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2011 Cfo Comp Survey
2011 Cfo Comp Survey
2011
A Research Report Sponsored by the American Institute of Certified Public Accountants
2011 CFO INCENTIVES AND COMPENSATION SURVEY This report is the result of a research project supported by the American Institute of Certified Public Accountants (AICPA). We thank all survey respondents whose participation made this project possible.
2011
Table of Contents
Executive Summary Survey Sample and Background Compensation Aggregate Analysis Industry Analysis Choice of Performance Measures Target Setting
4 6
8 11 18 25
2011
Executive Summary
This report examines executive compensation and incentive practices in the postrecessionary economic environment and focuses in particular on the choice of performance targets in CFO annual bonus plans. The data comes from a survey of AICPA members conducted MarchApril 2011. About 1,000 CEOs, CFOs, controllers, and other executives participated in the survey and shared detailed information about their compensation and incentive plans in 2010 and 2011. Our survey shows a downward trend in total compensation between 2008 and 2010 but predicts a substantial improvement in 2011. Many companies that had increased the emphasis on financial performance targets during the recession dialed it down again in 2010. Survey participants also indicated that 2011 earnings targets were much more likely to be achieved than during the recession. As a result, the difficulty of financial and nonfinancial targets was better balanced in 2010 and 2011 bonus plans than during the recession. Specifically, our findings are as follows: Median targeted return on sales increased from 4.6% in 2009 to 5% in 2010 and 6% in 2011 (see Figure 1, page 25). Moreover, the probability of achieving 2011 earnings targets went up considerably as wellthe average estimated probability of meeting an earnings target was 64% in 2011 but only 48% in 2009 (see Table 8, page 28). The estimated probability of meeting nonfinancial targets stayed largely unchanged64% in 2011 and 68% in 2009. Median CFO cash compensation declined by about 7% between 2008 and 2010 (see Table 4, page 10). Other top financial executives experienced a similar decline while CEOs, Presidents, and COOs saw an even greater decline.1
The estimates have to be interpreted with caution because they could in part be driven by differences in the sample of participating executives.
1
2011
In 2011, CFOs of private companies had on average 54% of their bonuses contingent on meeting financial performance, 14% contingent on explicit nonfinancial targets, 27% of their bonuses was awarded subjectively, and 5% in some other way (see Table 5b, page 19). The bonus weight on financial targets was lower in smaller private companies (about 50% in companies with sales below $50 million) and greater in larger ones (about 60% in companies with sales above $50 million). Many private companies had increased the bonus weight on financial targets in CFO bonus plans during the recession but lowered it again recently. For example, the average bonus weight on financial targets in private companies with sales between $5099 million was 47% in 2007, 65% in 2009, and 51% in 2011. Similar reversals of prior increases (albeit smaller in magnitude) took place in other companies, especially larger ones (see Table 5c, page 20). The most common type of nonfinancial targets in CFO bonus plans were operations targets (used in 16% of private companies). Targets related to market & strategy were used in 27% of smaller companies and up to 31% of the largest companies. Inversely related to size was the usage of targets related to CFOs accounting & IT functional dutiesup to 22% of smaller companies included them in CFO bonus plans while none of the largest companies did so (see Table 6, page 22). Nonfinancial targets were relatively easy to achieve as long as a they were formally included in the bonus plan formulathe average probability of achieving nonfinancial targets was 75% in companies that formally included them in their bonus formula but only 56% in companies that set nonfinancial targets without formally linking them to bonuses (see Table 9, page 29). Formally using explicit nonfinancial targets in CFO bonus plans (rather than relying on subjective evaluations) was associated with greater CFO involvement in major business decisions (see Table 7, page 24).
