The days of wine and roses — and gold-plated dental floss — may finally be over for high-profile finance chiefs.
According to the CFO.Com/Mercer CFO Compensation Survey, compensation growth for upper-echelon finance chiefs leveled off last year. In fact, total median compensation for CFOs in the survey dropped 1 percent in 2001.
The reason for the compensation stagnation? Mostly, top-drawer finance chiefs didn’t make tens of millions of dollars from gains on the options they exercised in 2001. With financial scandals being uncovered at a nearly weekly pace, some institutional investors have begun to openly question the wisdom of basing executive compensation on the short-term peformance of a company’s share price. And with an increasing number of corporations begining to expense options, some companies may chose to reduce the number of grants they offer relative to other forms of compensation.
Of course, back in the nineties, some investor groups flat-out demanded that the compensation of top finance managers be tied in large part to a company’s share price. After all, the activists argued, managers should be rowing in the same boat as shareholders.
The argument may still hold water. But with millions in executive compensation riding on a company’s share price, it appears that a few finance managers have simply gamed the system. To hit their earnings targets — and hence keep share prices moving up — senior executives at a few corporations have played fast-and-loose with their bookkeeping. Others have committed out-and-out fraud.
Accounting-gate won’t have corporate boards scrambling to set up lavish stock option plans for senior finance executives, that’s for sure. And as the CFO.com/Mercer survey reveals, options for top senior executives simply aren’t paying off the way they used to, either.
While options are still the biggest piece of the pay pie for many top-earning finance chiefs, the survey indicates that those equity grants started to lose their luster in 2001. In fact, the median gains on exercised options by top finance chiefs fell to $616,000 last year.
Admittedly, $616,000 isn’t exactly chicken scratch. Still, it’s a considerable drop-off from $964,000 — the average median gain for top CFOs who exercised options in 2000.
Even finance chiefs at the apex of our 2001 Top Ten list saw their option gains thin. Tyco International’s departing CFO Mark Swartz, for instance, realized option gains of $14 million last year. While that’s not quite a poke in the eye with a sharp stick, it’s not even close to the nearly $50 million Swartz raked in from exercised options the previous year.
Can’t Buy Me Love
Developed for CFO.com by Mercer Human Resource Consulting , the CFO Compensation Survey looks at the salary, bonuses, and long-term incentives of 234 finance chiefs working at 350 of the largest U.S. companies ($1 billion in revenues and up) that filed proxies between July 31, 2001 and April 5, 2002. The survey also looks at the pay of 355 CEOs.
To be sure, continued hefty option income helped keep the three highest CFO earners of 2000 — Tyco’s Swartz, Cisco Systems’ Larry Carter, and Sun Microsystems’ Michael Lehman — at the top of the list last year.
Swartz, Carter, and Lehman did play musical chairs in the rankings, which are based on realized total direct compensation (TDC). Realized TDC is the sum of salary, bonus, and long-term-incentives (including gains on options exercised, restricted stock values, and long-term incentive plan payouts).
After finishing number 1 in 2000 with a whopping TDC of $62 million ($49 million in option gains), Swartz slid to the runner-up slot this year with $32 million ($14 million in options).
Swartz’s compensation slide seems set to continue, too. Edward Breen, Tyco’s new chairman and CEO, said in an Aug.1 letter to employees that Swartz had decided to leave the company. Recently, several analysts had reportedly thought the highly-paid CFO might step down following Tyco’s recent poor performance, not to mention an internal investigation into the conglomerate’s bookkeeping. Swartz’s departure seemed imminent once the company named Breen to replace Swartz’s old boss, Dennis Kozlowski.
Sun’s CFO has fared better. Even though his total pay dropped 8 percent, from nearly $40 million ($39 million in option gains) to $37 million ($36 million in options) in 2001, Lehman was number 1 in our survey this year, up from third place in 2000.
Cisco’s Carter fell from second to third on the heels of a 40 percent drop in his total compensation. Interestingly, the Cisco finance chief made almost exactly the same amount from his options — about $29 million — in 2000 and 2001.
Meltdowns and Fizzles
Below the top three, the shift in CFO fortunes provides a neat snapshot of what’s happened to the economy over the last two years. As tech stock prices melted and the semiconductor industry fizzled, the finance chiefs of Hewlett-Packard, Apple Computer, Micron Technology, and Applied Materials (a semiconductor company) fell from the 2000 list of top earners.
Three of the four (H-P’s Robert Wayman, Apple’s Fred Anderson, and Applied Materials’ Joseph Bronson) failed to make a penny from their options in 2001. That’s a stark contrast from 2000. That year, Wayman took in $19 million in exercised options, Apple’s Anderson nabbed nearly $17 million, and Applied Materials’ Bronson made almost $10 million.
