CFO: manager and guarantor

Nowadays at corporate events or press conferences, it’s nothing new to see a CEO flanked by another executive: the Chief Financial Officer (CFO). In fact, as this role evolves in many big companies, CFOs are moving toward the center stage. They’ve become key decision makers in setting the strategic course of their companies, second in line only to the CEO. But at the same time, CFOs are still associated with vital specialized competencies in the context of financial and non-financial communication, and the firm’s overall financial position in general. Added to all this is a critical fiduciary function: oversight (and legal liability) for the correct management and presentation of financial reports. More and more often, the job description of a CFO encompasses technical/guarantor functions on one hand, together with strategic/decision-making functions on the other.

So the role of CFOs has evolved, but what impact has this evolution had on their remuneration, both in absolute terms and relative to the CEOs they report to? Does the pay grade of CFOs influence the quality of the reports and financial communication they produce? And do various kinds of incentives, either short- or long-term, affect how CFOs perform their duties to different degrees?

To find the answers to these questions, we analyzed the profiles and activities of 450 CFOs in big European companies over five years, from 2005 to 2009. These businesses operated in a variety of sectors, with the exception of Finance, and all were ranked on the FT Europe 500. We drew up the profiles of individual CFOs beginning with a series of variables relating to their qualifications and previous work experiences, decision-making power and the roles they actually play in their companies. Based on these data, we developed two summary indicators: one regarding the level of financial expertise, and the other reflecting the proximity to the role of the CEO.

We designed these indicators in such a way that one doesn’t necessarily exclude the other. In fact, striking a balance between the technical and managerial aspects of the role in some sense reflects the very essence of what CFOs have to do. As far as pay dynamics, instead, we computed the numbers both in absolute terms, and in comparison to the CEO’s compensation in the same company. Lastly, we measured the quality of reporting produced by each CFO as inversely proportional to the quantity of discretionary accruals on the company’s balance sheets.

Our initial findings showed that the more the role of the CFO is ‘CEO-like’ - in the sense that the CFO is a key player in strategic decision making and operations - the more likely the pay level of the two executives will be similar. This is also true from the standpoint of the incentive scheme on offer, with greater emphasis on incentives linked to overall company performance, which in turn results in closer alignment between the underlying aims of the two roles. But ultimately this can give rise to the risk of collusion, which negatively impacts the fiduciary function of the CFO.

A second aspect that seems to influence negatively on the quality of CFO reporting is the weight of long-term incentives on remuneration. In fact, when incentives take the form of equity in particular, CFOs may be tempted to manipulate accruals to leverage earnings management policies that can impact share prices. In contrast, this didn’t appear to be the case when short-term incentives play a more substantial part in the overall pay package.

A third aspect we explored ties in to the level of CFO expertise in the sphere of corporate finance. The more extensive the expertise, the better the quality of reporting. But this positive impact is still less than the opposite effect we see when the CFO’s salary is similar to the CEO’s, or when long-term incentives are a significant component of compensation.

Lastly, corporate governance also has a role to play: the broader the oversight of the Board of Directors, the higher the quality of reporting produced by the CFO. This demonstrates the potential benefits of closer supervision of the CFO by the Board.

As we’ve seen, in an organization both the explicit nature of the role of the individual CFO, as well as the remuneration system he or she is offered, impact the type of contribution this executive is able to provide. This impact can be negative or positive, as the case may be. In addition, the fact that a CFO has expertise in finance is in itself a plus. But in order to take full advantage of this expertise, the company has to design a specific incentive package for the CFO that differs from the CEO’s.

In other words, organizations have to come up with a profile for their CFOs enabling them to actively participate in the C-suite, but without undermining the specificities of their role, in particular with regard to their fiduciary duties. Lastly, boards of individual companies and regulators alike must be aware of the need to differentiate the system of incentives offered to CFOs and CEOs.