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Skin in the Game

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

Consultants Set the Bar

CFOs who have recently helped their companies craft guidelines say they simply follow consultants’ advice and available benchmarks. At Landauer Inc., an $84 million maker of radiation-detection monitors, the compensation committee decided last fall to require executives to hold twice their base salary in company stock. “That seemed to be a reasonable requirement” based on advice from Hay Group, says CFO Jonathon Singer. The fairly low multiple is due in part to the fact that executives now receive restricted shares rather than stock options, which means fewer shares overall are available through compensation.

With a base salary of $236,716 last year, Singer is required to hold just under $475,000 worth of stock, the equivalent of 9,442 shares at the February 4 trading price. Thanks in part to a grant of 2,350 restricted shares when he joined in October 2006, which will count even though all haven’t vested yet, Singer will likely fulfill his requirement this year, after less than two years at the company. However, he will still have to earn it, he says. Seventy percent of annual equity grants are awarded based on performance. “You have to look at it in the overall context of the compensation philosophy,” says Singer. “The trade-off is how much compensation is performance-driven versus retention-driven, how much is for short-term performance versus long-term.”

The Trade-Off

The biggest argument against making executives hold more stock, of course, is that in principle they, like all investors, should diversify their portfolios. “Any investor will tell you it’s smart to diversify,” says Jeffrey Jones, CFO of $828 million Vail Resorts Inc. “Managers should be able to do that without feeling they are hurting the company’s future prospects.” Pitney Bowes says explicitly in its proxy that it doesn’t want executives overly invested in the company. “While [an executive] is not discouraged from increasing the absolute level of holdings of Pitney Bowes stock, the company does not want its stock to comprise a disproportionate percentage of the executive’s net worth,” it reads.

What are the perils of overinvested executives? One is that they might become more risk-averse and more afraid to spend money as they strive to preserve value, says Kay. Asking for too much stock ownership can also subvert the retention aspect of the shares. A policy that says executives must hold a high percentage of their vested shares until they leave the company “could create an incentive for executives to leave a company in order to cash out shares, which you don’t want to do,” says McGurn. In the extreme, high executive share ownership may create an incentive for fraud — or at least irrational behavior. Conseco, for one, went bankrupt even as its executives were borrowing on the margin to buy its stock, as CFO reported in April 2000 (see “A Good Deal Too Much“).

In fact, some executives see the new guidelines as a desirable way to set boundaries on investor expectations. Having a preset expected level should “allow executives to sell and diversify at times” without the “angst” and “stigma” that can be attached to such sales, says Jones at Vail Resorts, which just last year implemented salary-multiple guidelines ranging from one to five times salary to conform to what its compensation consultant, Hewitt, said were best practices. As of last October, Jones held 88,801 shares (including vested options), about three times his requirement based on share prices at press time.


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