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2011
Table 1 describes industry affiliation and type of companies participating in the 2011 survey (646 of the 999 participants provided industry information). Manufacturing companies represent the largest group (18%), followed by retail, wholesale, transportation, and warehousing (15%), finance and insurance (14%), construction and real estate (10%), healthcare (9%), professional services (8%), and nonprofit organizations (8%). All other industrial groups represent less than 5% of the sample. Table 1 further shows the proportion of public companies in each industrial group. Table 1. Industrial Composition of Sample
Industrial Group Manufacturing Finance and Insurance Wholesale Trade Retail Trade Transportation and Warehousing Professional, Scientific, and Technical Services Construction Real Estate Healthcare Information and Media Mining, Oil and Gas Agriculture, Forestry, Fishing, and Hunting Hospitality and Food Services Arts, Entertainment, and Recreation Utilities Holding Company or Conglomerate Education Nonprofit Other Total Private 97 68 39 30 12 46 32 27 54 11 10 5 15 4 3 4 1 49 25 532 Public 20 25 5 8 6 5 2 5 4 8 5 1 5 3 5 0 0 0 7 114 Total 117 93 44 38 18 51 34 32 58 19 15 6 20 7 8 4 1 49 32 646 18.1% 14.4% 6.8% 5.9% 2.8% 7.9% 5.3% 5.0% 9.0% 2.9% 2.3% 0.9% 3.1% 1.1% 1.2% 0.6% 0.1% 7.6% 5.0% 100.0 %
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CompensationAggregate Analysis
Table 2 compares median annual base salaries and incentive pay for (i) CFOs at the company (corporate) level, (ii) other top financial executives (those directly reporting to CFOs), and (iii) executives with the title CEO, President, or COO. Table 2 separately reports on compensation in private and public companies but aggregates across companies of different size and industry. Size- and industry-specific results for the five largest industrial groups are presented in the next section. Panel A of Table 2 reports median 2010 compensation in private companies. It shows that the median CFO salary was $130,000 and the corresponding median bonus was $12,000. The median size of all other compensation components (multi-year cash bonuses, equity Table 2. Median 2010 Compensation
Panel A. Private Companies CEO President COO 51 156,600 20,000 14 CFO 413 130,000 12,000 25 Other top financial executives 105 122,000 9,310 100
Sample size Salary Bonus Sales (in Millions) Panel B. Public Companies
CEO President COO Sample size Salary Bonus Equity incentives Sales (in Millions)
insufficient
Notes: Table reports medians (obtained by ranking compensation and then selecting the value in the middle). Information on multi-year cash bonus, equity incentives, and other compensation is not reported if the median value was zero.
2011
incentives, and other compensation) was zero and is not reported. CFO salaries and bonuses were only slightly higher than compensation of other top financial executives. However, this was in part because of differences in the size of participating companies. The median sales of a private company whose CFO participated in this survey was $25 million as compared to $100 million in cases where other top financial executives participated. The top executives (CEOs, Presidents, COOs) in private companies earned median salary and bonus of $156,600 and $20,000, respectively. Panel B of Table 2 reports median 2010 compensation in public companies. Here, we can only compare CFOs with other top financial executives since the small number of participants in the CEO/President/COO category does not allow for reliable inferences. We note that the median size of a public company whose CFO participated ($113 million in sales) was much smaller than the size of a company where another financial executive responded ($1,735 million in sales). CFO salary of $200,000 and bonus of $25,000 was slightly higher than the median salary and bonus of other top financial executives of $175,000 and $35,000, respectively. Median equity incentive payouts in 2010 were negligibleno payout for CFOs of small public companies and $2,250 for other top financial executives in larger public companies. Table 3 reports on CFO compensation at the business unit level. The typical business unit of a private company had sales of $50 million and paid its CFO a salary of $125,000 and bonus of $12,000. In contrast, the typical business unit of a public company had sales of $208 million and CFO salary and bonus were $150,000 and $24,000, respectively.
Notes: Table reports medians (obtained by ranking compensation and then selecting the value in the middle). Information on multi-year cash bonus, equity incentives, and other compensation is not reported if the median value was zero.
2011
Finally, Table 4 assesses the trends in cash compensation (salary + bonus) since 2006 for a subsample of companies and business units with more than 20 employees (nonprofit entities were excluded). Table 4 shows that CFO cash compensation remained largely unchanged between 2006 and 2008 (the first full year of the recession) but declined by 7% between 2008 and 2010. Other top financial executives experienced a similar decline while CEOs, Presidents, and COOs saw even greater declines (although these estimates may be imprecise given that they are based on a small sample of 35 executives). The estimates in Table 4 have to be interpreted with caution, however, because we do not compare executive compensation in one year to the compensation of the same executives two years earlier (due to the anonymous participation of respondents). Instead, we identify individual and company characteristics that typically drive cash compensation (size, tenure, public vs. private companies, corporate vs. BU level, etc.) and assure that they are similar across years (see footnote to Table 4 for more explanation). Still, we cannot completely rule out the possibility that the differences between years are at least partly due to differences in characteristics of respondents and their companies. Table 4. Cash Compensation Trends
CEO President COO 35 225,000 -23% 292,750 -16% 347,500 24 80 11% 11% Other top financial executives 139 150,000 -7% 161,750
Sample size 2010 20102008 Change 2008 20082006 Change 2006 Sales (in Millions) Number of employees Public BU
Notes: Table reports medians of cash compensation (salary + bonus) and changes therein. It covers a subsample of companies and business units with 20 or more employees and excludes nonprofit entities. The changes reflect time trends as well as potential differences in respondents and companies participating in 2007, 2009, and 2011. To isolate the time trends, we compare companies of similar characteristics. For example, the typical (median) entity whose CFO participated in 2011 had $45 million in sales and 164 employees. Of the total sample of 405 entities, 16% were (a part of) publicly traded companies and 15% were business units. We select subsamples of 2008 and 2006 participants that have the same or similar characteristics. Information is not available for other top financial executives in 2006 because the survey did not separately collect data on financial executives that directly report to the CFO.
