From the May 2011 issue of Treasury & Risk magazine

CFO Pay Heads Up

With a surge in cash bonuses, pay packages return to pre-meltdown levels and then some.

Sometimes, the unexpected is a really good thing. That’s certainly true for CFO compensation. Thanks to a surprise increase that pushed the stock market back toward pre-crash levels, along with remarkably robust corporate results, executive pay seems to have fared very nicely in 2010—a far cry from 2009, when the total compensation trajectory wobbled as it rose only slightly. Depending on performance, the upward trend should continue, while compensation components should look a lot more like the packages seen before the market meltdown.

“If I could fly a banner, it would read ‘return to tradition,’” says Randy Ramirez, Northeast practice leader for the compensation and benefits practice at BDO, a Chicago-based tax and financial services consulting firm.

Certainly, the data show pay is up. Treasury & Risk commissioned a study of the 2010 compensation of 50 Fortune 500 CFOs from Equilar, a Redwood Shores, Calif.-based executive compensation research firm. According to the study, median total compensation rose 21.4% to $5.23 million. Individual components also posted handsome increases. For example, the median salary increased 4.8% to $756,227, while the value of equity compensation—including stock and option awards—went up 37.4% to $3.19 million.

The trend was decidedly industry agnostic. Total compensation for Northrop Grumman’s James Palmer rose 120% to $11.35 million, for example. Christopher Coughlin of Tyco International saw his pay rise 125% to $10.62 million and compensation for Cisco Systems’ Frank Calderoni also went up 125%, to $10.15 million.

And just two years after the market meltdown, pay at Wall Street firms also bounced back. That’s true most notably at Goldman Sachs, where CFO David Viniar took home  $13.95 million, vs. $837,365 in 2009, as the firm resumed equity awards after temporarily eliminating them.

One big driver of the increase was cash bonuses. “Cash is back,” says Carol Bowie, head of compensation policy development at Institutional Shareholder Services. Such incentives were low or non-existent over the past two years, as companies struggled to make their numbers and looked to conserve cash.

Based on tepid expectations for 2010, compensation committees set what seemed to be appropriately low bars for bonuses. But when corporate performance started to take off last year, hitting goals became much easier. According to Equilar, median total cash compensation, which includes discretionary and incentive payouts, rose 36.8% to $1.47 million.

“Businesses set conservative business plans, thinking it would be pretty tough going,” says Mike Halloran, worldwide partner at Mercer, a New York-based human resources consulting firm. “But this has been a good year for corporate earnings, and therefore we’re seeing better-than-average bonuses.”

Case in point: John Martin Jr. of Time Warner made $5.5 million in cash bonuses, up 68% from 2009, and his total compensation increased 62%, to $10.12 million.

Equity awards that gained value as the stock market rallied also drove total compensation higher. “Granted values were a lot lower a year before, so recent stock prices boosted them considerably,” says Aaron Boyd, research manager at Equilar.

Other research echoes these findings. For example, a study of CEO and CFO pay at 55 companies by Compensation Advisory Partners found annual incentives rose around 16% from 2009 to 2010, and the median value of long-term incentives rose 15% to 20%. Those incentives made up 65% of total pay, with a drop in stock option awards and an increase in performance shares.

In some cases, there may be another issue. “Some companies seem to be trying to make up for the pay that was missed the previous year due to failure to achieve performance goals,” says Bowie, noting that she’s seen many examples of executives earning the maximum bonus level under their incentive plan. In fact, Bowie cites a small number of cases where compensation committees have exercised “negative discretion” to lower goals when they seemed wildly out of whack.

Under Section 162(m) of the tax code, which caps the corporate deduction for executive pay at $1 million, boards can change performance goals if they’ve been set too low. For example, MeadWestvaco, a $6 billion packaging supplier in Richmond, Va., applied negative discretion when the company’s performance reached 200% of the goals, adjusting that to 175% of the target, according to Bowie.

