Over the years, CFO has reported on several studies concluding that women outperform men at key aspects of finance and business.
One suggested that the stock market reacts more favorably to acquisition announcements and secondary equity offerings by companies with female finance chiefs. Another documented that women-run hedge funds earn higher returns.
A third research effort found that companies with a higher representation of women in senior management roles outperform other companies.
Now comes robust new academic research showing that companies with women serving as chief financial officers are significantly less likely to misreport financial results. And it’s not just a correlation; the study results strongly support causation, according to its authors.
To be published in the August issue of the Academy of Management Journal, the paper builds upon prior studies by other researchers indicating that:
- An estimated 15% of public companies engage in accounting fraud annually, but fewer than 1% are caught doing so.
- Women are, on average, more risk-averse than men, among other social-psychological attributes that differ by gender.
- A 138-year-old mathematical principle called Benford’s Law reliably flags the likelihood of financial misreporting (which has been known since the mid-1990s) and correlates well with several accounting measures traditionally used to identify misstatements.
Under Benford’s Law, in naturally occurring collections of numbers, the leading digit (the first digit in any number) is “1” more often — approximately 30.1% of the time — than are the other digits. Each successive number has a lower probability of being a leading digit (17.6% for 2, 12.5% for 3, and so on, down to 4.6% for 9).
The principle applies to groups of numbers as diverse as those found in a newspaper (excepting page numbers), population data, and even the lengths of rivers (on any measurement scale) and street addresses. It does not apply when the set of numbers is artificially constrained, such as by setting a ceiling or defining the set as being all numbers between, say, 300 and 700.
When applied to line items in financial statements, Benford’s Law yields a “financial statement deviation” (FSD) score that indicates the degree to which the distribution of leading digits diverges from the expected distribution. The lower the FSD score, the lower the likelihood of financial misreporting.
The study authors used FSD scores so that they could study the entire population of public companies, rather than just the few that were caught fraudulently reporting their financials, says University of Alabama associate professor Sandra Mortal, a co-author of the study.
According to the research, companies with female CFOs had, on average, a 2.6% lower FSD score than those where men helm finance. Regression analyses tested the result against myriad variables to ensure a finding of causation.
“Given the increasing pressure on firms to have more female representation in top management positions, understanding how executive gender impacts corporate financial reporting can inform researchers, policy-makers, regulators, and the general public,” the study says.
The research covered 18,659 firm-year observations from 2006 to 2016 for 2,186 unique U.S.-based companies. The data set included 1,550 firm-year female CFO observations at 339 companies.
Is 2.6% a big difference?
“We did a back-of-the-envelope calculation of the overall cost of ‘cooking the books’ based on other research,” says University of Alabama associate professor Vishal Gupta, Mortal’s spouse and another co-author of the study.
“It didn’t make it into the final version of the paper,” he continues, “because there were a number of approximations in the calculation and, as you can imagine, peer reviewers and journal editors today are very mindful of what’s in [gender-focused] studies like this. But reducing fraud by even half a percent would provide a significant net benefit to corporate America.”
Of course, not all financial misreporting is the result of fraud; there are legitimate errors as well.
However, in cases where the SEC catches companies reporting fraudulent financials, their subsequent FSD scores plummet by an average of 6%.
Calculating FSD scores theoretically could provide regulators with an enforcement tool by identifying companies that are more likely to be engaging in fraud. “Our understanding is that the SEC is aware of it and has looked into it but has not gone public with whether they’re using it,” says Gupta.
The study also sought to measure whether high levels of external monitoring of companies, as represented by the levels of institutional ownership and analyst coverage, influence the relation between CFO gender and the likelihood of financial misreporting.
And that indeed was the case. Where institutional ownership was low (that is, companies in the lowest quintile of such ownership), companies with female CFOs had 6% lower FSD scores, on average. Where institutional ownership was high (the highest quintile), the difference shrunk to 1.6%.
The same trend was seen for analyst coverage — a 5.5% gap between men and women with low coverage narrowed to 1.6% with high coverage.
In addition to Gupta and Mortal, the study’s authors are Xiaohu Guo, a Ph.D. candidate at the school; Bidisha Chakrabarty of St. Louis University; and Daniel Turban of the University of Missouri.