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Spurred by regulatory change, directors and CFOs forge a new relationship.
Roy Harris, CFO Magazine
January 1, 2005
See the results of the CFO/NACD survey
Not long after Vada Hill joined the board of Denny's Corp., CFO Andrew Green took him on a road trip. When Hill stepped off the morning train in Philadelphia, the two men hit four local Denny's restaurants, sampling breakfast and lunch fare along the way.
The restaurant-hopping was a success, and not only because of the taco salads. ("I used to be CMO for Taco Bell," says Hill, now senior vice president, marketing, at Fannie Mae, "and I know taco salads.") Along with lessons about such menu items as the Philly Melt, Hill got a valuable tutorial about the chain — and its CFO. "He is clearly a holistic executive," says Hill, who developed "huge respect for Andrew for not just sitting behind a desk in Spartanburg," the company's South Carolina headquarters. Green says, in talking about everything from marketing to M&A, "I think I gave him a window into the company — one that's different from the CEO's."
While many companies hold meetings at stores, factories, and distribution hubs to expose directors to operations, it's not often that the CFO serves as tour guide. Nor, in the past, might a director have particularly wanted that. But times have changed. Sarbanes-Oxley and other federal mandates make boards more accountable than ever. And for boards to assume that new responsibility, they must spend more time with the CFO. Nell Minow, a founder of The Corporate Library, a Portland, Maine-based governance-research firm, says that when trying to improve their understanding of a company, "the most important thing for directors may be to have a better and more direct relationship with the CFO, and to get to know the CFO as a full person."
Dealing with the CFO on the same level as the CEO offers "a reality check," adds Charles Elson, Edgar S. Woolard Chair in Corporate Governance at the University of Delaware. The finance chief represents "another set of eyes, and another set of body-language communications" that a board member can observe.
The amount of interaction between CFOs and boards has certainly increased under Sarbanes-Oxley — especially Section 404, which assigns the audit committee the duty of documenting, testing, and assessing a company's internal controls. Improving the quality of the board's information depends in large part on the professional and personal skills of the CFO. Finance chiefs must be able to tailor their board presentations to suit the occasion as well as the finance and accounting background of the audience, offering simple bird's-eye-view reports in some instances and much more detail in others.
Beyond the Letter of the Law
Clearly, most board members expect the CFO to assume a stronger role in matters relating to governance. In an October survey CFO magazine and the National Association of Corporate Directors conducted with 434 NACD members, a full 42 percent of respondents who serve on public company boards said the CFO's primary role in corporate governance should be to "lead in ensuring that the letter of the law is met." Another 20 percent believe the CFO should go further, pushing "for change above and beyond the letter of the law" (see "The Directors' Take").
The results suggest that better communication with the CFO is linked to better governance. Asked about the quality of recent communication between the CFO and the board compared with five years ago, two-thirds of directors said it is better; 28 percent said it is "much better." The board's understanding of the company has improved because of this new level of interaction, said 71 percent of respondents; "greatly improved," in the view of 21 percent.
Among personal skills rated by directors, the ability to communicate ranked behind only integrity and independence, and just ahead of leadership. That's not surprising, given how important it is that busy outside directors be able to process information, says Debra Smithart-Oglesby, audit-committee chair at Denny's and a former CFO at Brinker International. Green knows "how to present things briefly and with clarity," she says. "Some CFOs make presentations that get too bogged down in detail, but Andrew will hit the high side first and then backfill to the level that the board members need."
"Trust, but Verify"
"The CFO is a very logical starting point" for governance reform, says former Securities and Exchange Commission chief Harvey Pitt, who is now CEO of Washington, D.C.-based director-training firm Kalorama Partners. That's because finance has been at the center of some of the most worrisome scandals, he says, "that were basically perpetrated under the noses of directors and others." Faced with concerns about what they hear from top management, directors may fall into "one of two undesirable extremes," he believes. "Either they are unduly pliant, which is of course illegal, or they become aggressively adversarial, which is counterproductive." Pitt suggests that board members adopt a position somewhere in between. "My view is the one Ronald Reagan had about the Soviet Union: trust, but verify."
