiplied, in terms of salary and bonus,” says Tim Ranzetta, president and chief operating officer of San Mateo, Calif.-based compensation-research firm Equilar Inc. “You also [weren’t told] the value of the perks, like office space or secretarial help,” he adds.
One of the more controversial aspects of the proposal is the inclusion of grant-date values for stock options and restricted stock — which may never be realized — in total compensation. “You [could be] creating a lot of estimates that are very misleading,” says Steve Gomo, CFO of San Jose, Calif.-based Network Appliance Inc.
Whether shining such a bright light on compensation will prompt wholesale changes remains to be seen. “Enhanced disclosure rules are going to put more pressure on compensation committees to rationalize and justify their choices, but I don’t think they’re going to change the way people get paid,” says Andy Goldstein of Watson Wyatt Worldwide. Still, executive-retirement and change-in-control packages may be scaled back as their full weight is realized, he says. Perks such as company cars and dry-cleaning expenses are also likely to go, or be converted into cash because “they raise eyebrows, even if they’re not worth that much,” says Jill Kanin-Lovers, a compensation-committee member for Heidrick & Struggles Inc., Alpharma Inc., and Dot Foods Inc.
Investor advocates are already pushing for the rules to go further. The Council of Institutional Investors (CII), for example, wants companies to disclose the goals executives must achieve to receive performance-based awards. “Unless investors can see where compensation committees are setting those hurdles, it’s hard for us to assess the quality of those plans,” says CII deputy director Ted White. Others want companies to disclose the ratio of the CEO’s pay to that of the average worker’s. Currently the average is 475:1.
So far, companies don’t seem too concerned about the new disclosures. “I’m not worried about it at all,” says Network Appliance’s Gomo. Ditto for Heidrick & Struggles, which has not previously disclosed CFO Eileen Kamerick’s salary. Says Kanin-Lovers, “Our CFO is great, so I think we’ll be very proud to disclose what we’re paying her.” — Alix Nyberg Stuart
CFOs’ pay compared with CEOs’
|Median Total Direct Compensation*|
|* Executives in place for past 3
Source: Equilar Inc.
Catering to the Extremes
Talk about your lukewarm reception. Since their debut in January, the new Roth 401(k) plans have attracted as many critics as customers. Although it’s a bit early to tell, a survey by Hewitt Associates LLC indicates that only 34 percent of companies are either likely or somewhat likely to adopt the plans this year.
Roth 401(k)s work like regular 401(k)s in reverse. Money stashed in Roth 401(k)s is taxed at contribution rather than withdrawal. For young workers who earn low salaries now and anticipate retiring at a higher income, the strategy may make sense. It may also make sense for wealthy individuals who want to avoid a big tax bite at retirement.
Employers considering these plans face two problems: first, the plans require additional administration and employee education. Second, their future is uncertain — the Roth 401(k) is set to expire in 2010 unless extended by Congress.
Despite those obstacles, the plans make sense for certain employee populations. At the headquarters of Demco Inc., a Madison, Wis.-based provider of services to school and public libraries, nearly half the workers are in their 20s and 30s, says Don Rogers, vice president of finance, noting that they can save for at least 25 years. “For a fair number of people, we suspect it might be the better choice,” explains Rogers, who worked with retirement consultants Francis Investment Counsel to provide informational sessions to explain the plans. The efforts appear to be working: as of February, 70 of the 300 eligible employees had signed up.
At the other end of the earning spectrum, the Roth 401(k) has more than tax appeal. Unlike Roth IRAs, which cap contributions from employees earning over certain amounts, Roth 401(k)s have no adjusted gross income limitations. Consequently, doctors’ and lawyers’ groups, which tend to have well-compensated employees contributing the maximum to their retirement plans, can take advantage of the additional savings.
Mike Scott, pension consultant with Blue Prairie Group of Chicago, believes the plans will catch on more broadly once sponsors have time to digest the regulations. Moreover, he says, Congress will most likely extend the provision, given that participants pay taxes now rather than in retirement. — Karen M. Kroll
Fairness as an Option
Little brings accounting rule makers and finance executives to loggerheads as quickly as the question of fair-value accounting. The Financial Accounting Standards Board has long advocated that companies carry assets at “market value” to the greatest extent possible in order to provide investors with a clearer picture of their financial condition. Companies almost uniformly cringe at the prospect of having to divine what the market might pay for assets they never intend to sell.