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CompensationIndustry Analysis
This section presents disaggregate analyses of CFO salaries and bonuses in five major industry groups: (i) manufacturing, (ii) finance and insurance, (iii) retail, wholesale, transportation, and warehousing, (iv) construction and real estate, and (v) healthcare. It also distinguishes between companies of different size. The downside is that the sample of observations for specific industry and size groups can be quite small in which case the results should be interpreted with caution. To maximize the number of available observations, our industry analysis combines private and public entities as well as corporate and business unit entities. These differences can be taken into account by noting that in 2010 CFOs of public companies earned on average $40,000 more in salary than CFOs of private companies of comparable size (this differential may be substantially higher in healthcare and lower in manufacturing sector). Also, corporate CFOs earned on average $30,000 more in salary than CFOs of business units of comparable size. There were also some differences regarding incentive compensation (bonus as a percentage of salary). Bonuses of business unit CFOs were on average lower by about 10% of their salaries as compared to corporate CFOs. For brevity, we do not separately discuss the results for all industries. Instead, we use Tables 4a and 4b (specific to manufacturing industries) as examples of how to interpret the results. All other tables have a similar format. Table 4a presents the distribution of CFO annual base salaries. The first column shows six salary ranges starting from low salaries of less than $75,000 to high salaries of more than $200,000. The next four columns are specific to companies of different sizes. For example, small manufacturing companies with sales less than $25 million typically paid a (median) salary in the $100,001125,000 range (10 out of the 27 small companies were in this range), yet there was also substantial variatione.g., 5 of the small companies paid salaries in the $75,001100,000 range and 8 companies even less; in contrast, 2 of the 27 small companies paid salaries greater than $200,000.
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Table 4b is organized similarly. However, for each combination of salary and sales ranges, it presents three rows containing low, median, and high values of 2010 bonus as a percentage of salary. The low is measured as the 25th percentile (i.e., not the overall lowest value but the highest from the low 25%), median and high values are measured similarly as the 50th and 75th percentiles, respectively. For example, a majority of manufacturing companies with sales in the $100499 million range and CFO salary between $125,001 and 150,000 paid a bonus between 1134% of salary for 2010 performance. From Table 4a, we see that this particular cell (salary-sales combination) includes 5 companies. When examining the results, it is useful to consider surrounding cells and column or row averages, especially if the sample size is small. In the above example, the bonus range of 1134% of salary is estimated based on just 5 observations. The bonus range for 20 companies of similar size ($100499 million in sales) was 647%; the bonus range for 16 companies paying similar salaries ($125,001150,000) was 334%. Finally, the overall 2010 bonus range for all manufacturing companies (41531%) is also a useful benchmark because it aggregates a larger number (88) of different manufacturing companies. It can also be compared across industriesfinance and insurance (41330%); retail, wholesale, transportation, and warehousing (41331%); construction and real estate (4723%), and healthcare (4920%).
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Notes: Each cell contains the number of CFOs with 2010 annual salaries in the rage indicated by the first column that work for companies with sales indicated by the first row. Bold cells highlight which range contains median CFO salary in companies of a given size. For example, the median CFO salary of companies with sales $2599 million was in the $125,001150,000 range; 12 companies paid salaries in the next lower range and 7 in the next higher range.
75,001100,000
100,001125,000
125,001150,000
150,001200,000
Average
Notes: The table shows for each combination of a salary range and company size (sales range): (i) low, (ii) median, and (iii) high 2010 bonus as a percentage of salary. Low/median/high means that 25/50/75% of observations in the same cell have a lower bonus. Cells with less than five observations are not shown.
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Notes: Each cell contains the number of CFOs with 2010 annual salaries in the rage indicated by the first column that work for companies with sales indicated by the first row. Bold cells highlight which range contains median CFO salary in companies of a given size. For example, the median CFO salary of companies with sales $2599 million was in the $150,001200,000 range; 3 companies paid salaries in the next lower range and 6 in the next higher range.
