Rethinking CFO Pay: What Works, What Does Not

by Cesar Bacani, 19 June 2012

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topics:
Human Capital Management

tags:
career development CFO pay Professional Development

If you were one of the 1,146 senior business executives worldwide who participated in a new study by PricewaterhouseCoopers on executive pay, you would have puzzled over two hypothetical questions.

The first one asked: If you had the choice of receiving $2,250 for sure or of gambling on a 50-50 chance of winning $5,250 (or lose the bet and get nothing), which option would you choose?

The second question went on: What if you are assured of an annual bonus of $41,250, which is $3,750 lower than the average $45,000 annual bonus of a senior executive of a large company? Would you take it, or would you gamble on a 50-50 chance of receiving a bonus of $90,000 (or lose the bet and get nothing)?

The results were perhaps not much of a surprise. The executives surveyed were generally risk-averse – 51% chose the sure thing, even though it is a smaller amount ($2,250), compared with the less certain but much larger amount ($5,250).

This is true even when the amount is increased and presented as a bonus opportunity. Only 28% of respondents said they would give up the certain but smaller amount ($41,250) for the much larger but uncertain amount ($90,000).

When incentives don’t work

So what is all this in aid of? The researchers were trying to pin down what works and what does not in the current model of executive pay, which focuses on incentive-based pay – specifically, long-term incentive plans that involve deferred bonuses in cash and/or shares linked to the achievement of certain targets.

Long-term incentive plans cover the CFO, of course, along with the CEO and other C-level executives. The issue is currently front and centre in the West, where the media and some shareholders are up in arms over the high compensation levels especially of banking executives – despite accusations that they are partly to blame for the recent global financial crisis.

For CFOs in the US specifically, the issue of incentive pay has also come under scrutiny after a Harvard Business School study concluded that there is direct link between larger bonuses and stock options paid to the CFO, on one hand, and fudged financial reports and more litigation, among other things, on the other hand.

Asia is catching up. In high-growth economies like China and India, the PwC report on executive compensation notes, intense competition for talented executives “has driven up reward packages and in those countries with high churn rates, long-term incentives are seen as a vital tool in retaining the best.”

But are they, really? “In those markets that have used them longest, it’s also becoming increasingly clear that there is something seriously wrong with [long-term incentive plans],” PwC says. “Companies invest an enormous amount into these plans, but the response from executives can rarely be said to justify the cost.”

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