But the opposing camps appear to have found some middle ground. In a proposal issued by FASB in January, the regulator gives companies the option of reporting certain financial assets and liabilities at fair value, and of including exposure-draft changes in earnings. The proposal essentially creates a way to circumvent cumbersome hedge-accounting rules associated with FAS 133, issued in 1998.
Given the choice involved, one longtime opponent of fair value — Philip D. Ameen, vice president and controller of General Electric Co. — is willing to offer limited support for FASB’s proposal. “It is hard to argue with an option…that seems to solve some of the problem of FAS 133. It isn’t a perfect [solution], but generally speaking, it is directionally an acceptable approach.”
Jack T. Ciesielski, publisher of the Analyst’s Accounting Observer newsletter, cautions that the proposal really is “an exploratory step for FASB to inch things along wherever possible toward fair value.” Any movement in that direction should cause CFOs to consider the long-term implications, says George J. Benston, a professor of finance at Emory University’s Goizueta Business School. “If I were a CFO, I’d be thinking, ‘Uh-oh, we’re moving down the slippery slope.'”
Where that slope will lead is still uncertain. Despite FASB’s stated desire to improve the information provided to investors, it’s an open question as to whether fair-value accounting will do that, says Benston. Enron, after all, carried all its derivative contracts at their estimated market value, he points out. Moreover, insists Ameen, fair value introduces an “unacceptable degree of uncertainty and instability to financial reporting.” — Rob Garver
At the end of last year, the national unemployment rate stood at 4.9 percent, down 0.05 percent from a year earlier. A modest improvement, certainly, but it was not enjoyed equally across the nation. In fact, according to the Bureau of Labor Statistics, unemployment increased in 17 states. Mississippi faced the largest increase, due mostly to the damage inflicted by Hurricane Katrina. In August 2005, the state’s unemployment rate sat at 7 percent. By the end of September, it had jumped to 9.8 percent. Louisiana experienced an even more drastic increase, with unemployment nearly doubling, from 6 percent in August to 11.4 percent in September, though it had dropped back to 6.4 percent by December.
Alabama and Florida had the greatest success driving unemployment down, despite their own hurricane woes. Alabama’s rate of 3.5 percent is considered an historic low for the state. Michael Randle, editor of Southern Business & Development magazine, says the strong performance of the automotive and defense sectors and the government’s ability to lure manufacturing deserve the credit. — Matt Lynch
Basel II, Eurobanks 0
Because of the constant movement of the tectonic plates, some scientists predict that the gulf between Europe and North America will be some 6,000 miles — twice its current distance — in about 250 million years. But a widening rift between the two continents is apparent in other areas now.
Take the recent decision by U.S. banking authorities to delay the implementation in the United States of the Basel II accord, set for 2008. While the move has been applauded by U.S. banking executives, who say more time is needed to study the accord’s impact, their counterparts in Europe are less than thrilled. Indeed, at a conference in Berlin, Commerzbank of Frankfurt chairman Klaus-Peter Müller groused that the decision to push the start date to 2009 “is not exactly what one would call good international cooperation.”
Müller, who also serves as president of the Association of German Banks, is not the only banker in Europe annoyed at the Americans. Others contend that delaying the agreement on capital-adequacy requirements is causing a great deal of confusion in their own implementation plans. What’s more, they claim the extra time might give U.S. financial institutions an unfair advantage over EU banks, which are sticking with the original date. For example, U.S. banks that do a lot of securitization will benefit from a reprieve in implementing Basel II, which has strict rules governing off-balance-sheet financing.
The delay also raises a host of questions about what will happen at U.S. financial institutions with businesses in Europe — and vice versa. Those questions need some fast answers given that many banks have already invested plenty of time and money in their Basel II implementations, asserts Cees Maas, vice chairman and CFO of Netherlands-based ING Group, who deems the delay “a setback in terms of creating a level playing field.”