Mostly as a result of the drop in options gains — along with a lack of bonus money — each of those three high-profile CFOs saw his total compensation plummet by about 96 percent last year.
Micron Technology’s finance chief, Wilbur Stover, did a tad better. Stover’s option gains dropped from $14 million to $2 million. The plunge drove Stover’s total compensation down by 61 percent, from $16 million in 2000 to $2 million in 2001.
Predictably, newcomers to the list emerged from sectors which experienced a resurgence in share prices. You’ll recall that when tech stock prices flagged, some previously out-of-favor industries experienced a jump-up in share prices.
Thus, the 2001 list includes CFOs from an insurer (Cigna), a life-sciences instrument maker (Applera), a bank holding company (MBNA), and a pharmaceuticals operation (Pfizer).
In fact, Cigna’s James Stewart ($9 million), Applera’s Dennis Winger ($8 million), and Pfizer’s Dennis Shedlarz ($4 million) made out handsomely on their options in 2001.
The one anomaly: MBNA’s Scot Kaufman, whose 2001 TDC included $1.6 million in salary, a $3.6 million bonus, nearly $6 million in restricted stock — and no gains for exercised options.
Shake Your Money Maker
Indeed, our survey indicates an overall correlation between CFO compensation and corporate performance.
The median net income of the companies in the 2001 survey fell 15 percent, while the CFOs at those companies saw their median total annual compensation (salary plus bonus) stay about the same.
In 2000, median net income of the companies in the survey of best-paid CFOs rose 9.2 percent. Total annual compensation of top CFOs that year rose about the same percentage.
The pay-performance link gets even clearer when you look at the expected total direct compensation of CEOs.
In 2001, as CEOs saw their companies’ median bottom lines fall 17.8 percent, their own expected TDC rose a mere 6.9 percent, according to figures supplied by Mercer. (Unlike realized TDC, expected TDC includes the present value of options and incentives granted in the current year. In this case, Mercer consultants used a binomial pricing model to calculate the value of the options.)
It was the first time in the nine years that the firm has been doing its compensation studies that the median expected TDC of chief executives failed to hit double digits. Conversely, the expected total pay of chief executives leaped 13.7 percent in 2000 and 24 percent in 1999. That mimicked increases of 8.9 percent and 15.1 percent in median company net income.
Incents and Betterments
The slow-down in the pay of CEOs isn’t likely to console CFOs, however. The fact is, finance chief pay still badly lags chief executive compensation. For five years in a row, the total pay of finance chiefs has hovered around 40 percent of that of CEOs.
Finance chiefs and chief executives are on equal footing, however, when it comes to holding a whole lot of stock options in their long-term incentive portfolios. According to Mercer, option grant values made up 77 percent of the average expected long-term incentives for both CEOs and CFOs last year.
Executives are likely to be on the lookout for ways to hedge that market risk. Peter Chingos, the head of Mercer’s executive compensation consulting practice, predicts companies seeking to retain qualified CFOs and CEOs will offer fewer option grants this year.
Instead, Chingos thinks many companies will begin to dish out more restricted stock to top executives. In addition, the Mercer consultant believes, a number of corporations will start offering senior managers other incentives based on earnings per share (EPS) and cash flow — rather than share price.
Further, some compensation experts believe the use of “performance shares” or “performance units” will rise this year. Such plans award units of stock or cash to executives if the company meets or exceeds certain long-term goals. Typically, those goals go out over a three or five-year period.
A performance-share plan might, for instance, pay an executive up to 10,000 shares of company stock if that manager’s business grows 15 percent over a three-year period, according to Chingos. The executive would get 11,000 shares if the company grows 16 percent, but zero shares if it grows less than 10 percent.
Conversely, performance units generally pay out in both stock and cash. One example: Under IBM’s plan for CFO John Joyce (commenced in 2001), Big Blue will pay the finance chief half in cash and half in restricted stock for his performance units. The cash payment would be based on the average closing price of IBM shares for January 2004.
That payout will be made only if the company hits a specified combination of targets — 80 percent of them EPS goals and 20 percent of them involving cash flow. Joyce, the tenth highest earner on our 2001 Top Ten list, will get 10,000 performance stock units if IBM hits its objectives on the head.
If the company meets 70 percent of its goals, the finance chief will claim the minimum (2,500 units). He’ll get a maximum of 15,000 units if the company achieves 120 percent of its objectives.
Although 35 percent to 40 percent of the companies in Mercer’s study have had such programs in place for years, they weren’t making much use of them, says Chingos.
They’re making use of them now. “These performance plans would take the pressure off stock price,” the consultant argues. If a company meets its business goals — but not its share price target — Chingos says executives can still “get a piece of their compensation tied to their internal success.”
For CFOs who’ve seen their companies’ share prices dragged down by the recent accounting scandal contagion, that’s something to cheer about.