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Performance Targets in CFO Compensation

An International Comparison
by Michal Matějka W. P. Carey School of Business Arizona State University

2011

2011 PERFORMANCE TARGETS IN CFO COMPENSATION: AN INTERNATIONAL COMPARISON This research project was supported by the American Institute of Certified Public Accountants (AICPA), Internationaler Controller Verein (ICV), and Associazione Nazionale Direttori Amministrativi e Finanziari (ANDAF). It was the result of a collaboration with research teams in Germany and Italy including Prof. Dr. Dr. h. u n , Dr. Matthias Mahlendorf, Ludwig Voußem, Jochen Rehring, and Prof. Angelo Riccaboni. We thank all survey respondents whose participation made this project possible.

©2011, Mi hal Matějka

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Table of Contents

Executive Summary Survey Sample and Background Compensation Performance Targets

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2011 PERFORMANCE TARGETS IN CFO COMPENSATION: AN INTERNATIONAL COMPARISON

Executive Summary
This report combines data on CFO compensation and incentives from three different countries. Two surveys in the U.S. and Germany were conducted March–April 2011 and one survey took place in Italy during October–November 2009. Although, in total, more than 1,600 CEOs, CFOs, controllers, and other executives participated in these surveys, for most of this report we only use a subset of the data specific to CFOs or financial executives directly reporting to CFOs. The main findings are as follows:1 CFO annual base salaries were relatively similar across the three countries. In Europe, salaries typically ranged from a low of $98,000 to a median of around $125,000. In the U.S., typical salaries were about 15% higher ranging from a low of $114,000 to a median of about $143,000. At the same time, incentive compensation of CFOs in the U.S. was greater than in Europe (see Table 1, page 8). Annual cash bonuses were the main component of incentive compensation in all countries. In particular, 71% of CFOs in U.S. private companies received annual bonuses in 2010, 5% received a payout from multi-year cash bonus plans and 13% were paid some equity compensation. In contrast, CFOs in Europe had no multi-year cash bonus or equity compensation plans and 66% of 38 the corporate CFOs in Germany and 58% of the 19 corporate CFOs participating in Italy were eligible for a bonus. Annual bonuses of corporate CFOs in U.S. and Italian private companies were awarded subjectively to a great extent. On average, 46% of CFO bonuses in U.S. private companies was contingent on meeting explicit financial targets and 39% was determined subjectively. Similarly, in Italy, 51% of CFO bonuses was contingent on financial targets and 35% was determined subjectively. In contrast, in German private companies and in U.S. public companies 69% and 73% of CFO bonuses, respectively, was contingent on financial performance targets and only 14% and 11% was determined subjectively (see Table 4, page 11).

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Compensation in Euros was onv t d to U S dolla s usin

x han

at €1 = US $1 4

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Bonus plans of business unit CFOs of U.S. private companies put relatively little weight on higher level financial targets such as business group or company earnings. Specifically, in private U.S. companies on average only 6% of business unit CFO bonuses was contingent on higher level financial targets as compared to 19% in German private companies and 22% in U.S. public companies (see Table 5, page 12). Compared to the U.S., CFO bonus plans in Germany were much more likely to include specific nonfinancial or individual objectives. For example, 35% and 24% of German companies made at least 10% of corporate CFO bonuses contingent on meeting operations or accounting & IT targets, respectively, while the corresponding percentages in the U.S. were 10% and 9% (see Table 6, page 13). When evaluating performance of financial executives at all levels (not just CFOs), 97% of 490 U.S. companies used an earnings target, 56% used some other financial performance target, 12% used an operations target, and 10% used at least one accounting & IT targets. For comparison, 79% of German companies used an earnings target, 43% used some other financial performance target, 46% used nonfinancial targets related to accounting & IT, 45% used some operations targets, and 19% teamwork targets (see Table 7, page 14). Both financial and nonfinancial performance targets in U.S. companies were relatively difficult to achieve. Specifically, the average likelihood of achieving an earnings target in the U.S. was 62% and the chance of achieving other financial targets was even lower at 51%. In Germany, the corresponding likelihoods were both above 70%. Similarly, the likelihood of achieving the three most common groups of nonfinancial targets in the U.S. ranged 74–79%, while the three most common groups in Germany had the likelihood around 84% (see Table 7, page 14).

