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Skin in the Game

Why, on the whole, CFOs should buy more of their companies' stock.

When James Lawrence left General Mills to become CFO of Unilever last September, investors hoped he would help boost the Dutch consumer-products giant’s lagging stock price. What they probably didn’t expect was that he would use his own money to do so. In two transactions spanning four months, the 55-year-old executive quietly bought about $20 million worth of Unilever stock on the open market, giving the stock a 7 percent pop in the days following the announcement of the purchases.

“What a vote of confidence,” says RiskMetrics Group’s Patrick McGurn. “We don’t see that often enough.”

At this point, few of Lawrence’s peers are following suit. In 2007, CFOs bought a grand total of $108.4 million worth of stock in their own companies, a pittance compared with the $565.4 million that they sold, according to InsiderScore.com. That doesn’t even include sales following options exercises, which add another $1.8 billion to the sales total. “There was a really nominal amount of buying by CFOs,” says Ben Silverman, research director for InsiderScore.com. “Certainly CFOs face some restraints on when they can trade, but judging by the number of sells, they’re obviously not that constrained.”

Sharing the Downside

More companies are waking up to the reality that investors expect executives to take downside risk — that is, suffer along with shareholders when the stock drops. In many companies, that translates into asking executives to hold more stock on the theory that they will work harder to preserve value in something they own compared with something they merely could own through stock options.

That theory is supported by a wealth of evidence that stock performance improves as executives increase shareholdings in the companies they run. According to an analysis of CFO shareholdings conducted by Watson Wyatt Worldwide for CFO magazine, companies whose CFOs held more shares generally showed higher stock returns and better operating performance. “Ownership makes people more prudent; they think harder about things like acquisitions, and how often to fly first-class,” says Ira Kay, global practice director of executive-compensation consulting at Watson Wyatt. He adds: “CFOs, more so than any other executive besides the CEO, should be encouraged to hold stock.”

For the group of 110 large companies that Watson Wyatt studied, for example, the high-performing half of the stocks returned an average of 52 percent to shareholders between 2003 and 2006, including stock-price gains and dividends, compared with the 39 percent the low-performing half returned. Among other differences in those groups was median CFO stock ownership: $13.9 million (excluding both vested and unvested stock options) for the top performers, only $2.8 million for the low performers.

Kay is convinced the correlation is not merely coincidental. “When you have downside risk, people behave differently,” he says. He has found similar evidence using a larger sample of companies and CEO data over a time frame of 10 years.

While big companies, including General Mills, have had policies on executive stock ownership in place for years, last year’s crop of CD&As (Compensation, Discussion, and Analysis Reports) shows that more are now implementing, or at least formalizing, policies about the minimum amounts of stock they expect executives to hold. According to consulting firm Frederic W. Cook & Co., 83 percent of 250 large companies had such guidelines in place as of last year, up from 57 percent in 2004.


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