CFOs and other top finance executives face a particularly tricky situation. On the one hand, while the outlook for compensation is weak, they may be in a better bargaining position than their peers in other senior positions. That's because the role of CFOs and treasurers in securing financing and managing capital has perhaps never been as important. "CFOs are in the driver's seat," says Paula Todd, managing principal with Towers Perrin, a Stamford, Conn.-based human resources consulting firm. For that reason, she feels compensation committees are likely to give CFOs and treasurers priority when allotting pay. Indeed, more companies are considering such special retention arrangements as cash contributions made to deferred compensation accounts for CFOs than for other top executives, according to David Swinford, president and CEO of Pearl Meyer & Partners, a New York-based compensation consulting firm.

But, that increased importance may be a double-edged sword. Todd Gershkowitz, a senior vice president at Farient Advisors, a New York-based compensation consulting firm, points to an increase in CFO turnover, which he attributes to companies' increasingly high expectations for finance executives. "Their reputations are on the line more than ever," he says.

For 2008, the primary driver of declining compensation for CFOs was annual performance-based bonuses. Treasury & Risk commissioned a study of the compensation of 50 Fortune 500 CFOs from Equilar, a Redwood Shores, Calif.-based executive compensation research firm, that shows median total compensation dropped 10.5% to $4.696 million, from $5.246 million in 2007, for the 30 CFOs in office for at least two years. But, a closer look shows base salary actually increased 7.3%, to $783,334, while aggregate bonus compensation–including discretionary, annual performance-based and long-term bonuses–dropped 23.3%, to $1.121 million. And annual bonuses plummeted from $897,050 to $522,550–a 41.7% decline.

Drops in compensation weren't across the board, however. At some companies, pay went up due to hefty stock awards. Peter Oppenheimer, CFO of Apple Computer, saw his compensation grow by 1,037% , thanks to a $19 million restricted stock award. Without that grant, his pay would have gone down. In other cases, compensation rose at businesses with a fiscal year ending before the September meltdown. At Oracle, whose fiscal year ends May 8, President and then-CFO Safra Catz received a 41% increase in pay. Thomas Staggs, CFO of Walt Disney, was given a 63% raise; the fiscal year at that company ends Sept. 8.

Such largesse is unlikely to recur because "2009 is going to be a big time for change in pay practices," says Alexander Cwirko-Godycki, research manager at Equilar. "Now that companies have had a chance to better understand the economic environment, they'll be designing pay packages accordingly."

That's an understatement. Recent surveys of company pay practices reveal a spate of salary freezes and, in some cases, reductions. For example, in a survey of 145 companies conducted by Watson Wyatt Worldwide in March, 55% of companies said they were freezing executive salaries, compared to 12% in a similar poll conducted in December. Also, 10% were reducing pay, while just 2% had done so three months earlier. Another 13% said they expected to cut compensation or were considering it. And one-third expected the dollar value of long-term compensation to decrease; the average drop was 35%.

"Companies that were talking about 4% to 5% increases in October are now talking about freezes," says Pearl Meyer's Swinford. As financial results continue to suffer, the decline in annual performance bonuses is likely to accelerate, especially in hard-hit industries such as retail and construction. "I wouldn't say bonuses will disappear," says Eric Hosken, client partner at Executive Compensation Advisors, a compensation consulting arm of Korn/Ferry International. "But they won't meet their target." If, for example, a CFO's target is 75% of base salary, he or she is likely to receive an amount more on the order of 50%.

At the same time, compensation committees are struggling to determine just what those targets should be. Steven Hall, managing director of Steven Hall & Partners, a New York-based compensation consulting firm, says many companies, uncertain of the economic outlook, are putting off making a definite decision. "They're setting targets, but with the discretion to move the numbers up or down, depending on results," he says.

But it's in the area of long-term compensation where experts expect the biggest cutbacks. The reason: the plummeting value of stock options. At about two-thirds of public companies, more than 75% of outstanding stock options are underwater or worthless, according to a recent survey by Grant Thornton, an audit and tax advisory firm.

In some cases, corporations are planning to increase the number of shares to make up for options' lost value. But, "most companies don't have enough shares approved by the shareholders to do that," says Hall. In that case, their only alternative is to ask shareholders to OK the granting of more stock–something they're often not willing to do. It's more common for companies to freeze the number of shares to the level during the previous year, replace them with restricted stock or make up part of the value through performance-based cash payments.

The most controversial method is the use of repricing, or "underwater options exchange," as it's now more commonly called. Generally, that means either awarding a lower number of new options at the current stock price, allowing executives to recoup some of the lost value, or permitting a one-to-one exchange. It's a cumbersome and tricky process that generally requires getting shareholder approval–and explaining to them why it's necessary.

For that reason, repricing is easiest for companies that don't need an OK from shareholders. Earlier this year, Google announced a voluntary program allowing employees–including senior executives–to exchange some or all of their options for the same number of new options at market value, with a vesting schedule extending the original by 12 months. But, according to Towers Perrin's Todd, the company didn't need shareholder approval, thanks to a stipulation in its plan allowing management to do so.

Still, 26 companies repriced or exchanged their options in the first three months of this year, according to Equilar. Another 11 completed exchange programs at the start of April and 46 have proposed taking such a step. Experts expect more to do so over the next year. "If the downturn continues, people are going to look more seriously at it," says Hall. In fact, more than half the companies surveyed by Grant Thornton reported putting in place a program to reprice options, or said they are considering making such a move.

