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CFO Style Still Makes a Difference

The tightening grip of regulations, along with the constraints of GAAP, might seem to offer little leeway for personal characteristics when CFOs make accounting and reporting choices. How much, some wonder, can a finance chief's own style or philosophy impact corporate decision-making, anyway?

Plenty, it turns out.

At least, that's the conclusion of a recent study of 359 finance executives from a range of firms, conducted by a trio of researchers in the Northwest. "We find that, across a wide range of accounting choices, individual CFOs are an important determinant of accounting practices," write Weili Ge and Dawn Matsumoto, both professors at the University of Washington in Seattle, and Jenny Li Zhang, a professor at the University of British Columbia.

In addition, the study measures how the effect of certain personal characteristics of the finance chief appears to be stronger under conditions that allow more finance discretion and that place higher job demands on the CFO.

Prior to this research, much of the academic study of accounting focused on the impact of the company itself -- such as its size or growth rate. Another body of established research, meanwhile, looked at the characteristics of CEOs, on policies concerning mergers and acquisitions, for instance, Ge says in a telephone interview with CFOworld. Few researchers had focused on CFOs, or the accounting choices they must make.

The Washington and British Columbia researchers certainly suspected, based on research that others had conducted, that individual characteristics played a role in finance decision-making. Still, it wasn't clear at the outset whether this would hold true, in a measurable way, when it came to the choices made in the reporting process, Ge notes. "We were interested in accounting choices," she says, "because they're different than other corporate decisions, as there's more constraints."

Behind the Research

But the story behind the research is nearly as interesting as the findings themselves.

Teasing out the personal impacts that an individual finance chief might have on the financial reporting process, for one thing, required differentiating personal factors from any decisions resulting solely from regulations and company characteristics. So the researchers started by analyzing only CFOs who had worked at two different publicly-held firms for at least two years each. That way, the professors could look at decisions made at each firm under both the CFOs in the study, as well as the actions taken at each firm under different CFOs. The focus was to try to determine whether the CFOs consistently selected accounting policies that were above or below the mean at each firm.

The team also controlled for extraneous factors, such as firm size and leverage ratio. "In this way, we could do a thorough job of disentangling the CFO effect from firm factors," Ge explains in the CFOworld interview.

The researchers analyzed six specific areas --- split between two general groups of factors -- in which CFOs have some discretion. The first group included tools that chief financial officers can use to achieve financial reporting goals. Those three tools were discretionary accruals, the use of operating leases, and the expected rate of return on pension assets. The second group of factors included earnings measures that typically signal some managerial intervention: earnings smoothing, meeting or beating analysts' expectations, and what the study refers to as what's known as an F-score -- a scaled probability that signals the likelihood of earnings management.

Masters Vs. CPA

To start, the researchers looked at several of the most readily observable characteristics of the CFOs, including age, gender, and educational background. Specifically, they examined whether the CFO had earned a CPA or business-related masters degree. The results of this first analysis were inconclusive. "They didn't tell a lot, and didn't explain accounting choices," Ge says.

More success, though, came in the researchers' findings about the statistically significant role of individual CFO styles or philosophies in accounting choices.

When it came to the use of discretionary accruals, and the amount of that usage, for instance, the difference attributable to a the individual executive's approach totaled 5.2% of total assets. Similarly, the value of operating leases varied by nearly 13% of total debt. What's more, the same finance chiefs who made greater use of operating leases also enjoyed a larger number of quarters -- about 24% more -- meeting or beating analysts' expectations.

Those findings confirm, of course, the long-held views of many finance chiefs themselves, and those who work with them. "CFOs have different tolerances for risk," says E. Peter McLean, chair of the global financial officers practice with Korn/Ferry International. And certainly, McLean adds, his or her actions, however different from those that other CFOs may have taken, must be guided by ethics and the law.

Knowing the Business Sure Helps

Mark Eisele, chief financial officer with Applied Industrial Technologies, cites the example of the choices facing a CFO whose company has General Motors as a major customer -- and who might have had to decide in recent years when, and how much, to allocate to a bad debt reserve. Rumors of the company's demise had long floated around the industry, yet even when it declared bankruptcy in 2009, its suppliers were getting paid. "You could say, 'Oh my gosh, they'll go bankrupt,' or you can say, 'It's GM and that won't happen,'" observes Eisele, whose company is a distributor of bearings, power transmission components, hydraulic components and other industrial systems. "Reasonable people can come up with different answers."

Despite what the Washington and British Columbia research team learned about the impact of CFOs' style on accounting choices, they didn't pinpoint the exact drivers behind their actions. Says Ge, "It could be innate personality or prior experience. But, we know the effect is not driven by firm characteristics."

Still, the study results overall certainly challenged any notion that finance executives easily can be substituted for one another, Ge says. If a board assumes it can hire anyone with CFO qualifications, and then use incentive compensation to prompt the making of certain desired accounting choices, that board may be fooling itself. For while the structure of an incentive package may have some influence, the CFO's personal style still will play a role in the decisions they make.

Recruiter McLean argues, too, that a CFO's fit with the culture of an organization is important. After his or her technical skills, that fit, he says, is "the distinguishing issue that is the decision point around hiring or not hiring the individual."

"CFOs are not just replaceable," is the way Ge summarizes the research findings. "You need a CFO whose style matches (the company's) need."


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