75,001100,000 0% 0% 3% 0% 0% 5%
100,001125,000
125,001150,000 23% 12% 15% 4% 28% 47% 4% 12% 32% 6% 22% 30% 20% 15% 30% 4% 33% 53% 4% 13% 30%
150,001200,000
Average
6% 15% 30%
Notes: The table shows for each combination of a salary range and company size (sales range): (i) low, (ii) median, and (iii) high 2010 bonus as a percentage of salary. Low/median/high means that 25/50/75% of observations in the same cell have a lower bonus. Cells with less than five observations are not shown.
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Notes: Each cell contains the number of CFOs with 2010 annual salaries in the rage indicated by the first column that work for companies with sales indicated by the first row. Bold cells highlight which range contains median CFO salary in companies of a given size. For example, the median CFO salary of companies with sales $2599 million was in the $125,001150,000 range; 5 companies paid salaries in the next lower range and 7 in the next higher range.
75,001100,000
100,001125,000
125,001150,000
150,001200,000
Average
Notes: The table shows for each combination of a salary range and company size (sales range): (i) low, (ii) median, and (iii) high 2010 bonus as a percentage of salary. Low/median/high means that 25/50/75% of observations in the same cell have a lower bonus. Cells with less than five observations are not shown.
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Notes: Each cell contains the number of CFOs with 2010 annual salaries in the rage indicated by the first column that work for companies with sales indicated by the first row. Bold cells highlight which range contains median CFO salary in companies of a given size. For example, the median CFO salary of companies with sales $2599 million was in the $125,001150,000 range; one company paid a salary in the next lower range and one in the next higher range.
100,001125,000
125,001150,000
Average
Notes: The table shows for each combination of a salary range and company size (sales range): (i) low, (ii) median, and (iii) high 2010 bonus as a percentage of salary. Low/median/high means that 25/50/75% of observations in the same cell have a lower bonus. Cells with less than five observations are not shown.
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Notes: Each cell contains the number of CFOs with 2010 annual salaries in the rage indicated by the first column that work for companies with sales indicated by the first row. Bold cells highlight which range contains median CFO salary in companies of a given size. For example, the median CFO salary of companies with sales $2599 million is in the $150,001 200,000 range; one company paid a salary in the next lower range and one in the next higher range.
75,001100,000 0% 7% 15% 0% 6% 9%
100,001125,000
Average
8% 10% 47%
Notes: The table shows for each combination of a salary range and company size (sales range): (i) low, (ii) median, and (iii) high 2010 bonus as a percentage of salary. Low/median/high means that 25/50/75% of observations in the same cell have a lower bonus. Cells with less than five observations not shown.
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Note: Tabulated is the percentage breakdown of total bonus paid to CFOs for meeting each of the listed performance targets (for a subsample of private companies with 20 or more employees, excluded are business units and nonprofit entities). Percentages do not sum up to 100% because the category other performance targets is omitted.
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Table 5a shows that, on average, CFOs earned 48% of their 2010 bonus for meeting financial performance targets, about 10% for meeting objective nonfinancial targets, and 38% was awarded subjectively without preset targets (the remainder was earned in some other way). CFOs of larger companies had more of their bonus contingent on meeting financial performance targetsthe bonus weight was 58% in the largest companies (with sales greater than $500 million) and 42% in the smallest (with sales below $25 million). Conversely, smaller companies determined a greater part of their CFO bonus subjectively. The relative importance of objective targets in Table 5a may be underestimated if much of CFO bonuses depend on targets that are difficult to achieve (e.g., financial targets may earn zero bonus payouts at the end of a year even though financial targets initially accounted for a big part of the bonus opportunity). Table 5b addresses this issue by presenting data based on the relative importance of various targets in the (current) 2011 bonus plan in the hypothetical case that 2011 performance exactly meets all targets. Table 5b. Performance Targets in CFO Bonus Plans in Private Companies (Cont.)