The bigger worry, of course, is that the United States could tinker with the agreement itself. Any such changes, says Patricia Jackson, partner at Ernst & Young in London, could force banks to make wholesale changes to their information-technology systems. “Then we’re talking real hard money.” — Janet Kersnar
Do You Hear an Echo?
If imitation is the sincerest form of flattery, this month CFO should be very flattered indeed. UK-based consultant Jeremy Hope, co-founder of consulting firm The Beyond Budgeting Round Table, has published a new book that samples liberally from this magazine. CFO writers and research are cited no fewer than 47 times in the endnotes to Reinventing the CFO (Harvard Business School Press, 2006), Hope’s analysis of the evolving role of the chief financial officer.
Like any good consultant, Hope describes a multistep plan for CFOs who want to transform themselves. He exhorts finance executives to “liberate themselves from detail” and encourages the creation of a strong finance team and the streamlining of repetitive functions. He also suggests that the finance chief should develop a framework for good governance and become the company’s “regulator of risk.” Although these are sound suggestions, they may be old news for the many finance executives who have already taken such steps.
While we heartily agree with some of the author’s main themes — that the CFO has become a strategic partner to the CEO and that the challenges facing today’s finance chiefs involve both number crunching and the development of a broader corporate vision — we suspect our readers may have gotten that message already…in a certain magazine. — Kate O’Sullivan
Ever since the demise of Arthur Andersen, there has been speculation about what would happen if another Big Four firm went south. In January, the U.S. Chamber of Commerce published a report calling for policy makers, businesses, and auditors to make cautionary provisions to prevent such an event from ever happening again.
The Chamber is calling for a three-part action plan: increased competition among top-tier firms (currently the Big Four handle more than 80 percent of audits), better access to directors’ and officers’ insurance policies, and more tort reform. Action is needed in all three areas to protect auditors from being held fully accountable for the actions of a few of their employees or clients, says Thomas E. Peisch, a partner at law firm Conn, Kavanaugh, Rosenthal Peisch & Ford LLP, in Boston.
“The law holds corporations criminally culpable for the actions of their employees, and aggressive prosecutors are taking advantage of that,” explains Peisch. As a result, he adds, auditors run a higher risk of being held civilly accountable for corporations’ criminal actions. “Such was the case with Arthur Andersen,” he says. The report suggests others in the Big Four could take similar falls in an environment “where business losses by a client can result in lawsuits, and a single indictment — even without a conviction — can result in the destruction of thousands of jobs.”
The report — which marks the business community’s first defense of auditors since Enron imploded — is also meant to educate Congress, says David Chavern, a vice president of the U.S. Chamber of Commerce. “The risks to the auditing industry are not widely understood by legislators,” explains Chavern, who adds that a majority in Congress believes auditors will continue to exist regardless of the markets. “That’s not so,” he says. “We need to give more thought to the role of auditing in the economy.”
Peisch says the report is just the beginning of a long process that will require a “sea change in the law and the way federal prosecutors behave.” To Laura L. Cox, a partner at PricewaterhouseCoopers LLP, however, the report is “a welcome contribution to the broader discussion on the future of the auditing profession.” — Laura DeMars
The End of Confidentiality
When reorganizing in bankruptcy, companies used to be reasonably certain that the confidential financial information they gave credit committees would remain just that — confidential. But that was before the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 went into effect.
Now, because of what Simon Kimmelman, chair of the creditors rights and insolvency practice group of Sterns & Weinroth PC, terms a “sleeper provision,” the way in which information is shared between creditors’ committees and other creditors has been altered. Section 1102(b)(3), he says, has “far reaching” implications.
Specifically, the law directs credit committees to provide access to information to creditors not on the committee. But it doesn’t define such terms as access, information, or disclosure. While the provision appears innocuous, reorganizing firms may hesitate to share information, knowing that it could be viewed by a larger group. “It will backfire, in terms of the business’s ability to get a fresh start,” says Bill Lenhart, national director financial recovery services at BDO Seidman LLP.