That’s not to say all CFOs enjoyed increases. Timothy McLevish of Kraft Foods, for example, saw his compensation drop 23%, as his bonus declined from $2 million in 2009 to $665,000 in 2010, because the company’s North American unit failed to meet targets.

For now, the increased value of their long-term stock incentives seems to be making CFOs less eager to jump ship. The reason: Hiring companies are reluctant to make job candidates whole on their equity. “These incentives typically were based on stock prices that have gone up 50% to 100%, and a company might not want to write a check that big,” says Joshua Wimberley, senior client partner and head of the North American financial officers practice at Korn/Ferry International, an executive search firm in New York. “It’s hard to extract a sitting CFO right now.” According to Wimberley, CFO turnover at Fortune 100 companies was roughly 12% in 2010, compared to 16% in recent years.

Whether the upward trajectory for compensation continues in 2011 depends entirely on company, economic and stock market performance. “If the economy continues to shift and companies can show results, compensation committees will pay for performance,” says Melissa Burek, a partner at Compensation Advisory Partners.

Specifically, salary increases should continue, though at a more moderate pace than in 2010. “With greater stability, you’ll see pay go up,” says Equilar’s Boyd.

Steven Hall, managing director of Steven Hall & Partners, a New York-based compensation consulting firm, predicts pay raises could come in around 3%. “We’re seeing a retrenchment from the old days when senior executives used to get annual salary increases greater than the rank and file,” Hall says. “They’re going to be in line with the rank and file.” And salaries will continue to be the smallest piece of compensation—about 20% of total pay, compared to 30% from short-term bonuses and the rest long-term incentives, he says.

Overall compensation could increase anywhere from 10% to 20%, depending on company stock performance, with the vast majority of the gain coming from components other than base salary, says Steven Van Putten, managing director of Pearl Meyer & Partners, a New York-based compensation consulting firm.

At the same time, some companies worry about retaining their CFOs, especially when stock option grants set after the market began to recover start to vest. Ramirez says “a large number” of clients have started asking about  putting in place two- to three-year retention plans to keep valued executives who can help lead the business as growth picks up. “I can’t tell you how many plans we’re putting in place,” he says. “They want to lock these guys up now.” To that end, companies are mostly using restricted stock units that pay out in cash rather than common stock.

For comp committees, the process of setting targets should be somewhat easier than it has been. Comp experts say companies now feel they have a better handle on projections and can set more realistic goals. As targets become more accurate, it should mean fewer surprises in payouts. There won’t be a lot of, “You earned a lot more than we thought you would, because the company earned a lot more than we thought we would,” Hall says. 

The metrics now in use are more appropriate to a growth environment, though compensation experts seem to disagree about just what those measurements should be. Ramirez, for example, focuses on metrics such as revenue growth, operating income and free cash flow that CFOs can control better than measures like earnings per share.

Van Putten, however, sees a move away from using cash flow in incentive plans, with more emphasis on revenue growth. A company that had placed a 30% weight on cash flow, for example, might replace that with top-line increases, because it’s not just about growth, but profitable growth. “There’s still a balance between operating profit and dollar revenue,” he says, adding that many companies are still likely to use earnings per share as a metric.

Whatever the measure, the emphasis will continue to be on long-term performance-based equity and away from stock option awards and time-vested restricted stock. The biggest topic of discussion, in fact, is the right amount of long- vs. short-term compensation. “The key in everything now is pay for performance,” says Van Putten. A typical example: a plan in which an executive has to boost earnings per share by 10% a year for three years or forfeit any long-term compensation.

In fact, the other side of the coin is what Hall calls “no pay for no performance.” And that is likely to have an impact on such indirect compensation as change-of-control and other severance packages. Change-of-control packages might go from three times salary and bonus to perhaps two times, he says, or regular severance  from two times salary to 18 months’ worth. Tax gross-ups—payments that cover taxes on severance—have drawn fire from corporate governance groups and are a thing of the past. “New executives aren’t getting that benefit any more,” says Hall.

