THE BUCKS AREN'T STOPPING.

CFO pay rose markedly last year on the strength of bonuses and options.

When it comes to compensation, public companies want their chief financial officers and other senior executives to take stock. That doesn't mean asking for a self-assessment: They want CFOs to receive much of their compensation in the form of stock options and other stock-based pay that builds over time and through incentives.

This isn't a new phenomenon, but research shows just how prevalent options and other non-cash incentives have become. At 51 very large corporations, averaging $22 billion in revenues, more than half of total CFO pay is now in the form of stock, according to New York compensation consultants Pearl Meyer & Partners. Pearl Meyer released its annual survey of those multinationals' pay practices this spring after an analysis of proxy statements covering pay in 2000.

Another survey by consulting firm Watson Wyatt Worldwide finds that among 1,545 companies ranging from small to very large, guidelines for stock ownership for the second-to fifth-ranking senior executives -- a group that ordinarily includes the CFO -- ranges from 2.8 to 3.1 times base salary. While that's lower than the 4.5 multiple given the CEO, it's slightly higher than the corresponding number in the 1999-2000 survey period.

Numbers from this year may eventually reflect the nation's ongoing economic malaise, but data from 2000 showed it was a bountiful year for top CFOs. According to Pearl Meyer data, total CFO pay at the largest companies shot up an average of 17 percent over 1999 levels, bringing their average total pay to a record $2.77 million. Stock option awards, which grew 25 percent to $1.41 million, for the first time comprised more than half of total remuneration.

As much as shareholder activists have railed against "excessive" compensation -- particularly pay packages laden with options that can send annual CEO compensation skyrocketing to eight and even nine figures -- the die has been cast. Compensation committees, cajoled by consultants and clued in to what competitors are doing, have been loath to let CEOs and other corporate brass fall behind in the pay race.

Watson Wyatt goes so far as to call the U.S. "the land of opportunity" when it comes to executive pay -- particularly for CEOs. Even at lower management levels, the firm says, the notion of linking outsized rewards to high performance has become ingrained. Its most recent survey, the firm says, "confirms our long-held belief that combining CEO stock ownership with stock options is likely to be the best method of linking executives' and shareholders' interests."

But stocks can go down, of course, and opportunities can fizzle. The heavier reliance on options and incentives puts considerably more of top managers' pay at risk. After stock options, the second highest area of growth in elite-level CFO pay was annual incentives, up 16 percent to $469,000, Pearl Meyer found. Salary increased 9 percent to $507,000, and long-term incentives grew just 2 percent, to $383,000. "CFOs are being compensated more like entrepreneurs at a time of heightened market uncertainty and risk, rendering pay-for-performance a much rougher road to riches," says Steven Hall, a managing director with Pearl Meyer. "It will be years before their stock options can be exercised -- and then only if the stock price has risen."

Pearl Meyer uses the Black-Scholes method of valuing options and imputes their annual value at one-third of the total grant (see table, page 42). Hall says that's a common valuation method for companies that regularly pay dividends and don't show excessive stock volatility.

Watson Wyatt found that the average bonus paid to top managers it surveyed was 34.2 percent of base salary, versus an average target of 35.3 percent -- an indication that "overall actual performance was slightly below expectations." For CEOs, however, bonuses were slightly higher than target, 62.5 percent vs. 61.2 percent. Yet the firm's research showed that the CFO or top financial officer did slightly better in terms of percentage increase in the past year, with base salary rising 6.5 percent and total cash 8.1 percent; the corresponding CEO percentages were 5.1 percent and 7.9 percent.

Controllers, treasurers, top tax executives and top audit executives at the surveyed companies also enjoyed record total remuneration in 2000, according to Pearl Meyer. As with the CFO, salary decreased as a portion of total pay, bringing the at-risk pay of these executives to unprecedented levels. For controllers, treasurers and top audit executives, long-term incentive also fell as a proportion of total pay.

Controllers, the most highly compensated of this group, neared the $1 million mark in 2000, earning an average of $932,000 in total remuneration, an 8 percent hike over 1999, the Pearl Meyer data showed. Stock options, valued at $426,000, now average half of controllers' total remuneration. Average salary increased 6 percent to $264,000, but represented only 28 percent of total compensation, down slightly from the prior year, while annual incentive was up 16 percent, to $161,000. However, long-term incentive was down 15 percent, to $81,000.

Treasurers also neared the $1 million mark last year, averaging $927,000, a 16 percent increase over 1999, Pearl Meyer reported. Their compensation mix was similar to controllers: stock option value was up 31 percent, averaging $403,000 and representing 43 percent of the mix. Salary, which increased 8 percent to $253,000, represented only 27 percent of pay, a slightly smaller proportion than in 1999.

