Good CFO/Bad CFO

Passed in 2002, Sarbanes-Oxley introduced the most sweeping changes to U.S. business legislation since the 1930s. And most of the responsibility for effecting this change has fallen on CFOs, particularly insofar as sections 302 and 404 are concerned. Those sections, of course, require all public companies to report on the effectiveness of internal controls over financial reporting.

By Ed Zwirn
Wed, August 31, 2011

Passed in 2002, Sarbanes-Oxley introduced the most sweeping changes to U.S. business legislation since the 1930s. And most of the responsibility for effecting this change has fallen on CFOs, particularly insofar as sections 302 and 404 are concerned. Those sections, of course, require all public companies to report on the effectiveness of internal controls over financial reporting.

Xue Wang of Emory University's Goizueta Business School looked at 27,797 executive-year observations from the ExecuComp database between 1998 and 2005 and found that post-Sarbox compensation increased for companies with strong internal controls while decreasing for firms with weak internal controls.

Specifically, the median total compensation of CFOs at companies with strong internal controls rose 12.9% during the period, going from $1,026,584 to $1,158,927. On the other hand, members of the sample working at companies with weak controls fell 10.6%, from $771,697 to $689,932.

In contrast, total compensation for other non-CEO, non-COO executive officers held steady, both at companies with strong internal controls and weak internal controls. Using executive officers other than CFOs "allows me to isolate the effects of increased disclosure requirements from those of other contemporaneous events," Wang writes in the paper, which will appear in an upcoming Journal of Accounting Research.

The results also show, not surprisingly, that while the forced turnover rate for "good" CFOs dropped slightly during the period, going from 5.7% to 5.3%, their less-exacting colleagues had a turnover rate that rose sharply, from 7% to 11.3%.

"The difference between the two sub-samples is significant, which suggests that increased disclosure requirements improve accounting information properties to a greater degree in firms with weak internal controls, and that boards in these firms make greater use of accounting information in determining executive turnover," Wang writes.

The general economic effects of increased disclosure have been well-documented, particularly as far as capital markets are concerned. But these latest findings "present empirical evidence to support the fundamental link between disclosure and information asymmetry reduction, albeit in a different institutional setting, that of the executive labor market," says Wang.

"The mandatory internal control disclosures under SOX are a credible mechanism that effectively distinguishes good CFOs from bad ones by revealing the firm's internal control quality," the professor observes.

Originally published on www.cfoworld.com. Click here to read the original story.
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