2011 Sample size Financial targets Nonfinancial targets Subjective 2009 Sample size Financial targets Nonfinancial targets Subjective 2007 Sample size Financial targets Nonfinancial targets Subjective 171 50.6% 14.1% 33.2% 124 43.4% 14.1% 37.8% 124 46.7% 11.6% 40.5% 94 55.9% 11.7% 31.3% 64 57.2% 14.3% 27.3% 45 59.4% 13.9% 26.0% 622 50.5% 13.2% 34.1% 143 50.6% 10.2% 33.1% 73 40.2% 12.8% 41.8% 65 65.0% 8.8% 23.2% 55 60.1% 13.7% 25.6% 42 64.6% 9.5% 25.9% 19 66.8% 11.8% 21.3% 397 54.6% 10.9% 30.7% <25 85 49.7% 13.3% 30.4% 2549 46 49.7% 19.8% 26.1% Sales (In Millions) 5099 100199 200499 47 47 23 50.5% 61.5% 61.1% 11.6% 13.6% 10.9% 31.2% 24.7% 19.3% >500 16 61.1% 12.2% 20.4% Average 264 53.6% 13.9% 27.2%
Note: Same subsample as in Table 5a. Tabulated is the percentage breakdown of total bonus CFOs expect to earn in the next period if performance is on target along all dimensions. For example, the most recent survey from March 2010 asked CFOs about the percentage of their 2011 bonus they expect to receive for meeting financial targets if 2011 performance exactly meets all targets.
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On the whole, the results in Table 5b are similar to those in Table 5a except that the bonus weights on objective targets are slightly higher. If 2011 performance meets all targets, CFOs will earn on average 54% of their 2011 bonus based on financial performance targets (as compared to 48% in 2010) and 14% based on nonfinancial targets (as compared to 10% in 2010). Both Tables 5a and 5b present a comparison with prior years. It is interesting to note that many companies increased the emphasis on financial performance targets in CFO bonus plans between 2006 and 2008 (the first full year of the recession). However, this increase was temporary because the weights on financial targets went down again between 2008 and 2010. Table 5c shows that this phenomenon is most strongly pronounced in companies with sales in the $5099 million range. In these companies, the bonus weights on financial performance targets increased by almost 20% between 2006 and 2008 but then decreased by more than 15% between 2008 and 2010. Similar changes of somewhat smaller magnitude took place in larger companies (with sales of $100 million or more). Smaller companies (with sales less than $25 million) kept their bonus plans largely unchanged or possibly adjusted their bonus plans to the recession with some delay (e.g., companies in the $2549 million sales range substantially increased the emphasis on financial performance targets between 2008 and 2010).
Table 5c. Changes in Bonus Weights on Financial Targets in CFO Bonus Plans
<25 -2.3% -1.0% -0.9% 0.0% 2549 +9.7% -6.0% +9.5% -3.2% Sales (In Millions) 5099 100199 200499 -15.3% -2.9% -10.2% +19.5% +7.6% +9.4% -14.5% +18.3% +1.4% +4.2% -3.5% +7.4% >500 -9.8% +10.3% -5.7% +7.4% Average -2.8% +4.0% -1.0% +4.1%
Note: This table is based on the information presented in Tables 5a and 5b (tabulated is the change in bonus weights on financial targets in CFO bonus plans for the different time periods). The changes reflect time trends as well as potential differences in respondents and companies participating in 2007, 2009, and 2011.
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Table 6 provides more details about the type of nonfinancial performance targets used in CFO bonus plans. It tabulates the percentage of private companies that used various nonfinancial targets in their CFO bonus plans. The first part of Table 6 considers nonfinancial targets regardless of their relative importance in CFO bonus plans (i.e., regardless of the bonus formula weight), the middle part only considers targets that accounted for at least 10% of the bonus opportunity and the last part considers targets that accounted for 20% or more of the bonus opportunity. The most common and most important nonfinancial performance targets in CFO bonus plans were operations targets as reflected for example in metrics of efficiency, quality, safety, process improvement, or cost control. Of the 269 private companies where data on CFO bonus plans is available, on average, 16% used at least one of these metrics, 11% of the companies awarded at least 10% of CFO bonuses based on one of these metrics, and 8% of the companies awarded at least 20% of bonuses based on one of these metrics. Although the usage of operations metrics varied somewhat among companies of different size, both small and large companies considered these targets important. The next important group are nonfinancial targets related to market & strategy, which includes targets such as for example market share, customer satisfaction, or business development milestones. On average, 9% of the companies used of one of these targets, 7% awarded at least 10% of CFO bonuses, and 5% awarded at least 20% of CFO bonuses based on one of these targets. In contrast to operations targets, the usage of targets related to market & strategy varied greatly depending on company size. For example, among the largest companies (with sales greater than $500 million) 31% used one of the market & strategy targets, while only 27% of companies with sales less than $100 million did so. In contrast, the usage of explicit nonfinancial targets relating to CFO functional responsibilities in the area of accounting & IT (e.g., timeliness and efficiency of internal and external reporting, ERP system implementation) and finance (e.g., working capital management, capex planning, M&A deals) was inversely related to company size. Up to 22% of companies with sales less than $100 million used one of these targets while hardly any of the largest companies did so.
