Risk & Compliance

Say Yes to Dr. No?

New research suggests that CFOs are an essential counterweight to optimistic CEOs.
Don DurfeeJuly 1, 2006

In 1917 the U.S. Navy was in a panic over German U-boats, which had been sinking American ships in the Atlantic. Henry Ford, who had earlier boasted that his assembly lines could push out a thousand submarines a day, offered his company’s services. If he could build cars, he reasoned, why not boats? The Navy took him up on his offer and ordered 100 steel sub chasers.

One year later, Ford delivered — sort of. After various mishaps, he had managed to produce only 17 awkward, leaky vessels.

It’s no secret that big corporate decisions aren’t always made according to the tidy principles taught in business school. Hunch and hubris trump net present value more often than many care to admit. Sometimes the result is a success. Other times it’s a corporate train wreck. Such decisions tend to share one feature, though: they are generally made by a powerful, confident CEO who meets little serious internal opposition.

Curbing a chief executive’s more outlandish ideas seems like a natural job for the CFO. After all, finance executives are increasingly the number-two executive and are by training inclined to look for the possible reasons why a good idea might turn out badly. But do CEOs and CFOs really approach important decisions differently?

A new study by researchers at Duke University provides some answers. The preliminary findings (a working paper is due out this fall) show that there is some truth to the clichés about CEOs being the company cheerleaders and CFOs being habitual naysayers. They also point to some reasons why a balance between these executives is so hard to maintain.

Looking on the Sunny Side

The researchers surveyed more than 2,000 executives, including CFOs in the Americas, Europe, and Asia and CEOs in the United States. In addition to asking managers what they consider when making decisions, they also posed questions designed to gauge the respondents’ personalities, such as their optimism and aversion to risk.

There are indeed differences between the two executives. Chief executives are a more optimistic breed: in the United States, 79 percent of them fall into the “highly optimistic” category, compared with 65 percent of CFOs. Meanwhile, U.S. CFOs are far more optimistic than their European and Asian counterparts.

CFOs stress different factors when deciding how to allocate the company’s money. Finance executives across regions look first at an NPV ranking of projects, followed by the timing of cash flows and the returns that the same division has earned in the past. CEOs — while looking at many of the same financial measures — give more emphasis to intangible factors, such as the reputation of the divisional manager and that manager’s confidence in the project.

In part, these differences reflect job requirements. CEOs are supposed to come up with the big ideas and provide the enthusiasm to rally the company around the vision. Boards expect the CFO to be critical, examining big ideas for flaws. But there is often something else going on: it seems that executives’ personality traits have a way of spilling over into the decisions they make for their companies.

For example, companies run by highly optimistic CEOs are significantly more likely to have high levels of short-term debt, to maintain a high dividend, and to time the debt market, according to the Duke researchers. CFOs aren’t immune to the effects of optimism: companies whose finance executives are comfortable with risk tend to have high debt-to-equity ratios.

“What we see is that people’s personalities affect decisions more than they probably should,” comments John Graham, a finance professor at Duke’s Fuqua School of Business and one of the study’s authors. “If I’m more risk averse than you, should my risk aversion show up in my company’s capital structure? If I’m optimistic, should I be trying to issue debt when rates are low, as opposed to letting the company’s liquidity needs determine it? In a purely academic sense, no.”

Granted, the idea that egotistical bosses can strike deals for the wrong reasons isn’t a new one. And the insight that executives aren’t always purely rational is one that has long guided corporate salespeople. Paul DiModica, president of DigitalHatch, a sales and marketing consulting firm, coaches salespeople on how to tailor their pitch to personality cues. For example, an executive with photos of himself climbing mountainsides or hugging celebrities suggests a risk taker who may be open to an emotional sales pitch. “People talk about buying logically, but they always buy emotionally,” he says.

Don’t Ask the Guru

But while this undercurrent of irrationality is a boon to salespeople, it can be a bust for shareholders. That’s particularly true since CEOs — who are the more optimistic group — often wield great control over decisions such as M&A. Among the U.S. companies surveyed (including both large and small firms), 44 percent of CEOs say they make acquisition decisions with little input from others — a reason, perhaps, why so many acquisitions fail to add shareholder value.

Having a balance of views in the decision process could improve that record. Studies have shown that a small group of experts tends to make better decisions than the lone genius. At the very least, a skeptical CFO can offer a dose of reality to an open-minded CEO.

That’s the catch, of course. CEOs don’t get to be CEOs by being modest. “If you’ve managed to reach the top of an organization, there’s a very good chance that you have a dominant personality,” says Paul Taffinder, a psychologist and a London-based partner with Marakon Associates, a management consulting firm. “If the organization doesn’t have mechanisms to balance that, you can have problems.”

Robert Cuddihy, CFO of iDNA, a New York–based corporate-communications firm, says that this was the problem for his company a few years ago before the board brought in a new management team that included him. “We were structured in the past as ‘Follow the guru and ask no questions,’” says Cuddihy. “Anyone who challenged got fired. But if you look at an idea from multiple perspectives, you can refine it and get a better result than the guru can alone.”

The dominant CEO may be less of a problem for many European companies, which have a more collective decision-making process. Like other European firms, Danfoss, a manufacturer based in Denmark, makes most of its big decisions through an executive committee, which includes the CEO, the COO, the CFO, and often division presidents. “When we are considering an idea for an acquisition, our CEO is very passionate and takes a more strategic point of view,” says CFO Ole Steen Andersen. “As the CFO, it’s my duty to be more critical and look out for the risks. But in the end, we get much more alignment around the decision, and that allows us to move fast into the postacquisition phase.”

For companies without such a structure, the burden is on the CFO to tactfully nudge the CEO in the right direction. That’s something that doesn’t come easily to many finance executives, says Cynthia Jamison, national director of CFO services for Tatum LLC. “CFOs can be bad at the softer skills of communication — eye contact, reading your audience, picking your moment,” says Jamison, who has held seven different CFO positions and works with many others in her current job. “All of that plays back into how the pushback is heard and received by the CEO.”

Jamison recommends that CFOs explain their objections to a particular project in terms of why it won’t achieve the business strategy the CEO is pursuing. And even then, the CFO should disagree selectively. “Disagree on every point, and you’ll wear out your welcome,” she cautions. “Pick the points that really have a dramatic impact versus the little ones that may not be the best approach to something, but that you can let go.”

As Duke’s research shows, however, many CFOs — Americans, especially — are optimists themselves. And since all optimists tend to see a world that reflects their mood, there’s the risk that two of them in the same executive suite could be a bad combination. That calls for the cheerful CFO to deliberately play the curmudgeon.

“I’m an optimistic person,” says iDNA’s Cuddihy. “But a skeptical outlook comes with the territory. You don’t want to be Dr. No, always torpedoing someone else’s dream. Yet if you show your optimism too clearly, then the CEO might go even farther in that direction.”

Don Durfee is research editor of CFO.

Irrational Decisions

Personal traits are associated with certain corporate policies.
(U.S. respondents only)

Optimistic CEOs are more likely to:

  • pay high dividends
  • issue debt when they think interest rates are low
  • have high levels of short-term debt

Risk-taking CEOs are more likely to:

  • pursue acquisitions
  • have a speculative-grade rating

Optimistic CFOs are more likely to:

  • issue debt when they think interest rates are low

Risk-taking CFOs are more likely to:

  • use debt rather than equity
  • issue debt when they think interest rates are low
  • have a high debt/equity ratio

Source: Duke University survey

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