Directors now "turn to CFOs to get not just a sense of how we're doing, but how others are handling the same types of issues — what I call three-dimensional financial reporting," says Pitt. As an example of what can happen in the absence of such reporting, he cites Royal Dutch/Shell, whose oil-reserve accounting added unproven reserves to its "proven" total, putting them in a category requiring more verification, and also boosting profits. Its joint-venture partners, ChevronTexaco and ExxonMobil, had reported on the disputed reserves as well, "but neither partner accounted for them as proven, which means inflated profitability in the oil industry," says Pitt. "Only someone who really understood the business itself could have provided the guidance that [Royal Dutch/Shell's] audit committee and outside directors needed. That has to come from the CFO."
Gail Schoettler recently joined the board of a fourth public company after terms as Colorado's state treasurer, lieutenant governor, and U.S. ambassador to the World Radio Communications Conference. She says being a director today (she is chair of the Fischer Imaging Corp. board) "is totally different from when I was on boards back in the 1970s and '80s." In her view, "the CFO has become much more important in the discussion about strategy and problem-solving." With boards facing a "very touchy issue" in expecting the finance chief to be an independent voice yet also a team player with the CEO, it helps audit committees, at least, to get CFOs alone — "to give them a chance to say what they want to say." She notes that "sometimes they just need to vent."
Indeed, 17 percent of respondents to the CFO/NACD survey worry that ties between their companies' CEO and CFO are too close, while 13 percent lack confidence that the CFO would cooperate fully in providing information reflecting poorly on the CEO. Nell Minow suggests that the full board meet alone with the CFO, without the CEO, and formally report on such meetings to investors.
Finance and the board always worked smoothly at The Home Depot Inc., says executive vice president and CFO Carol Tomé, but until the past few years, "there was a much more casual format. There were no slides; just discussions around the table." In fact, when the board did get financial reports, Tomé says, "we basically gave them a data dump. There was no conclusion and no analysis. They had to do all the work."
In her three years as CFO, though, that has changed, along with the number of full board or audit-committee meetings, which totaled 13 last year. Among the documents prepared for the board, Tomé is especially proud of her department's monthly one-page snapshot of financial performance and trend analysis. Greg Brenneman, Burger King's CEO and a Home Depot audit-committee member, credits Tomé with being "good at simplifying things so that you're not spending hours with these financials. She offers a clear understanding of what's behind the numbers, in English."
Specifically, Tomé is adept at "taking the board through the reserve analysis each quarter," explaining amounts that Home Depot set aside for general liability, workers' compensation, and medical and pension liability. "She looks at it from a key-account perspective," says Brenneman. "It's almost Accounting 101, but it's helpful to get people to understand."
Tomé says board members take particular interest in Home Depot's "critical accounting policies, which require judgment and actuarial analysis. It can be like funny money if you don't understand the reasoning behind it." She frequently brings the treasurer, controller, or other finance-team members in to talk to the audit committee at its meetings — a trend more boards report as directors ask to dig deeper for information on operations.
Sandbagging Doesn't Work
Brenneman laughs at the idea that Tomé — who was named CFO by Robert Nardelli when he became CEO — might not tell the board if the two disagreed on a major issue. "Bob and Carol are very consistent in their messages," says Brenneman, but Tomé has a well-deserved reputation for being outspoken.
"I can be as hard as nails when I have to be," says Tomé, who credits Nardelli with supporting what she calls an "open kimono" approach with the board, "talking about the bad stuff as well as the good stuff." Recently she's been critical of the company's inventory-turn rate, telling directors that "it isn't where it should be, although we're making progress." As CFO, she explains, "you have to communicate from independence and authority."
When it comes to working individually with directors, Tomé, like Green of Denny's, likes one-on-ones. In early October, she spent a full day with a new director, audit-committee member Laban "Labe" P. Jackson Jr., chairman and CEO of Kentucky real estate developer Clear Creek Properties Inc. (He also serves on the audit committee of JPMorgan Chase.) "We talked about internal controls a lot," says Tomé, and paid visits to the treasurer and controller, tax-department head, director of finance operations, and vice presidents of internal audit and of financial planning and analysis.