For many companies, determining the right long-term incentive approach is even tougher than pinpointing annual bonus levels. "They're asking, how can we change our plan when we're not sure where the world is going," says Hall. And they're afraid to ask shareholders for permission to make controversial moves when they can't be sure that longer-term economic trends will bear out the need for them. He points to one client that, after weeks of work, was ready to include in the company proxy a request for more stock, only to pull back at the last minute. "They felt, what if the stock comes back. Maybe we've got enough for this year," he says.

The other area in the spotlight is severance, particularly tax gross-ups. These payments, made by companies to cover taxes on an executive's severance package, can inflate golden parachute payments considerably. According to RiskMetrics, which recently studied change-in-control provisions at 329 companies, the average payment to top executives with the benefit was $72.5 million, 65% higher than the average at corporations not providing a gross-up. Some companies are reducing the multiple from three years of service to one year, according to Todd. In other cases, they're getting rid of it altogether. Recently EMC, Fortune Brands and Colgate-Palmolive eliminated their tax gross-ups, and she expects many more to follow suit over the next year.

But, of course, poor results aren't the only reasons for looming changes in compensation levels and structure. Another is the public fury over exorbitant pay, especially the recent outcry over retention bonuses paid to AIG executives, and the fear of becoming the next target of media and shareholder wrath. "It's going to get tougher and tougher going forward," says Hall. "There will be more scrutiny, more of a need to justify what they're doing to shareholder groups."

Take, for example, the issue of discretionary bonuses. Few companies are likely to give any over the next year, according to Randy Ramirez, regional practice leader in the human capital consulting practice of BDO Seidman, a Chicago-based tax and financial services advisory firm. He points to a struggling global manufacturer of specialized materials that recently decided not to award such bonuses even to the highest-performing top executives. "They don't want to be on the front page of the paper for giving $500 million in bonuses when their results aren't great," he says.

Then there's the potential trickle-down effect from restrictions placed on financial services companies receiving money through the Troubled Assets Relief Program (TARP). In its most recent version, the legislation prohibits cash bonuses to senior officers of companies receiving TARP funds other than grants of long-term restricted stock, which can vest only after the company pays back its TARP obligations and can exceed no more than one-third of total compensation. At companies receiving more than $500 million in aid, the limits apply to the top five executives and at least 20 of the next most highly compensated employees. At companies getting less money, fewer executives have to comply. The legislation also prohibits severance payments for top executives, as well as compensation plans that "would encourage manipulation of the reported earnings . . . to enhance the compensation" for any employee. And there's a $500,000 cap on the tax deductibility of the salaries of top executives.

How will these restrictions affect non-financial companies? One area is "say on pay." The stimulus bill directs the Securities and Exchange Commission (SEC) to issue final rules on non-binding say on pay votes within one year. The decision, which would apply to all companies receiving TARP money, is likely to be in place before the 2010 proxy season. As for the current season, there are more than 100 shareholder proposals asking companies to adopt say on pay provisions, up from 76 in 2008, according to RiskMetrics.

Some companies are taking preemptive action. For example, Amgen's proxy pointed shareholders to an online survey about performance goals; results will be posted after the company's May shareholder meeting. Prudential Financial created a link on its Web site to permit investors to comment on its compensation plan. "It's better to manage your shareholders now than to wait for them to take action," says Steve Van Putten, U.S. east division practice leader of Watson Wyatt's executive compensation consulting practice. Perhaps most important, experts expect Congress to pass legislation mandating say on pay for all public companies this year.

Another concern is compensation that encourages excessive risk-taking. Few companies have the same compensation structure as financial services firms, in which a large percentage of pay is determined by short-term results. Still, the relationship between how compensation is awarded and the potential for taking imprudent risks, according to experts, is topic No. 1 among compensation committees. In particular, the buzz is about how to find the right balance. "Huge bonuses on short-term results are going to aggravate risk-taking behavior," says Van Putten.

The proposed solutions vary widely. In some cases, they involve putting more into fixed pay and less into incentives, according to Todd. Another cutting-edge approach is "bonus banking," in which executives receive their entire bonus only if the company meets performance expectations over a specific period of time. Then there's the possibility of a hold-till-retirement provision, allowing executives to take ownership of shares only when they retire, or a move to performance-based stock programs, in which shares vest only if performance goals are reached, rather than granting options based on amount of time at a company, what Van Putten calls "pay for pulse."

Perhaps the most significant step being discussed is clawback provisions. According to Watson Wyatt, 23% of companies surveyed in March had instituted provisions to recover cash and stock incentives in cases where financials have been misstated, up from 13% in December. "They make sure that people think twice about the long-term implications of their decisions," says Gershkowitz.

But there's one potentially significant drawback to many of these measures: unintended consequences. Critics point to federal legislation in the early 1990s that mandated a $1 million cap on salary deductions for companies. After that, salary levels dropped and long-term incentive pay went up. "Just because you cap something doesn't mean another problem doesn't spring out someplace else," says Todd. For example, TARP legislation nixing compensation plans that could "encourage the manipulation of reported earnings" might end up eliminating any incentives tied to performance measurements. Companies receiving TARP funds might pay back their bailout money before they're ready to escape compensation restrictions. And hold-till-retirement provisions could entice high-performing individuals to leave their companies early if that's the only way to get access to their shares.

The bottom line: When it comes to compensation in the current environment, no one's crystal ball is infallible. There are just too many unknowns.

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