With the return to a more stable environment comes less reassessment of plan design, a big change from companies’ efforts to deal with a volatile market and slow growth by experimenting with shorter measurement periods and other changes. “I think we’re almost back to where we were before the crash,” Hall says.

Generally, compensation plans are more like the models of about three years ago, with a combination of goals based on company financial performance and individual objectives. That includes the usual suspects—base salary plus an annual bonus and long-term incentives measured over a period of three years. “We’re back to seeing simple programs,” Ramirez says.

He points to a client that had put in place a highly complex plan with a matrix including 144 potential payouts depending on a combination of revenue and net income. That’s been replaced with a simpler plan using operating income and free cash flow, along with minimum thresholds.

But while comp committees feel more secure about setting goals, the process is still tricky. For one thing, continued economic recovery is by no means a certainty. For another, boards are looking for more accuracy in their targets. As a result, companies are developing goals and performance metrics with more rigor than ever before. “There’s a lot more work in terms of trying to get the right numbers,” says Mercer’s Halloran. Boards are involved in an unprecedented amount of goal-setting scrutiny, says Hall, adding that he recently received three calls in one day from companies about pinpointing goals. Companies with better-than-expected performance where top executives earned bonuses well above 2010 targets are “saying, ‘We want a bull’s-eye this time,’” Hall says.

That means testing target ranges and performance hurdles other than stock price, as well as looking at what competitors are doing. Boards are asking for such details as five years of performance history instead of the usual three or scrutinizing assumptions about growth more carefully than before. 

The say-on-pay stipulations in Dodd-Frank are heightening the stakes. Dodd-Frank gave investors a non-binding vote on the pay packages of top executives, to be held at least once every three years. Every six years, shareholders get to vote on whether the pay vote should occur every one, two or three years. “Companies are really struggling with the challenge of how to pay their executives what they believe is warranted and have it be perceived by investors as justified by company performance,” says Bowie.

Of course, a negative say-on-pay vote is not only humiliating but also means going back to the drawing board. To boost their chances of getting a yes vote on pay, companies are also sprucing up their proxies with executive summaries touting their corporate governance practices. “It makes it easier for shareholders to see good things being done for them, so the company will get a positive say-on-pay vote,” says Hall, who is working with about six companies on such proxies.

Dodd-Frank affects compensation in other areas, particularly clawbacks. The law requires public companies to adopt policies to recover incentive-based compensation from current and former executives in the event of a restatement for any reason, going back three years. Failure to do so would result in delisting. But the law includes few specifics, leaving the Securities and Exchange Commission to flesh out the details.

While many more companies started to include such provisions before the passage of the bill, even those with clawbacks fear theirs won’t pass muster when the rules are defined, probably in time for the 2011 proxy season. As a result, some companies with clawbacks in place are waiting for details to come out before making any changes, and some without provisions are putting off establishing any.

Less pressing, at least to non-financial companies, than it was in the past is the relationship between risky behavior and compensation structures. Boards turned more attention to adding formal risk assessment processes after 2008, and many now have new systems in place. “It’s still front and center, but boards of directors have become more savvy about the whole process,” says Burek.

There’s also less uncertainty about the rules the SEC issued in 2009 requiring companies to disclose whether overall compensation programs could create incentives for excessive risk-taking, in cases where firms found evidence of any problems. After many companies received letters from the SEC asking why they hadn’t included such disclosures, most firms started to include them in proxies; generally, the disclosures attest to a lack of risk problems. “In the majority of cases, it’s fairly boilerplate,” says Bowie.

Ultimately, however, it’s all about performance. And that means there’s a good chance compensation will continue on an upward incline, at least for the foreseeable future.

To see compensation charts, click here.

To read about the compensation for European treasurers, see Double Your Pay in Switzerland.

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