When the CFO Quits, Will Bankruptcy Follow?

Because of the superior information that top executives have, they usually are in a position to recognize if their company’s stock is headed for a decline — before the realization hits outside investors. That gives the executives a chance to resign before that happens.

But how useful is the resignation of a CEO or CFO to investors seeking indications of a possible future bankruptcy?

To answer this question, Joseph Beams of the University of New Orleans, Hua-Wei Huang of SUNY Old Westbury and Yun-Chia Yan of the University of New Orleans Department of Accounting investigated a sample of 9,942 firm years from 2008 and 2009.

Their results, to be published in an upcoming issue of Accounting and The Public Interest, “show a significant relationship between CEO and CFO resignations and the firm’s subsequent bankruptcy even after controlling for other predictors of bankruptcy.”

But not all is equal between finance chief and boss. The CFOs’ pre-bankruptcy resignation rate was found at 9.52% to be higher than that of their bosses at 7.22%.

More strikingly, Beams, Huang and Yan found that future bankruptcy and “the resignation of the CEO only (have) a significant relationship when (the) resigned CFO is not included” in their model. “This means that a CFO resignation is a greater predictor of a future bankruptcy.”

The authors suggest two possible explanations.

“It may be because the CFO is more involved in the financial aspects of the company and, therefore, in a better position to identify the impending demise,” they write. “It is also possible that both the CEO and CFO may recognize the situation but that the CEO is more likely to stay because the CEO is the top executive and the CFO may feel less obligated to hang on.”

In either case, the strong linkage between the resignation of the executive most likely to possess financial information and subsequent bankruptcy points to an inadequacy of Reg FD and other disclosure requirements, they argue,

While the SEC requires companies to report the reasons for the resignations of top executives on form 8-K, “the timeliness and completeness of the disclosures may not be adequate to protect the investing public,” they conclude. “If top executives of a company are able to predict a bankruptcy several years beforehand and prior to the public’s knowledge, there is a risk of improper disclosure.”