Not surprisingly, those involved in current bankruptcy cases have sought guidance from the courts. In the bankruptcy case of Refco Inc., for example, the creditors’ committee, along with an ad hoc committee of senior subordinated noteholders, presented the judge with a motion to set boundaries around its obligation to provide information to other creditors. Judge Robert Drain granted it, stating that the committee can choose to disclose confidential information, but is not required to do so. Instead, he wrote, the committee can set up a Website that provides general information on the case, such as a calendar of upcoming events.
Other cases in the Southern District of New York, where Refco filed, may be able to adopt that protocol. Whether it will apply in all bankruptcies is uncertain. “One can only hope that a lot of provisions in the act will be modified,” says Kimmelman. — K.M.K.
The Great Rate Debate
General Motors notwithstanding, companies have been eager to issue or increase their dividends ever since the federal tax rate on them was lowered to 15 percent. Last year, some 1,949 companies increased their payment, according to Standard & Poor’s. But will the trend continue if Congress opts not to renew the current rate?
There’s no question where finance executives stand on the issue. A recent survey by Eaton Vance Corp. found that three out of four CFOs want the dividend tax rate to be extended past its December 31, 2008, expiration date. The same survey found that 43 percent of finance executives of dividend-paying companies believe if the Tax Act of 2003, which reduced the tax rate on dividends and capital gains from 35 percent to 15 percent, is not renewed, the economy will be severely affected.
“Dividends are a sign of good corporate governance and company strength,” says Duncan W. Richardson, chief equity investment officer at Eaton Vance. Any tinkering with the rate, say Robert Willens, a tax and accounting analyst at Lehman Brothers, would not only be a “real blow to the economy,” but would cause the current trend of companies offering higher and more-frequent dividends to “shrivel up.”
Since the tax rate was lowered, companies have taken full advantage. According to Standard & Poor’s, 63 percent of the S&P 500 increased or initiated dividend payments in 2005. Some of those increases, says Richardson, topped 100 percent. Citicorp, for instance, paid 20 cents per share in 2002 and now pays 49 cents per share. Eaton Vance paid 4 cents in 2002 and 10 cents in 2005. GM was one of only 11 companies to cut their dividend.
Democrats and Republicans have yet to find common ground on the matter. Part of the problem is that extending the rate even for a year will cost $10 billion. Yet Scott Hodge, president of the Tax Foundation, believes, “Congress will get around to extending the rate even if Republicans have to bribe Democrats to agree by making a few concessions. They know the markets will tumble if it’s not renewed.”
At press time, both the Senate and the House were reviewing dividend legislation. Meanwhile, companies were showing their own brand of optimism: some 54 companies had announced dividend increases by mid-February. — L.D.
75% think the President’s dividend rates should be renewed
44% think Congress will make the cuts permanent
43% believe a failure to extend cuts would negatively affect the economy
*Finance executives of dividend-paying companies
Source: Eaton Vance Corp.
Now Boarding, at a Price
Who among us, while waiting in an airport security line, has not wondered how much we’d pay to jump to the front? We might offer a day’s salary, but would we surrender our financial information?
It’s a question many business travelers will have to answer when the Transportation Security Administration rolls out its Registered Traveler program this summer. For an annual fee, travelers who have submitted to extensive personal-background checks and carry biometric identification cards can qualify for expedited treatment at security checkpoints. As part of the background checks, participants must also allow access to commercial databases, including credit histories and other personal information.
Kevin Mitchell, chairman of the Business Travel Coalition, believes the latter step is a program killer. He points out that commercial databases are “notoriously inaccurate” and vulnerable to abuse. Several cases of database misuse have emerged this year; in fact, Congress rebuked the TSA itself in 2005 for improperly retaining travelers’ personal information.
Frequent fliers say that a little extra scrutiny is a small price to pay for speedy check-in. “We just want to spend our time most effectively, so the trade-off is something we’d be willing to make,” says Doug Vicari, CFO of Highland Hospitality, a McLean, Va.-based real estate investment trust. “As the CFO of a public company, you go through a background check process,” he adds. This would be “similar to the checks I went through when we first issued securities.”
In the end, says David Bearman, CFO of Hughes Supply, a wholesale distributor of construction, repair, and maintenance equipment, “it is a personal issue” whether or not to participate. But, he adds, “most other countries have much more government intrusion into your personal information.”
The Registered Traveler program is slated to roll out in June. — R.G.