By the numbers: Shining light on CFO pay packages
CFOs and other corporate financial executives hate having part of their pay decided subjectively; they prefer formulas that rely on objective financial and non-financial targets to determine whether they receive their bonuses. That’s one of the key findings from the latest CFO Compensation Survey, sponsored by the American Institute of Certified Public Accountants and conducted by Michal Matejka, associate professor of accounting. Given widespread CFO dissatisfaction a sensible question is why so many companies continue to rely on it, Matejka says.
CFOs and other corporate financial executives hate having part of their pay decided by the whims of their bosses. They prefer formulas that rely on objective financial and non-financial targets to determine whether they receive their bonuses.
That’s one of the key findings from the 2013 CFO Compensation Survey, sponsored by the American Institute of Certified Public Accountants and conducted by Michal Matejka, an Associate Professor of Accounting at the W. P. Carey School of Business. Matejka has been overseeing and analyzing the biennial survey of AICPA members since 2007. Nearly 2,500 CEOs, CFOs and other financial executives responded to this year’s edition, which examines trends in the design and execution of financial-executive pay packages.
Matejka says it’s little surprise that CFOs don’t like to be evaluated subjectively. “These are the numbers people,” he says. “They like formulas. They understand objective targets. I suspect they’re the people at their companies least comfortable with subjectivity.”
Fine tuning
This year’s survey found that “highly dissatisfied CFOs had 40 percent of their bonus awarded subjectively as compared to 25 percent for satisfied CFOs.” The survey also found that the reliance on subjective assessments in U.S. companies is much greater than in Dutch and German companies. Only Italian companies were more prone to use subjectivity in pay setting, the study reported.
Given widespread CFO dissatisfaction with subjective evaluation as a factor in compensation, a sensible question is why so many companies continue to rely on it.
One reason, Matejka says, is that presidents and CEOs may want to give themselves flexibility in deciding the size of their underling’s bonuses. Subjectivity in pay setting “correlates highly with the CEO being the owner of the firm and probably the one who started it and is accustomed to running the show. If you design an objective formula, you essentially delegate — you give power to the formula. Some CEOs aren’t comfortable with that. They want to decide the bonus.”
Another reason is the concern that pure financial targets can lead CFOs to favor short-term gains over the long-term health of the company, Matejka explains. Quarterly earnings targets offer an obvious example. A CFO can take a variety of steps to boost short-term earnings that may hurt a company in the longer term. Consider, say, reducing a company’s allowance for doubtful accounts. That can raise this quarter’s earnings but also misrepresent the amount of receivables that the company will eventually collect.
“That’s the weakness of delegating the bonus decision to a formula — you can motivate people to game the system,” Matejka says. But the solution isn’t to shun formulas, he says. It’s to fine-tune them in ways that reduce perverse incentives.
Companies can do that in a variety of ways: They can add non-financial targets to their bonus formulas, they can have their board members help in evaluating in their CFOs or they can adopt bonus pools.
With a bonus pool, a company agrees to set aside money to pay bonuses but hands out the funds only if performance exceeds a pre-announced threshold. That way, the company protects itself against paying bonuses when performance falters, but it moves away from subjective pay setting and toward a more transparent, objective way of rewarding good work.
This year’s survey found that the proportion of subjectively awarded bonuses was lower in companies that used these tools.
Attention to detail
If asked to design a bonus plan, Matejka says that he would include detailed non-financial targets. “I’d want something relating to market share and strategy,” he says. Other non-financial metrics could work, too, including measures addressing customer loyalty, corporate reputation, product quality or employee safety, he says. According to the survey, “The most common type of non-financial targets in CFO bonus plans were operations targets (used in 15 percent of private companies), targets related to accounting and IT functional duties (13 percent) and teamwork targets (12 percent).”
Targets need not be tough to reach. In fact, the survey revealed that on average, CFOs were able to hit their non-financial targets about 75 percent of the time and their financial ones about 69 percent of the time.
