So, after several rough years, pay levels are moving back on track–at least from a senior executive's perspective. This must be comforting to finance chiefs who, thanks to the Sarbanes-Oxley Act, have certainly been on the firing line for the past several years–even as their compensation seemed to be losing ground or at the very least, standing still.

Some reasons for the jump–the recovery of the U.S. economy and equity market–are somewhat obvious. But a less apparent source of the momentum relates to pure supply and demand–there just aren't that many candidates with the financial expertise and willingness to take on the responsibility and increased liability. "CFOs are pretty hot tickets right now in terms of recruiting," says Paula Todd, a managing principal at Towers Perrin. "More CFOs seem to be making it to the top five [highest paid officers in a proxy], often coming in ahead of a lot of off-the-line execs?? 1/2 I'm sure the savvy ones are having bargaining leverage when they're recruited."

COMPLIANCE PROVIDES BOOST

The need to report on financial controls offers CFOs–as well as treasurers, controllers and other key members of the finance team–a unique vantage point from which to offer guidance about their company's financial structure and soundness. That also helps explain the sharp rises in compensation for controllers and treasurers in 2004, also culled from the Pearl Meyer survey, which shows non-option compensation surged 37% to $797,000 on average for controllers and 19% to $682,000 for treasurers.

But besides moving up, finance executive compensation packages have been changing, particularly when it comes to the use of options and other long-term compensation, as companies prepare for option expensing requirements. Last year IBM Corp. won praise for overhauling its equity compensation program, putting in place a performance feature tied to share price appreciation for most annual equity awards and granting stock options only to senior executives who first buy IBM shares with a portion of their annual bonus. And several other large companies, including Merrill Lynch & Co., American Express Co. and Time Warner Inc., have recently said they have either eliminated or plan to cut back on option grants. "Option values tended to be down [in 2004], because the size of the grants were lower, but it was offset by rising stock prices on a Black-Scholes valuation," says Jannice Koors at Pearl Meyer. But for those companies that have not yet made changes, last month's postponement by the Securities and Exchange Commission (SEC) of the stock option expensing deadline is likely to become the excuse for putting off consideration of their compensation plans until after the final rules go into effect.

In the case of Motorola's Devonshire and many others, options still comprise a large part of certain large company pay packages. Lehman Brothers Holdings Inc.'s CFO David Goldfarb received options valued at more than $7 million last year, according to proxy statement research by Equilar. Gap Inc.'s Byron Pollitt earned 81% of his $4.98 million in compensation in the form of options.

Scrutiny over outsized pay packages at the CEO level has been trickling down to other senior officers, a trend that will accelerate for CFOs as they rise up the pay scales. "Performance-based pay is the hot topic this proxy season," says Pat McGurn, special counsel and executive vice president of corporate governance group Institutional Shareholder Services. "Before this year, most [shareholder] pay proposals were cap proposals–[capping] the pay for CEOs at X-times the lowest paid employee, or limiting awards. Now, proposals include [adding] more performance measures to existing pay packages, baking substantial performance into their pay plans." There are clear benefits to senior financial executives from the emphasis on restricted shares over stock options. "Restricted grants are to a certain degree more valuable because you don't have to think about when to exercise them," says Allen Geller, a managing director at Raines International, an executive search firm. There is always the risk with options that they could be underwater at the time when they become eligible to be exercised, a risk that restricted stock does not carry. Some have criticized restricted stock grants that do not carry other conditions, however, calling them pay-for-hanging-around rather than pay-for-performance.

With an increase in shareholder activity, compensation experts say performance requirements are being considered, and put in place, more frequently. "The [earlier] move to restricted stock was a honeymoon period, without a lot of pressure," says Daniel Marcus, a principal and senior executive compensation consultant at Mercer Human Resource Consulting. "Compensation committees are spending enormously more time on performance goals, putting it in place and asking if it's reasonable from a shareholder perspective." Marcus is also seeing more and more CFOs being called upon by compensation committees to help structure these goals, tapping into their financial expertise and drawing insights into shareholder perspectives.

Structuring a pay-for-performance plan involves many choices. "The things that are most complicated to address are performance requirements, the right measures to use and how [to] set long-term goals for executives, especially in a cyclical business," says Seymour Burchman, senior vice president at Sibson Consulting. "Our view is you need to design plans that make sense for your company." A company in a turnaround situation is likely to pay more to attract and keep star-quality talent than is a more stable company.

Burchman, like most compensation analysts, doesn't think options will go away entirely. For some companies, especially young startups that need to rely more on leverage than cash, a 100% option plan may still make sense, even under the new expensing rules.

CUSTOM-MADE TO FIT

The performance goals attached to restricted shares can vary widely as well. Darren Jackson, CFO of Best Buy Co., received 35,250 restricted shares in the company's fiscal year ending February 2004, with 71.6% vesting in line with certain performance indicators tied to either the level of the common stock or other unstated goals, according to the proxy. McDonald's Corp. CFO Matthew Paull's grant is similarly tied to target levels of diluted earnings per share growth during the vesting period. Doreen Toben, CFO at Verizon Communications Inc., received $1.9 million in restricted shares that vest in three years, subject to Verizon's total shareholder return relative to that of other companies.

The drive for more balance between pay and performance will no doubt continue, but it will be only one of several factors determining where compensation goes from here. "One of the things CFOs have on their side is [the fact that] they are being asked to do much more," says John Challenger, CEO at Challenger Gray & Christmas Inc., the Chicago-based outplacement consulting firm. "I do think CFOs have some advantages in their negotiations."