If there are clouds on the horizon, they are taking the form of criticism of excessive option usage and companies' willingness to reprice options that slide "underwater" when the stock price falls below the exercise price specified in the grant. This latter practice has been curtailed somewhat in the past couple of years, experts say, but a tidal wave of option grants in some companies has resulted in significant "overhang."

Says Watson Wyatt: "The increasing level of overhang/potential dilution (stock options outstanding plus options that are available for future grants as a percentage of total shares outstanding) is gradually becoming a concern. Our recent research on overhang indicates that shareholder returns may, in fact, decrease as ever-higher levels of overhang are reached."

However, Pearl Meyer's Hall doesn't expect "massive reductions in the use of options." Stock prices in general have slipped in the past year, which makes options cheaper to issue. He does think there will be increasing usage of long-term incentives and restricted stock tied to carefully targeted performance criteria.

"We're seeing things like granting premium-priced options with a strike price above the fair-market value. Then there are companies that are using performance-accelerated vesting. They might have a vesting period of five to 10 years for options, but the executive could get there in two to three years by meeting performance targets."

But the frisson over options has troubled some corporate managers. "In the last year, people gotten so many underwater options that they've lost faith in them," Hall says. "Some companies, too, have lost faith and said, 'When we do options, we'll keep it simple, and stick to fair-market pricing and straight vesting programs.'"

Stern Stewart & Co., widely known for its development of economic value added (EVA[R]) techniques, has a compensation practice that attempts to align rewards with EVA.

That includes options, though Gregory Milano, a partner with New York-based Stern Stewart, contends that option programs need to be carefully considered before implementation.

"Especially in a large company with multiple units, the number of people that are truly motivated is limited to senior people at the consolidated company level," Milano says. At lower management levels, granting shares is more logical. "Options are leveraged instruments, with high levels of risk and reward, and people at those lower levels don't have the means to bear that risk," he says.

Fundamentally, Milano thinks options programs should give management the rewards promised by the leveraged buyout programs of the 1980s, "but not put the entire company at risk." Too frequently, he says, executives get rewarded even by stocks that rise just 3 percent a year. At some companies, outsized options programs "have gotten a bit ridiculous."

But using options effectively is just one compensation challenge. "Our business is in finding behavioral problems," says Milano. "The end-of-year gaming can be pretty amazing -- the structure of a typical bonus plan is such that it is easy to understand why they are set up the way they are, but that can lead to strange behaviors."

Stern Stewart tries to get companies to align rewards with metrics like EVA. To do that, Milano says, it tries to separate the reward process from budgeting, though he says that can be politically unpopular, especially with executives who control budgets. Companies attempting to curb costs often limit bonuses to 150 percent of salary, he says. "But once you've hit that, you're at what we call the 'go golfing' point, because then it pays not to work too hard. If you do, there will be complaints that you're sandbagging your budget."

He adds: "Too many pay packages actually do more to discourage performance than encourage it. If [the package] encourages you to be mediocre, then you're not reaching for the stars. You're not looking at it as an entrepreneur would."

What tale will 2001 tell? Watson Wyatt noted that total cash compensation given to top managers in 2000-01 rose 7.8 percent, off considerably from the 11.4 percent boost the year before. Moreover, it found that stock option usage has declined in the past three years, from 93.1 percent to 76.2 percent. Performance stock options and phantom stock issuance have also fallen, albeit from much lower levels. Watson Wyatt's conclusion: executive pay "may be leveling off."

Indeed, is there any reason to think that top CFOs will see another 17 percent pay hike this year? "My take is that it's not likely, and I'm not sure that 17 percent was real, because options were involved," Hall says. "A lot of the increase was purely a result of stock movement upward." He does think a "pullback" in the rate of increase is probable.

While executive compensation surveys often present eye-popping data from very large companies, not all do. One recently released by Abbott, Langer & Associates of Crete, Ill., introduces what may be a far more realistic note to the field. Its database of small and mid-sized companies -- as well as government entities and nonprofits -- turned up a median CFO annual compensation of just $109,319. The median cash compensation figure jumps to $322,905 when company revenues exceed $1 billion, ALA says, adding that "some" CFOs may make up to $600,000.

This last number may seems like a prince's ransom to many small-company CFOs, but for the elite group, it would be a very large and highly unacceptable pay cut -- and certainly not a viable option.

2000 vs. 1999 Percent Change in Compensation Components Chief Financial
Officer Compensation Mix ($000s)
                              2000          1999          Percent
                              Value   Mix   Value   Mix   Change
Salary                        $507    18%   $466    20%   9%
Annual Incentive              $469    17%   $403    17%   16%
Total Cash                    $976          $869          12%
Total Long-Term Incentive     $383    14%   $377    16%   2%
Total Compensation            $1,359        $1,246        9%
Stock Option Imputed Value *  $1,406  51%   $1,124  47%   25%
Total Remuneration            $2,765  100%  $2,370  100%  17%
(*)Stock option imputed value is one-third of the option grant value.
Source: Pearl Meyer & Partners