That high rate of achievement raises the question of whether the targets were too easy; after all, three-out-of-four are odds that nearly any gambler would take. Matejka says that an analyst must dig deeper to answer that question.
A critical piece of information is the trend over several years. And it turns out that financial targets have grown easier as the economy has improved since the 2008-2009 financial crisis. When the economy was slumping in the immediate wake of the crisis, only half of CFOs managed to achieve their earnings targets. Two years later, in 2011, that number had risen to two-thirds. It crept up again this year.
The achievability of non-financial targets, in contrast, held roughly stable over that period.
How might one interpret these seemingly contradictory findings? To Matejka, they suggest that some companies are taking a long view in designing their pay formulas — they’re being tough during hard times, easier during good times and also letting the two kinds of bonuses balance each other.
Previous versions of the survey have found — and this year’s edition reconfirmed —that many companies avoid paying bonuses for negative financial performance. If they don’t at least break even, they don’t give bonuses. During recessions or industry downturns, then, some CFOs may see their pay sag. But companies appear to compensate by making financial targets easier in good times, Matejka says. That way, the bad times and the good times even out.
The non-financial targets, which are steadily achievable, also may represent a way to buffer against ups and downs. They continue to provide motivation even when CFOs are unlikely to see bonuses for financial performance. “What this means is, if you’re going to get any bonus in tough times, it’s probably going to be for these long-term non-financial measures,” Matejka says. “I find that reasonable — it keeps people focused on the long term,” even when larger economic events defy their best efforts.
Something a company should avoid is ratcheting targets upward in response to employees meeting them, Matejka adds. That can gradually move goals from achievable to unachievable and sap their incentive effect. “You don’t want to punish managers for good performance,” he said.
Overall, median compensation didn’t increase much for the CFOs surveyed this year. In fact, median compensation for the respondents has been roughly stable since the surveys began, rising only by single digits with each version of the report. This time, the median private company CFO reported a salary of $150,000 and a bonus of $15,000, while her public-company counterpart reported a salary of $206,000 and a bonus of $40,000. The median private company had sales of $33 million, while the median public company had sales of $138 million.
This contrasts with the trend in CEO pay, which sank during the recession but rebounded strongly afterwards.
“Unlike CEOs, CFOs typically did not see substantial fluctuations in their compensation during the recession,” the survey says. “That likely explains why 2012–2010 increases were much smaller than those of CEOs.”
That’s one of the key findings from the 2013 CFO Compensation Survey, sponsored by the American Institute of Certified Public Accountants and conducted by Michal Matejka, an Associate Professor of Accounting at the W. P. Carey School of Business. Matejka has been overseeing and analyzing the biennial survey of AICPA members since 2007. Nearly 2,500 CEOs, CFOs and other financial executives responded to this year’s edition, which examines trends in the design and execution of financial-executive pay packages.
Matejka says it’s little surprise that CFOs don’t like to be evaluated subjectively. “These are the numbers people,” he says. “They like formulas. They understand objective targets. I suspect they’re the people at their companies least comfortable with subjectivity.”
Fine tuning
This year’s survey found that “highly dissatisfied CFOs had 40 percent of their bonus awarded subjectively as compared to 25 percent for satisfied CFOs.” The survey also found that the reliance on subjective assessments in U.S. companies is much greater than in Dutch and German companies. Only Italian companies were more prone to use subjectivity in pay setting, the study reported.
Given widespread CFO dissatisfaction with subjective evaluation as a factor in compensation, a sensible question is why so many companies continue to rely on it.
One reason, Matejka says, is that presidents and CEOs may want to give themselves flexibility in deciding the size of their underling’s bonuses. Subjectivity in pay setting “correlates highly with the CEO being the owner of the firm and probably the one who started it and is accustomed to running the show. If you design an objective formula, you essentially delegate — you give power to the formula. Some CEOs aren’t comfortable with that. They want to decide the bonus.”