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Note: Same subsample as in Table 5a (i.e., CFO bonus plans in private companies with 20 or more employees). Tabulated are percentages of companies that used at least one nonfinancial performance target from the listed categories in their CFO bonus plans. The first part of the table covers usage of nonfinancial targets that accounted for less than 10% of the bonus opportunity, the middle part of the table covers targets accounting for 1019% of the bonus opportunity, and the last part tabulates percentages of companies where listed nonfinancial targets accounted for 20% or more of CFO bonuses. Operations includes targets pertaining to, for example, efficiency, quality, safety, process improvement, or cost control. Market & Strategy includes targets such as market share, customer satisfaction, business development milestones. Accounting & IT refers to timeliness and efficiency of internal and external reporting, ERP system implementation, software upgrades, or management satisfaction. Finance refers to working capital management, capex planning, M&A deals, divestitures, or investor relations. Teamwork refers to employee turnover, leadership, or collaboration & communication. Sustainability refers to energy use, emissions, social reporting, or stakeholder satisfaction.
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Explicit nonfinancial performance targets related to teamwork & human resource management (e.g., employee turnover, leadership, collaboration & communication) were not uncommonon average 10% of the companies used of one these metricsbut they rarely had a significant bonus potential attached to themonly 1% of the companies awarded 20% or more of CFO bonus based on these metrics. Finally, it seems that sustainability metrics (e.g., energy use, emissions, social reporting, stakeholder satisfaction) were rarely used in CFO bonus plans. Additionally, it may be of interest whether reliance on different nonfinancial performance targets is associated with different CFO roles or different balancing of their various responsibilities. For example, companies often seek CFOs that are actively involved in major business decisions (rather than involved primarily in financial reporting and other CFO functional duties). Table 7 identifies CFOs who perceive they are highly involved in decisions concerning the range of products/services offered, customer segments targeted, capital expenditures, operating costs, inventory, and accounts receivable. It compares the bonus plans of these highly involved CFOs with bonus plans of CFOs that have moderate or low influence on these decisions. The first part of Table 7 shows that companies with low and high CFO involvement were similar in terms of size (average sales of $111 and $110 million, respectively), overall bonus opportunity (25% vs. 27% of salary paid out as bonus in 2010), and the relative emphasis on financial performance targets (48% vs. 50% of total 2010 bonus). The difference is that companies where CFOs are highly involved in major business decisions relied less on subjective evaluations (31% vs. 39% of total 2010 bonus) and instead relied more on explicit nonfinancial performance targets (13% vs. 9% of total 2010 bonus). The second part of Table 7 provides more details regarding the type of nonfinancial targets favored by companies where CFOs are highly involved in decision making. Specifically, it presents the percentage of companies that awarded at least 10% of CFO bonus opportunity based on the different types of nonfinancial performance targets. The most striking difference is the more frequent use of targets related to operations (e.g., efficiency, quality, safety, cost control)19% of companies with highly involved CFOs included some operations targets in their bonus plans while only 7% of companies with low CFO involvement did so. Similarly, 1014% of companies with highly involved CFOs used market & strategy, accounting & IT and finance targets, while only 46% of companies with
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low CFO involvement did so. There was even a difference with respect to the usage of sustainability metrics6% of the 81 companies with high CFO involvement used at least one such metric while none of the 171 companies with low CFO involvement used these metrics. The only area where there was little difference pertains to teamwork & human resource management. This may also be the area where it is difficult to set quantitative targets and some amount of subjectivity in evaluations is inevitable.
Sample size Low CFO Involvement Sample size High CFO Involvement Sample size Total
% of companies using nonfinancial targets from one of the categories below Oper M&S A & IT Fin Team Sust 171 171 171 171 171 171 7% 5% 6% 4% 4% 0% 81 19% 252 11% 81 10% 252 7% 81 14% 252 9% 81 10% 252 6% 81 5% 252 4% 81 6% 252 2%
Note: Same subsample as in Table 5a (i.e., CFO bonus plans in private companies with 20 or more employees). High CFO involvement is the percentage of companies whether CFO reported on average a high influence on decisions in the following areas: range of products/services offered, customer segments targeted, capital expenditures, operating costs, inventory, and accounts receivable (Low CFO involvement stands for moderate or low influence in these areas). Bonus/Salary represents the percentage of salary earned as 2010 bonus. Last four columns in the first part of the table describe the percentage of 2010 bonus that CFOs earned based on financial performance targets, nonfinancial targets, subjective evaluations, and in other ways. The second part of the table shows the percentage of companies that awarded at least 10% of CFO bonus opportunity based on at least one nonfinancial performance target from the following areas: Oper operations, M & S market & strategy, A & IT accounting & IT, Fin finance, Team teamwork , Sust sustainability (see the notes of Table 6 for more detailed descriptions).