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Survey Samples and Background
Data used in this report come from three separate surveys conducted in the U.S., Germany, and Italy. In the U.S., 999 AICPA members active in business and industry as financial executives participated in a survey conducted during March–April 2011.2 In Germany, the survey also took place during March–April 2011 and a majority of the 452 participants were ICV members in various financial executive positions. The survey in Italy took place during October–November 2009 and 228 ANDAF members, mainly CFOs, participated. Most of the analysis in this report is specific to subsamples of these three surveys consisting of financial executives who are either CFOs at the corporate or business unit level, or who directly report to CFOs. As a result, the samples analyzed in this report are smaller than the total number of participants. All three surveys included the same questions (translated in German and Italian) about compensation, incentives, and the choice of performance measures in annual bonus plans. In addition, the U.S. and German surveys collected detailed information about the type of nonfinancial performance measures used and perceived difficulty of targets. Therefore, in what follows, we first compare total compensation levels across the three countries. Subsequently, we discuss the relative importance of various performance targets in CFO annual bonus plans and compare difficulty of different targets.

Fo mo d tails a din th U S su v y, s th “2011 CFO Compensation Survey” http://wpcarey.asu.edu/incentives/2011-results.
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po t availa l at

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Compensation
This section compares compensation of financial executives in the U.S., Germany, and Italy. Specifically, Table 1 reports compensation of corporate CFOs in private companies, Table 2 reports compensation of CFOs in business units of private companies, and Table 3 reports compensation of other financial executives directly reporting to corporate CFOs in private companies (there is not enough data on public companies to present similar comparisons) To the extent possible the samples compared are selected so that companies are similar in terms of sales volume. Compensation and sales reported in Euros are converted to U.S. dolla s usin x han at €1 = US $1 4 Th is no adjustm nt fo differences in income taxes or the cost of living. All surveys collected information on (i) annual base salaries, (ii) annual cash bonuses, (iii) multi-year cash bonuses, and (iv) equity compensation. However, for a large majority of financial executives in private companies incentive pay came solely in the form of annual cash bonuses. For example, while 71% of 298 CFOs in U.S. private companies received annual bonuses in 2010, only 5% of them received a payout from multi-year cash bonus plans and 13% were paid some equity compensation. For comparison, CFOs in Europe had no multi-year cash bonus or equity compensation plans and 66% of 38 the corporate CFOs in Germany and 58% of the 19 corporate CFOs participating in Italy were eligible for a bonus. Therefore, Tables 1–3 compare only annual salaries and bonuses. All tables in this section present the low, median, and high compensation to describe va iation within a h ount y “Low” is measured as the 25th percentile—i.e., not the overall lowest compensation but the one ranked 25th lowest out of 100, median and high values are measured similarly as the 50th and 75th percentiles, respectively. We also present median sales for each of the subsamples so that differences in size can be taken into account whenever it is not possible to control for size by sample selection.

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Overall, Table 1 suggests that CFO annual base salaries were relatively similar across the three countries. In Europe, salaries typically ranged from a low of $98,000 to a median of around $125,000. In the U.S., typical salaries were about 15% higher ranging from a low of $114,000 to a median of about $143,000. The main difference was that, in the U.S., a greater proportion of o po at CFOs’ total compensation was paid out as a bonus contingent on performance. For example, the median CFO bonus in the U.S. was $20,000 (14% of salary), while it was only $6,300 in Germany (5% of salary) and zero in Italy. This difference may even be understated to the extent that, compared to Germany, many U.S. companies were slower to recover from the recession and their 2010 bonuses were still below long-run averages.

Table 1. Compensation of Corporate CFOs
Panel A. Private Companies in the U.S. Sample size Salary Bonus Sales (in Millions) Low 298 114,000 0 21 Median 298 142,890 20,000 45 High 298 190,000 46,000 100

Panel B. Private Companies in Germany Sample size Salary Bonus Sales (in Millions) Panel C. Private Companies in Italy Sample size Salary Bonus Sales (in Millions) Low 19 98,000 0 21 Median 19 126,000 0 42 High 19 182,000 16,800 98 Low 38 98,000 0 28 Median 38 122,500 6,300 47 High 38 147,000 21,000 92

Notes: Panel A and B report on 2010 Compensation in the U.S. and Germany. Panel C reports on 2008 Compensation in Italy wh th su v y took pla a li “Low” is measured as the 25th percentile (i.e., not the overall lowest compensation but the highest from the low 25% in the sample), median and high values are measured similarly as the 50th and 75th percentiles, respectively. Information on multi-year cash bonus, equity incentives, and other compensation is not reported because low, median, and high values were zero in all samples.