Another reason is the concern that pure financial targets can lead CFOs to favor short-term gains over the long-term health of the company, Matejka explains. Quarterly earnings targets offer an obvious example. A CFO can take a variety of steps to boost short-term earnings that may hurt a company in the longer term. Consider, say, reducing a company’s allowance for doubtful accounts. That can raise this quarter’s earnings but also misrepresent the amount of receivables that the company will eventually collect.
“That’s the weakness of delegating the bonus decision to a formula — you can motivate people to game the system,” Matejka says. But the solution isn’t to shun formulas, he says. It’s to fine-tune them in ways that reduce perverse incentives.
Companies can do that in a variety of ways: They can add non-financial targets to their bonus formulas, they can have their board members help in evaluating in their CFOs or they can adopt bonus pools.
With a bonus pool, a company agrees to set aside money to pay bonuses but hands out the funds only if performance exceeds a pre-announced threshold. That way, the company protects itself against paying bonuses when performance falters, but it moves away from subjective pay setting and toward a more transparent, objective way of rewarding good work.
This year’s survey found that the proportion of subjectively awarded bonuses was lower in companies that used these tools.
Attention to detail
If asked to design a bonus plan, Matejka says that he would include detailed non-financial targets. “I’d want something relating to market share and strategy,” he says. Other non-financial metrics could work, too, including measures addressing customer loyalty, corporate reputation, product quality or employee safety, he says. According to the survey, “The most common type of non-financial targets in CFO bonus plans were operations targets (used in 15 percent of private companies), targets related to accounting and IT functional duties (13 percent) and teamwork targets (12 percent).”
Targets need not be tough to reach. In fact, the survey revealed that on average, CFOs were able to hit their non-financial targets about 75 percent of the time and their financial ones about 69 percent of the time.
That high rate of achievement raises the question of whether the targets were too easy; after all, three-out-of-four are odds that nearly any gambler would take. Matejka says that an analyst must dig deeper to answer that question.
A critical piece of information is the trend over several years. And it turns out that financial targets have grown easier as the economy has improved since the 2008-2009 financial crisis. When the economy was slumping in the immediate wake of the crisis, only half of CFOs managed to achieve their earnings targets. Two years later, in 2011, that number had risen to two-thirds. It crept up again this year.
The achievability of non-financial targets, in contrast, held roughly stable over that period.
How might one interpret these seemingly contradictory findings? To Matejka, they suggest that some companies are taking a long view in designing their pay formulas — they’re being tough during hard times, easier during good times and also letting the two kinds of bonuses balance each other.
Previous versions of the survey have found — and this year’s edition reconfirmed —that many companies avoid paying bonuses for negative financial performance. If they don’t at least break even, they don’t give bonuses. During recessions or industry downturns, then, some CFOs may see their pay sag. But companies appear to compensate by making financial targets easier in good times, Matejka says. That way, the bad times and the good times even out.
The non-financial targets, which are steadily achievable, also may represent a way to buffer against ups and downs. They continue to provide motivation even when CFOs are unlikely to see bonuses for financial performance. “What this means is, if you’re going to get any bonus in tough times, it’s probably going to be for these long-term non-financial measures,” Matejka says. “I find that reasonable — it keeps people focused on the long term,” even when larger economic events defy their best efforts.
Something a company should avoid is ratcheting targets upward in response to employees meeting them, Matejka adds. That can gradually move goals from achievable to unachievable and sap their incentive effect. “You don’t want to punish managers for good performance,” he said.
Overall, median compensation didn’t increase much for the CFOs surveyed this year. In fact, median compensation for the respondents has been roughly stable since the surveys began, rising only by single digits with each version of the report. This time, the median private company CFO reported a salary of $150,000 and a bonus of $15,000, while her public-company counterpart reported a salary of $206,000 and a bonus of $40,000. The median private company had sales of $33 million, while the median public company had sales of $138 million.
This contrasts with the trend in CEO pay, which sank during the recession but rebounded strongly afterwards.
“Unlike CEOs, CFOs typically did not see substantial fluctuations in their compensation during the recession,” the survey says. “That likely explains why 2012–2010 increases were much smaller than those of CEOs.”
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