Tomé understands why directors might worry about wrongdoing. "Directors, investors, and employees should all be concerned about it," she says, although in reality, "you can never protect yourself against crookedness, evilness, and fraud." In her view, "it's essential for the CFO's credibility with the board that you lay out the facts. You must not sandbag. If you have an issue, it's going to be found out the next quarter."
Since 2002, Tomé has been a director of UPS. She saw similarities with the Home Depot model, and figured board membership offered a chance to learn things that might help at her company.
From her experience at Home Depot in such areas as explaining medical liability reserves, Tomé says, "I brought the same rigor" to the finance department at UPS. "Drivers will have accidents," she notes.
UPS finance chief Scott Davis says his company has always felt that "our outside directors need to have a grasp of the business," leading it to plan at least two meetings a year at operational sites — including one last year in China. Typically, the board starts with a pre-meeting-day dinner attended by all 10 directors, as well as key managers and employees from the host facility. Lately, though, UPS has added "a private session for outside directors," where they learn additional information about operations from the insiders.
"I have a fairly sizable portion of the board meeting," says Davis. "There's definitely a lot of feedback from the audit committee," especially when he examines the company's risk profile. "They want to make sure resources are put in the right area." Lately he has helped the board understand package-flow technology. Davis, whose background is in technology, explains to board members how the new system "will make the drivers work smarter," by giving them the capability to time deliveries more precisely. Boards expect "the CFO to be a better businessman today than he was 10 years ago," he says.
Leadership Via Walking
"It's leadership via walking," says Vada Hill of the day he and Andrew Green spent at the Philadelphia Denny's restaurants. "As a CFO," says Hill, "you've got to get out in the field and see how your money is being used — how your strategy is playing out in the marketplace. There's no substitute for talking to a restaurant manager about what's driving the growth, and seeing the innovative things they can do." Among the topics covered in their time together: security issues for 24-hour urban operations, and one outlet's addition of a second banquet room to increase community participation.
The only downside to the restaurant visits, says Hill, may be the calories from all that testing. After the tour, he found himself thinking that "the key challenge is, how do you do it and not gain 10 pounds?"
But for this, too, the CFO may have had an answer. While the director ordered the Meat Lover's Breakfast, Green got the Slim Slam.
Roy Harris is senior editor at CFO.
See the results of the CFO/NACD survey
If You Can't Join 'Em
Few CFOs are being tapped as directors.
Despite steeper liability exposure and heavier time demands these days, more finance chiefs are looking into becoming directors. Financial Executives International reports that 1,000 of its 15,000 members have let FEI share their résumés with companies that are hunting, usually for audit-committee members.
But boards have been slow to draw on this willing and able talent pool.
Among Fortune 1,000 audit-committee members, only 2.9 percent are CFOs, according to an FEI analysis. That compares with 6 percent who hold academic titles as professor or dean, and 75 percent who are listed as chairman, vice chairman, CEO, COO, or president. Big-company finance chiefs seem somewhat more in demand. Recruiter Heidrick & Struggles finds nearly 19 percent of Fortune 1,000 CFOs serving on at least one outside board, and 8 percent seated on their own board.
"The challenge is finding those who will make good board members, not just good audit-committee members," says Theodore L. Dysart, a Heidrick partner with its global board of directors practice.
Why has the movement toward CFOs on boards been so slow? FEI expected an increase after it successfully lobbied for Sarbanes-Oxley to require a financial expert on each audit committee. But while "a natural choice would be current or retired CFOs," notes FEI vice president Chris Allen, the Securities and Exchange Commission later allowed CEOs and others who supervise finance experts to qualify as experts themselves. And many boards preferred to stick with CEOs instead. It's "not a supply problem but a demand problem," Allen says.
Andrew Green of Denny's Corp. and Scott Davis of UPS are among the majority of CFOs who are not on a public-company board. "The phone rings a lot in that area," says Davis. But currently, he's restricted his outside board activity to serving as a director of the Federal Reserve Bank of Atlanta and on the finance committee of the Georgia Council on Economic Education.
"I would love to join one at some time," says Green. "I know boards present greater risks for their members now, but I think it would be fascinating to be involved in guiding another company at a time like this." —R.H.