Knowledge Center Reports

Paying the Newly Hired CFO: A Compensation Analysis

February 3, 2014

A company in search of a new CFO must decide whether to fill its vacancy by promoting a current employee or by hiring an external candidate. The decision depends on a number of factors, including the suitability of internal successors, compensation, and whether the company needs to significantly alter its strategic direction.

Equilar examined the pay of the 158 CFOs hired by the S&P 1500 companies during 2012. The results show that CFOs hired externally earned significantly more in their first year than CFOs who were promoted from within, mostly due to grants of large stock awards. This report analyzes those findings and highlights the characteristics of companies that experienced CFO turnover in 2012, including their past performance, size, and sector.

Key Findings

• External Hires Received Higher Pay. CFOs hired externally received the highest median total compensation packages across all indices of the S&P 1500 index. Large-cap companies provided the largest pay premium, paying their externally-hired CFOs 40.6% more than internally-promoted CFOs. Mid-cap and small-cap companies also spent more on outside talent, paying premiums of 20.0% and 36.6%, respectively.

• Most of the Compensation Premium Received by New Hires Came in the Form of Stock Awards. Across the S&P 1500, new hires received stock grants that were larger than those awarded to internally promoted CFOs. New hires received median stock awards of $1.37 million, $537,000, and $315,000 at large-cap, mid-cap, and small-cap companies, respectively. The corresponding median awards for internally-promoted CFOs were $584,000, $304,000, and $91,000.

• Smaller Companies Made More External Hires. Within the mid-cap and small-cap segments, companies that hired CFOs externally had lower median revenue than companies that promoted existing employees to the position of CFO. In contrast, large-cap companies that hired externally were nearly twice the size of companies that promoted from within. Small-cap companies hired 59% of their new CFOs externally, while large-cap and mid-cap companies both hired 45% of new CFOs externally.

• Low-Performance Large Companies Hired Externally, as did High-Performance Small Companies. Among large-cap companies, those that hired external CFOs had a three-year total shareholder return (TSR) of 9.0%, compared to a 14.1% TSR for those that promoted from within. Among small-cap companies, those that hired external CFOs had a three-Year TSR of 12.6%, compared to a 5.6% TSR for those that promoted from within. The difference in performance between mid-cap companies making new hires and those making new promotions was insignificant.

• Internal Promotions Were Most Concentrated in the Finance and Healthcare Sectors. Financial and Healthcare companies combined hired 19 internal CFO candidates compared to six external candidates. Other sectors combined hired 60 internal and 73 external CFO candidates.

• Not All External Hires Were CFOs at their Previous Employers. Among the 31 externally-hired CFOs who served as Named Executive Officers at a publicly-traded company during the year prior to their hire, 19 were employed as CFOs.

Methodology

Equilar reviewed data for 158 companies in the S&P 1500 index that hired or promoted a new CFO during their latest fiscal year. The group of companies included those that hired CFOs externally as well as those that promoted to the CFO position from within an organization. The following tables summarize key information pertaining to the companies in the dataset:

S&P 500

S&P MidCap 400

S&P SmallCap 600

Total Compensation

For the purposes of this analysis, total compensation was calculated as the sum of base salary, discretionary bonuses, the target value of short-term cash bonuses, restricted stock awards, stock option awards, the target value of long-term cash and equity incentives, and all other compensation. All elements of compensation including salary, bonuses, and equity awards were measured on an as-reported basis. Values for all equity awards represent the grant-date value of new awards as reported by the company.

S&P 500 CFOs hired externally received median compensation of approximately $3.6 million. Internally-promoted CFOs received median total compensation of approximately $2.1 million. This difference was less pronounced among mid-cap and small-cap companies. The pay premium received by external hires over internal promotions for large-cap, mid-cap, and small-cap companies were 40.6%, 20.0%, and 36.6%, respectively. The following chart displays median total compensation (in millions) for internal promotions and external hires in all three major segments of the S&P 1500 index.

Equity

Externally-hired CFOs received larger equity grants than their internally-promoted counterparts. Among S&P 500 companies, new hires received a median value of roughly $2 million in equity, compared to $1.1 million for internally-promoted CFOs. New hires often receive large initial equity grants in order to align their interests with those of shareholders, whereas internal candidates often already own some equity at the time of their promotion. Many companies making external hires also use stock to compensate executives for the unvested equity they sacrifice by leaving their previous employers. Cash compensation for new hires and internal promotions was similar. Interestingly, mid- and small-cap internally-promoted CFOs received more cash compensation than new hires.

Since equity awards play such a large role in determining compensation, it is useful to examine them in greater detail. Options play a minor role compared to stock awards. At the median, externally-hired large-cap CFOs received five times more stock as options than did internally-promoted. The discrepancy was similar for all indices regardless of whether a CFO was a new hire or an internal promotion. In the mid-cap and small-cap, externally-hired CFOs and internally-promoted CFOs, received no options.

Large-cap new hires received a median of $1.37 million, compared to $584,000 for internally-promoted CFOs. On a proportional basis, the difference was even more acute among small-cap companies: $315,000 for new hires compared to only $91,000 for internal promotions.

Sector Breakdown

In 2012, S&P 1500 CFOs in 2012 split evenly between new hires and internally promoted candidates, with each category totaling 79. Financial and healthcare companies strongly favored internal candidates, while most other sectors exhibited a slight preference for new hires.

Total Shareholder Return

The chart below provides the three-year total shareholder return for the companies studied prior to a CFO’s hire or promotion. While low-performance, large-cap companies were more likely to hire external CFOs, the same pattern did not hold for mid-cap and small-cap companies. There was no appreciable difference in the performance between mid-cap companies that hired externally and those that promoted internally. Among small-cap companies, there was a positive correlation between performance and external hiring. This result supports the notion that CFOs may not be held as responsible as CEOs for company performance. It is also possible that high-performing small companies hire outside talent due to optimistic aspirations and a relative lack of internal financial expertise.

Summary of Compensation Statistics

S&P 500

S&P MidCap 400

S&P SmallCap 600

Please contact Amit Batish at abatish@equilar.com for more information. Amit Batish is the Content Manager at Equilar. Data for this article was compiled by Frank Gonzalez, Senior Research Analyst. The author of the article is Nicholas Baldo, Research Analyst.