by Ed Zwirn

Should CFOs Get on-Board?

Aug 22, 20113 mins
IT LeadershipIT Strategy

Research says CFO directors seem to bring firms higher earnings quality & better internal control, though there are drawbacks

The percentage of CFOs serving on their companies’ own boards is not large, thanks in part to Sarbox guidelines promoting board independence. But the logic of those guidelines — which equate independence with earnings quality — may not hold true in the case of the finance chief.

It’s an old debate, of course. But it is made new in post-Sarbox terms by Jean C. Bedard and Rani Hoitash of Bentley University’s Department of Accountancy and Udi Hoitash of Northeastern University. They looked at 2004-2007 records from 7,034 publicly traded companies, and found that the 549 of them that picked their own CFOs for board seats were less likely to report internal control weaknesses as described under Sarbox Sections 302 and 404.

And in addition to being less likely to file earnings restatements, these companies with the CFO having board representation also exhibited higher accrual-based earnings quality, according to the three professors’ yet-to-be published research paper.

According to the research, the CFO board member may stand alone among C-suiters in terms of internal directors bringing beneficial results to the company.

“These effects are not due to simply having more executives in the board room, as we find that having more insiders in general on the board is actually negative to financial reporting quality and having the COO on the board does not improve financial reporting quality,” the paper states. But the CFO on the board is seen as a special case.

The ‘Downside’ of Higher Pay

One downside of having the CFO on the board, as some companies might see it, could be a better paid and more deeply entrenched CFO.

CFOs on their own boards took in 27.3 % more cash ($89,290) and 34.5% more total cash and compensation ($218,715) than their finance colleagues relegated to the outside. The mean tenure of CFOs on the board was 9.65 years, compared to 5.44 years for CFOs not ensconced in the inner sanctum.

“Recent work shows that the CFO’s importance is rising and that the impact of CFOs over certain corporate outcomes outweighs the influence of CEOs,” the paper concludes. “Our overall results suggest benefits of CFO appointment to the board of directors, which are not seen in the appointment of more executives in general or the appointment of the COO in particular.”

Concentrating on Performance

One other possible explanation observed by the authors: It may be that the “entrenchment and increased power” of director CFOs allows them “to concentrate on performing their own responsibilities in a more effective manner.”

Some background on why the finance chief gets special attention from the researchers is worth noting. In fact, the entire 38-page report could be of great interest to CFOs.

“In focusing on CFO board membership, we build on research recognizing that the role and importance of CFOs has grown relative to other corporate officers,” the researchers say, citing some past work. “However, very few studies of corporate governance differentiate CFOs as board insiders from other corporate officers. Treating top management as a group implicitly assumes similarity within the group, but CFOs are differentiated from other officers on the basis of their specialized role and knowledge in the financial reporting function.”

So, the paper says, “it is important to examine variation in the CFO’s place in the corporate structure, and how that variation relates to the quality of the financial reporting function (the CFO’s area of authority).”