SHAREHOLDERS AREN'T ALWAYS SMILING

Total compensation for CFOs–including salary, bonus, options and restricted shares–inched up 1% in 2005, according to an analysis by compensation consulting firm Equilar Inc. of the proxy statements of 215 S&P 500 companies filed between May 2005 and early April 2006. That compares to a 7.3% rise in total compensation for a similar-size group in 2004. Base salaries for the group rose 6.8%in 2005, while bonuses were up 1.6%. The value of option grants for the group was down 5.9%, based on Black-Scholes valuations, and restricted stock surged 15.9%. A separate survey of cash-based portions of finance department compensation (salaries plus annual bonuses only) found a rise of 15.5% for CFOs, while treasurers saw a 6.3% rise and controllers' pay surged 22%, according to Mercer Human Resources Consulting.

San Mateo, Calif.-based Equilar also provided Treasury & Risk Management with detailed analysis of CFO compensation for 50 companies. To see how well shareholders did relative to the finance chiefs, the analysis compares annual changes in total shareholder returns to changes in each executive's total compensation. Although there are other measures often used to gauge how well shareholders and their companies perform, it's worth noting when a CFO like Gary Crittenden from American Express Co. sees a 20.9% rise to $9.6 million in compensation during a year when shareholder returns fell 7.9%, and Doreen Toben, CFO at Verizon Communications Inc., was awarded $6.7 million, a rise of 12.8% from the previous year, while shareholders saw the company's stock price tumble 21.7%. In a year of continued turbulence for major airlines, UAL Corp.'s shareholder returns were down 26.9% as CFO Frederic Brace saw a 14.2% compensation gain, albeit to a comparatively low $816,949. Brace was one of only two CFOs on our list whose compensation was below $1 million; the other was Google Inc.'s George Reyes, whose $814,375 was the lowest on the list, despite a 3.9% bump up from 2004. Meanwhile, holders of Google stock during the year got a much better deal, with returns up 115.2%.

Companies are continuing to reduce option grants in favor of other forms of compensation as they become subject to the new expensing rules. "During the last year, I've really seen a lot more of it, and in the last six months even more," says Ellen Williams, a senior client partner at Korn/Ferry International. "A lot of companies are in transition with their compensation plans." But this change is not entirely attributable to the SEC's expensing requirements; the stock market played a role as well. "Companies whose stock prices are depressed are turning to restricted shares from options because the restricted shares have value," says Allen Geller, a managing director at executive recruitment firm Raines International. With many key finance executives sitting on underwater options, these companies are favoring restricted shares over options as a way to keep their best people from straying. "The issue is, 'how can we [encourage] them to stay while other organizations are doing well?'" says Geller.

For most companies, the road to a new approach to compensation is a long one, but changes are being seen in the most recent proxies that appear to anticipate the new compensation rules. "There's a group of companies that really want to be on the leading edge," says Todd of Towers Perrin. In its 2006 proxy, Pfizer Inc. completely overhauled the presentation of executive compensation, using a tally sheet approach to break out components of compensation for its top five officers (which did not include CFO Alan Levin). The company eliminated meeting fees on committee retainers for its directors and introduced a new executive long-term incentive program.

MOVING OUT IN FRONT EARLY

Pfizer is also ahead of the game when it comes to listing details of executive perquisites, including incremental costs for personal use of company aircraft, cars and drivers. The SEC disclosure proposals in their current form would reduce the dollar amount for disclosing perks and other personal benefits for each executive officer from $50,000 (or 10% of total salary and bonus) to $10,000. Although Pfizer was recently highlighted in the Corporate Library's Pay for Failure report for not doing enough to align executive pay with shareholder interests, the company appears to be more than willing to expand on its disclosures well before the rules are made final.

Whether the eventual SEC disclosure rules compel companies to tie executive pay to long-term performance goals that better reflect shareholder return remains to be seen. "Two areas that are always quite difficult for companies are making sure they have the right measures and being able to set appropriate goals," says Seymour Burchman, managing principal at Semler Brossy Consulting Group. While many firms continue to struggle to find the right balance, Burchman advises clients to focus on their long-term plans and those factors that drive the value of a company. For instance, as is often the case with technology start-ups, growing earnings is often more challenging than top-line growth, so for tech firms, aligning compensation targets to bottom-line results may be most beneficial. Compensation goal setting should also include market or investor expectations and consideration of the company's historical performance.

The timing of the compensation metrics selected could also be important. "A lot of public company CEOs, CFOs and management are rewarded by how the year ended up, and that doesn't drive consistent and reliable behavior," says Stephen Payne, president of Hackett-REL total working capital, a division of the Hackett Group. "They induce seasonality or volatility into a business organization," says Payne, who argues that companies should consider average performance metrics on a monthly basis. "It forces people to say, 'let's do the right thing every day.'"

PAYING FOR MEDIOCRITY

The Corporate Library's Hodgson believes that, on the whole, U.S. companies could be doing a much better job in aligning compensation with shareholder interests. "I would caution companies from using off-the-shelf incentive plans like everybody is using," says Hodgson. Some plans use the same metric to award annual bonuses as they do long-term incentives, giving double rewards for the same results. Many use metrics compared to peer group companies at a very low threshold, so executives are compensated for mediocre or below-average results. "That's a typical off-the-shelf plan and it's not setting challenging enough targets for compensation," says Hodgson. But there are a handful of innovative companies Hodgson points to that are moving in the right direction. At Whole Foods Market, cash payouts to executives, including bonuses, are subject to a "salary cap policy," set in 2005 at 14 times the average cash compensation of all full-time employees. Whole Foods also makes options grants available to all full- and part-time employees, and says about 93% of options granted under its current plan have been given to employees who are not executive officers. The alignment seems to fit for CFO Glenda Flanagan Chamberlain, whose $1.17 million total compensation rose 52.8%, just under the 57.7% rise in shareholder returns.

Another standout is Costco Wholesale, which used peer-company comparisons when determining executive compensation, and ended up setting their pay below that of many peer executives. Costco emphasizes long-term incentives over shorter-term cash and bonuses and its executive bonus program includes metrics such as sales, controllable expenses, pre-tax income and inventory shrinkage. Since the company didn't meet its pre-tax income goal for 2005, requested bonuses by President and CEO James Sinegal and Chairman Jeffrey Brotman were halved to $100,000.