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Table 2 compares compensation of CFOs at the business unit level. In the U.S. and Germany, annual salaries were similar to those of corporate CFOs mainly because the participating business units were larger than companies where corporate CFOs participated. We do not make any comparisons with Italy, where the sample is very small and likely not representative. Table 2 also shows some differences between the U.S. and Germany with respect to incentive compensation at the business unit level. In particular, unlike at the corporate level, the low and median bonuses in the U.S. and Germany were comparable. Still, the typical high bonus of $50,000 (29% of salary) in the U.S. was greater than the high of $32,200 (19% of salary) in Germany.

Table 2. Compensation of CFOs at the Business Unit Level
Panel A. Private Companies in the U.S. Sample size Salary Bonus Sales (in Millions) Low 27 110,000 3,000 30 Median 27 140,000 12,000 67 High 27 175,000 50,000 300

Panel B. Private Companies in Germany Sample size Salary Bonus Sales (in Millions) Panel C. Private Companies in Italy Low Sample size Salary Bonus Sales (in Millions) 4 154,700 15,400 95 Median 4 179,200 46,900 133 High 4 196,000 66,500 161 Low 25 102,200 2,940 32 Median 25 126,000 16,800 79 High 25 168,000 32,200 140

Notes: Panel A and B report on 2010 Compensation in the U.S. and Germany. Panel C reports on 2008 Compensation in Italy wh th su v y took pla a li “Low” is m asu d as th 25th p ntil (i , not th ov all low st compensation but the highest from the low 25% in the sample), median and high values are measured similarly as the 50th and 75th percentiles, respectively. Information on multi-year cash bonus, equity incentives, and other compensation is not reported because low, median, and high values were zero in all samples.

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Table 3 compares compensation of other financial executives directly reporting to corporate CFOs. As in Table 2, annual salaries were similar to CFO salaries, participating companies were larger, and there was not enough data to make comparisons with Italy. We find again that although the median bonus was similar in the U.S. and Germany (about 7% of salary), the typical high salary and bonus were greater in the U.S.—$170,000 in salary and $35,000 in bonus (21% of salary) as compared to $134,400 and $21,000 (16% of salary) in Germany.

Table 3. Compensation of Corporate Financial Executives Reporting to CFOs
Panel A. Private Companies in the U.S. Sample size Salary Bonus Sales (in Millions) Low 79 99,000 0 56 Median 79 129,000 9,400 170 High 79 170,000 35,000 500

Panel B. Private Companies in Germany Sample size Salary Bonus Sales (in Millions) Panel C. Private Companies in Italy Low Sample size Salary Bonus Sales (in Millions) 5 63,000 0 42 Median 5 70,000 0 84 High 5 99,400 11,200 2,100 Low 117 91,000 0 69 Median 117 112,000 8,400 158 High 117 134,400 21,000 490

Notes: Panel A and B report on 2010 Compensation in the U.S. and Germany. Panel C reports on 2008 Compensation in Italy wh th su v y took pla a li “Low” is m asu d as th 25th p ntil (i , not th ov all low st compensation but the highest from the low 25% in the sample), median and high values are measured similarly as the 50th and 75th percentiles, respectively. Information on multi-year cash bonus, equity incentives, and other compensation is not reported because low, median, and high values were zero in all samples.

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Performance Targets
When awarding annual bonuses, companies can evaluate performance relative to (i) financial targets (e.g., earnings or sales), (ii) objective nonfinancial targets (e.g., customer satisfaction, quality, safety), or (iii) rely on subjective evaluations without pre-set targets (discretionary bonuses). Using this distinction, this section examines how companies in the U.S., Germany, and Italy award bonuses to their CFOs. To assure comparability, we exclude nonprofit entities and separately report on performance targets of corporate CFOs (Table 4) and CFOs at the business unit level (Table 5). Table 4 shows a striking difference between private and public companies in the U.S. regarding the emphasis on financial performance targets in corporate CFO bonus plans. The average bonus weight on financial performance targets was 73% in public as compared to 46% in private companies. Correspondingly, 39% of CFO bonuses in private companies was determined subjectively as opposed to only 11% in public companies. In this regard, U.S. private companies were similar to Italian private companies where subjective evaluations accounted for 35% of CFO bonuses. In contrast, German private companies were much like U.S. public companies in that 69% of CFO bonuses was contingent on financial performance targets and only 14% was determined subjectively. In

