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    Chief Financial Officers as Inside Directors.
    research summary posted July 27, 2015 by Jennifer M Mueller-Phillips, tagged 13.0 Governance, 13.01 Board/Audit Committee Composition, 14.0 Corporate Matters, 14.06 CFO Tenure and Experience 
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    Title:
    Chief Financial Officers as Inside Directors.
    Practical Implications:

    These results have implications for boards when deciding on the appointment or replacement of insiders to the board. Specifically, since only a few non-CEO executives can be granted a board seat, the board should carefully consider which executive would enhance the effectiveness of the board. The results demonstrate that the CFO can enhance board effectiveness with respect to the quality of the financial reports. Yet, the results also show that CFOs who serve on the board are more entrenched. Therefore, boards should carefully consider whether the benefits of appointing the CFO to their board outweigh the costs.

    Citation:

    Bedard, J. C., Hoitash, R., and Hoitash, U. 2014. Chief Financial Officers as Inside Directors. Contemporary Accounting Research 31 (3): 787-817.

    Keywords:
    chief financial officers (CFO), organizational structure, board of directors, financial statements
    Purpose of the Study:

    Chief financials officers possess specialized knowledge and play a key role in the current economic and regulatory environment. This is the first study to distinguish a specific board insider, the CFO, from other insiders based on that officer’s specific knowledge and role within the corporate hierarchy. The authors investigate the association between the inclusion of a company’s chief financial officer on its board of directors with financial reporting quality and with CFO entrenchment. They examined first how financial reporting quality is affected by board membership of the CFO based on two contrasting perspectives. The first is consistent with the agency theory that a board seat provides officers with power and influence; thus, there could be negative consequences from reduced board independence associated with officer appointments. With CFOs on the board, the authors could observe lower financial reporting quality among companies making this choice. On the other hand, the CFO can positively contribute to board effectiveness by improving mutual advice and collaboration. Companies should perform better in those areas relating to CFO functions. The second concern is the risk of entrenchment at the cost of investors.

    Design/Method/ Approach:

    The authors used a sample of 7,034 firm year observations. The study sample is based on companies included in the Audit Analytics governance database for 2004 through 2007. The main results are reported using two-stage models. The first stage addresses factors associated with the presence of the CFO on the board, and the second stage tests the association of CFO board membership with financial reporting quality, CFO compensation, and turnover.

    Findings:
    • Companies with CFOs on the board have more effective internal control over financial reporting, higher accruals quality, and lower likelihood of restatements.
    • The results showed a 4.28 percentage point reduction in material weakness (MW) disclosure likelihood.
    • This suggests that suggest that these CFOs are more likely to share information with other board members about the status of the financial reporting function and secure sufficient resources to invest in the establishment, documentation, and testing of internal controls.
    • The results implied that CFOs are more aligned with shareholder interests.
    • CFOs who serve on their own boards receive 26.9 (36.3) percent higher cash (total) compensation.
    • Further, CFOs serving on their own boards are less likely to face turnover following poor corporate performance. However, the authors also find that board membership does not protect the CFO from turnover when poor performance relates specifically to financial reporting quality.
    • These results suggest that serving on the board generally enables CFOs to gain more resources from the company and avoid penalty in times of difficulty, unless that difficulty is related to their direct responsibility.
    Category:
    Corporate Matters, Governance
    Sub-category:
    Board/Audit Committee Composition, CFO Tenure & Experience