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Target Setting
The previous section examines performance measures in CFO bonus plans. The choice of performance measures and bonus weights attached to them communicates to managers which areas of the business to focus on. An equally important dimension of annual bonus plans is the choice of targets for each of the objective measures included. The relative ease or difficulty of assigned targets is likely to affect how managers allocate their time and effort (e.g., a bonus plan that includes financial measures as well as nonfinancial indicators of long-term performance may still induce myopic focus on short-term financial measures if the corresponding financial targets are more challenging than the nonfinancial targets). This section examines how companies set earnings targets as well as other financial and nonfinancial targets. The sample includes all companies and business units (private and public) where performance target data is available, except for nonprofit entities. Thus, the findings are not specific just to CFO bonus plans as in the previous section. We start out by examining earnings targets which were affected most by the recent recession. Figure 1 shows the trend in earnings targets between 2008 and 2011. The downwardsloping trend in the first two years reflects the effect of the global business downturn. The Figure 1. 20082011 Earnings Targets
7% 6.0% 6% 5% 4% 4.0% 3% 2008 2009 2010 2011 5.4% 5.0% 4.6% 5.0% Earnings targets Actual Earnings
Note: Median earnings targets (return on sales) are marked in blue and median actual earnings are marked in red. 2010-2011 earnings targets and 2010 actual earnings are from the 2011 survey (about 570 entities included), 2008-2009 earnings targets and 2008 actual earnings are from the 2009 survey (about 830 entities included).
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worst of the recession hit most companies towards the end of 2008. As a result, the median targeted return on sales of 5.4% in 2008 was highly unrealistic. The actual 2008 return on sales of 4.0% was well below the target. Consequently, 53% of the companies failed to meet their earnings target, while 16% exactly met and 31% exceeded their target. In addition, 2009 earnings targets were revised downwards considerably to 4.6%. After 2009, the trend is upward sloping. In 2010, earnings targets increased slightly to 5%. More importantly, the median actual earnings came exactly at the target. Consequently, the proportion of companies that exactly met (15%) or exceeded (47%) their target went up substantially and the proportion of companies that failed to meet their target went down (38% as compared to 53% in 2008) and was within the range of 2040% commonly reported in studies prior to the recession. Following improved performance in 2010, earnings targets for 2011 were revised upwards to 6%. Figure 2a shows a more detailed distribution of 2011 earnings targets and Figure 2b compares it to the distribution of 2009 targets. It is noteworthy that in both years there were hardly any earnings targets just below zero. Instead, there was a high frequency of earnings targets at or just above zero. For example, in 2011 there were only 2 cases of earnings equal or greater than -1% of sales and smaller than 0% but 70 cases of earnings in the next range where earnings were equal or greater than zero and smaller than 1% of sales. Of the 70 case in the range at or just above zero 36 were exactly equal to zero. Apparently, instead of a negative earnings target many companies preferred to set a zero or a small positive target. Table 8 looks at the perceived difficulty of earnings targets as reflected in respondents estimates of the probability that they will meet them. The first part of Table 8 focuses on the difficulty of 2009 targets, i.e., targets set during the worst of the recession. The average probability of achieving 2009 earnings targets was only 48%. This probability was even lower for targets set at zero (35%) and for negative targets (24%). Thus, similar to 2008 targets (see Figure 1), 2009 earnings targets were often unlikely to be achieved. Interestingly, the average probability of achieving 2009 nonfinancial targets was 68%, much higher than in the case of earnings targets. Also, the difficulty of nonfinancial targets did not depend much on earnings targetsnonfinancial targets remained achievable even if earnings targets had little chance of being met. Thus, it seems that companies often used nonfinancial targets to offset the high difficulty of earnings targets.