Table 4. Performance Targets in Corporate CFO Bonus Plans
Type of Company Sample size Financial targets Nonfinancial targets Subjective Other Sales (in Millions) U.S. Public 24 73.3% 10.4% 11.4% 4.9% 287 U.S. Private 281 45.7% 10.7% 39.2% 4.4% 45 German Private 30 69.4% 16.3% 13.7% 0.7% 67 Italian Private 24 50.6% 14.2% 35.2% 0.0% 169

Notes: Tabulated is the percentage breakdown of total bonus paid to CFOs for meeting each of the listed performance targets. Nonfinancial targets also in lud sp ifi individual o j tiv s “Oth ” may in lud ompany -wide bonuses or fixed bonuses specified in an employment contract.

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both European countries, there was also a greater emphasis on specific nonfinancial targets than in the U.S. In addition to performance targets described in Table 4, business units commonly make bonuses contingent on meeting higher-level (company or business group) financial targets. Table 5 compares the relative importance of these and other performance targets in annual bonus plans of CFOs at the business unit level. Specifically, Table 5 shows that the combined bonus weight on business unit and higherlevel financial performance targets was greater in public companies (63%) than in private companies (51% in the U.S. and 52% in Germany). In addition, bonus plans in U.S. private companies put relatively little weight on higher level performance targets (6% as compared to 19% in German private companies and 22% in U.S. public companies). Similar to Table 4, German companies put greater bonus weights on specific nonfinancial targets than public or private U.S. companies did. Table 6 provides more details regarding the various nonfinancial performance targets used in corporate CFO bonus plans. The table aggregates across public and private companies because the differences between them were not very large. 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. Table 5. Performance Targets in Bonus Plans of Business Unit CFOs
Type of Company Sample size Financial targets Higher-level fin. targets Nonfinancial targets Subjective Other Sales (in Millions) U.S. Public 34 41.5% 21.9% 18.6% 14.0% 4.0% 215 U.S. Private 27 44.3% 6.3% 13.5% 24.8% 11.1% 67 German Private 25 33.2% 19.2% 28.8% 19.6% 0.0% 79 Italian Private
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Notes: Tabulated is the percentage breakdown of total bonus paid to CFOs for meeting each of the listed performance targets. Higher-level financial targets include business group or company performance. Nonfinancial targets also include specific individual objectiv s “Oth ” may in lud ompany-wide bonuses or fixed bonuses specified in an employment contract.

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In particular, Panel A of Table 6 shows that bonus plans of corporate CFOs in Germany were more likely to include operations targets (e.g., quality, safety, process improvement, or cost control) and accounting & IT targets (e.g., efficiency of internal and external reporting, ERP system implementation). For example, 35% and 24% of German companies made at least 10% of corporate CFO bonuses contingent on meeting operations and accounting & IT targets, respectively, while the corresponding percentages in the U.S. were Table 6. Frequency of Various Nonfinancial Targets in CFO Bonus Plans
Panel A. Corporate CFO Bonus Plans Targets used Sample size Operations Market & Strategy Accounting & IT Finance Teamwork Sustainability Sales (in Millions) Used 246 14.6% 10.6% 15.0% 12.2% 8.9% 3.3% 75 U.S. 10%+ 246 10.2% 8.5% 8.9% 6.5% 4.1% 2.0% 75 20%+ 246 7.7% 6.5% 5.3% 3.7% 0.8% 0.8% 75 Used 29 37.9% 17.2% 31.0% 10.3% 0.0% 0.0% 63 Germany 10%+ 29 34.5% 13.8% 24.1% 10.3% 0.0% 0.0% 63 20%+ 29 20.7% 6.9% 13.8% 3.4% 0.0% 0.0% 63

Panel B. Business Unit CFO Bonus Plans Targets used Sample size Operations Market & Strategy Accounting & IT Finance Teamwork Sustainability Sales (in Millions) Used 55 27.3% 18.2% 12.7% 10.9% 14.5% 1.8% 120 U.S. 10%+ 55 21.8% 12.7% 5.5% 5.5% 7.3% 1.8% 120 20%+ 55 18.2% 9.1% 3.6% 3.6% 3.6% 0.0% 120 Used 33 63.6% 9.1% 60.6% 18.2% 30.3% 3.0% 112 Germany 10%+ 33 33.3% 6.1% 42.4% 9.1% 18.2% 3.0% 112 20%+ 33 24.2% 6.1% 30.3% 0.0% 6.1% 3.0% 112