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The second part of Table 8 examines the difficulty of 2011 earnings targets. The average probability of meeting earnings targets went up considerably from 48% in 2009 to 64% in 2011. This increase came largely from companies with a positive 2011 earnings target. Zero and negative earnings targets still had a low probability of being achieved42% and 29%, respectively. The average probability of meeting nonfinancial targets went slightly down from 68% in 2009 to 64% in 2011. This decrease came largely from companies with zero or negative 2011 earnings targets where the probability of meeting nonfinancial targets decreased from 59% to 46% and from 61% to 46%, respectively. As a result, the difficulty of nonfinancial targets and earnings targets was better balanced in 2011 and
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Note: Sample includes all private and public entities (corporate and BU level), excluding nonprofit organizations, for which data is available. Loss refers to entities with negative 2009 or 2011 earnings targets. Exactly zero refers to entities with 2009 or 2011 earnings target equal to zero. Profit refers to entities with positive earnings targets.
companies were less likely to rely on nonfinancial targets to offset difficult earnings targets. Table 9 provides more details on how companies use nonfinancial targets. About 29% of the sample (157 out of 541 entities with available data) formally used some nonfinancial targets and linked them to a nontrivial percentage of the 2011 bonus opportunity (on average 41%). The remaining 71% of the sample companies used nonfinancial targets informally, i.e., targets were set outside of the bonus plan with little or no bonus weight assigned to them. Instead, companies with informal nonfinancial targets relied much more on subjective evaluations (which accounted for 34% of 2011 bonus opportunity as compared to 9% in companies with formal nonfinancial targets) and also relied somewhat more on financial targets. More importantly, Table 9 shows that the probability of achieving 2011 nonfinancial targets was much higher in companies formally including them in their bonus plan than in companies using them informally (75% as compared to 56%). To a lesser extent, earnings targets were also easier to achieve in companies formally including nonfinancial targets in their bonus plans (69% probability of achieving as compared to 60%). Finally, there is evidence that companies using nonfinancial targets informally, i.e., companies relying
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Note: Sample includes all private and public entities (corporate and BU level), excluding nonprofit organizations, for which data is available. Formal use refers to companies that include explicit nonfinancial targets into their bonus formula (and attach a nontrivial bonus weight to them). Informal use refers to companies that set some nonfinancial targets but attach little or no bonus weights to them. Complain is the percentage of respondents who disagree with the following statement: Overall, my compensation package is well-designed.
greatly on subjective evaluations rather than on explicit nonfinancial targets when awarding bonuses, experienced greater dissatisfaction with their compensation policies. Specifically, 33% of respondents from those companies did not think that their compensation package was well designed as compared to 21% of respondents in companies formally including nonfinancial targets in their bonus plans. Table 10 provides further details on the difficulty of nonfinancial targets formally used in annual bonus plans. It shows that the difficulty of targets across the six nonfinancial categories was similar. Specifically, the probability of meeting targets related to operations, market & strategy, and finance was 7476% and the probability in areas related to accounting & IT, teamwork, and sustainability was 8082%. Thus, the key driver of nonfinancial target difficulty is whether it has a nontrivial weight in the bonus formula; it is secondary in this regard which type of nonfinancial target is being used.
Note: Sample includes all private and public entities (corporate and BU level), excluding nonprofit organizations, for which data is available. Tabulated is the average probability of meeting nonfinancial performance targets from the following areas: Op operations, M & S market & strategy, A & IT accounting & IT, Fin finance, T teamwork, S sustainability (see the notes of Table 6 for more detailed descriptions).
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In summary, the recession did have a strong effect on annual bonus plans and performance targets therein. Many companies (especially larger ones) increased bonus weights on earnings and other financial measures of performance. Also, earnings targets became difficult to achieve in part because companies were reluctant to set negative targets even if they were often more realistic than zero or just-above-zero earnings targets. Nonfinancial performance targets remained achievable which may have further increased the pressure to focus on short-term financial results. Although our data does not speak to the effectiveness of companies bonus plans, it seems that an abnormally high emphasis on earnings, cash-flow, and other financial results crucial for survival is justifiable during a crisis. Nevertheless, companies that want to be well positioned to benefit from a postrecessionary rebound in the economy cannot afford to overemphasize short-term financial results and curtail investing in long-term projects for long. Accordingly, executive bonus plans should more effectively balance financial targets with nonfinancial performance indicators that are often better reflective of long-term business success. Our survey findings are consistent with this expectation. Many companies that had increased bonus weights on financial performance measures during the recession dialed them down again in 2010. Also, earnings targets were much more likely to be achieved than during the recession and their average difficulty was comparable to the difficulty of nonfinancial targets, which restored the balance between the different types of targets and encouraged focus on short-term financial goals without neglecting the long-term. Combined, this evidence suggests that our sample companies are well on the way to recover from the adverse effects of one of the worst recession in recent memory.
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Please contact me if you wish to share your experiences, make any comments or critical suggestions, or otherwise contribute to ongoing research on the role of CFOs and controllers in today's business environment.
Michal Matjka W.P. Carey School of Business Arizona State University P.O. Box 873606 Tempe, AZ 85287-3606 Phone: 480-965-7984 E-mail: Michal.Matejka@asu.edu