Notes: Tabulated are percentages of companies that used at least one nonfinancial performance target from the listed categories in their CFO bonus plans. “Us d” f s to usa of nonfinan ial ta ts that a ount d fo l ss than 10% of th onus oppo tunity, “10%+” f s to ta ts a ountin fo 10–19% of th onus oppo tunity, and “20%+” f s to targets accounting for 20% or more of CFO bonuses. “Operations” in lud s targets pertaining to, for example, efficiency, quality, safety, process improvement, or cost control. “Market & Strategy” in lud s ta ts su h as ma k t sha , ustom satisfaction, business development milestones. “Accounting & IT” fers to timeliness and efficiency of internal and external reporting, ERP system implementation, software upgrades, o mana m nt satisfa tion “Finance” f s to working capital management, capex planning, M&A deals, divestitures, or investor relations. “Teamwork” f s to employee turnover, leadership, or collaboration & communication “Sustaina ility” f s to energy use, emissions, social reporting, or stakeholder satisfaction.

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10% and 9%. On the other hand, none of the 29 German companies with available data used teamwork or sustainability targets in their corporate CFO bonus plans, while at least a small percentage of U.S. companies did so. Panel B of Table 6 reports on bonus plans of business unit CFOs. As in Panel A, German companies were much more likely to use operations targets and accounting & IT targets than U.S. companies. Moreover, teamwork targets at the business unit level were more common in Germany than in the U.S. even though the reverse was true at the corporate level. Table 7 shows another way to assess the use of nonfinancial performance targets. Unlike prior tables, it covers all participating financial executives not just CFOs and thus describes the frequency of various targets in a much broader sample. When evaluating performance of financial executives, 97% of 490 U.S. companies used an earnings target, 56% used some other financial performance target, 12% used an operations target, and 10% used at least one accounting & IT targets. German companies relied somewhat less on financial targets and much more on nonfinancial targets related to accounting & IT (46%), operations (45%), and teamwork (19%). Table 7 further shows that both financial and nonfinancial performance targets in U.S. companies were relatively difficult to achieve. Specifically, the average likelihood of Table 7. Frequency and Difficulty of Performance Targets
Targets used Earnings Other Financial Operations Market & Strategy Accounting & IT Finance Teamwork Sustainability N 473 272 60 38 49 36 38 8 U.S. Used by 96.5% 55.5% 12.2% 7.8% 10.0% 7.3% 7.8% 1.6% Difficulty 61.8% 51.0% 74.4% 73.7% 78.7% 76.9% 79.5% 81.3% N 249 136 142 37 145 24 60 15 Germany Used by Difficulty 79.0% 73.7% 43.2% 70.4% 45.1% 84.1% 11.7% 78.5% 46.0% 84.9% 7.6% 71.9% 19.0% 84.0% 4.8% 83.0%

Notes: The table is based on responses of 490 financial executives (not just CFOs) in the U.S. and 315 financial executive in Germany who estimated the likelihood of achieving at least one of the targets above. “N” f s to th num of respondents who provided a lik lihood stimat “Us d y” is the frequency of targets, calculated as N/490 in the U.S. and N/315 in Germany “Diffi ulty” is th av a stimat d lik lihood (0–100%) that a 2011 performance target from one of the above categories will be achieved.

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achieving an earnings target in the U.S. was 62% and the chance of achieving other financial targets was even lower at 51%. In Germany, the corresponding likelihoods were both above 70%. Similarly, the likelihood of achieving the three most common groups of nonfinancial targets in the U.S. ranged 74–79%, while in Germany the likelihood for the three most common groups was around 84%. In summary, CFOs in U.S. companies can earn relatively high bonuses provided that they achieve their performance targets which are relatively challenging and typically based on financial results. At the same time, when awarding CFO bonuses, private companies in the U.S. greatly rely on subjective evaluations and discretionary bonuses. In contrast, CFOs in German companies typically earn smaller bonuses and their bonus plans often include multiple financial and nonfinancial performance targets that are relatively easy to achieve. The common use of specific individual and nonfinancial targets in Germany reduces the need for subjectivity in performance evaluations. Thus, for many U.S. and Italian private companies that greatly rely on subjective evaluations of CFO performance, it may be worth considering an increased reliance on explicit nonfinancial targets especially because survey participants from these companies reported a relatively low satisfaction with the overall design of their compensation.

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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 Matějka 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