Human Capital

CEO Pay Is Higher When the CFO Is Newly Hired

Research suggests finance chiefs are prone in early years on the job to "manage earnings," perhaps because of compensation-motivated pressure from ...
David McCannDecember 9, 2019
CEO Pay Is Higher When the CFO Is Newly Hired

The job of chief executive officer pays well — and even better when an incumbent CEO is working with a newly hired CFO.

Researchers at Duke University’s Fuqua School of Business studied more than 23 years of data from S&P 1500 firms. They found that CEOs took home an average of 10% more compensation when working with a finance chief who was hired after them (known as a “co-opted” CFO).

The study, “CFO Co-option and CEO Compensation” (forthcoming in the INFORMS journal Management Science), offers quantifiable insights into a phenomenon that is difficult to document: the influence CEOs have on colleagues who could potentially increase their pay.

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Previous research has shown that CEOs may exert influence up the chain of command on a co-opted board. Specifically, when newly appointed board members work with an incumbent CEO, the board’s oversight is also weaker and CEO compensation is as much as 20% higher, the school notes.

The Fuqua study looks at what happens working in the opposite direction, down the chain of command, when CEOs lean on their CFOs.

“CEOs ultimately have power over CFOs, arguably more so when the CEO played a role in hiring the CFO,” said study co-author Bill Mayew, a Fuqua accounting professor. “They may pressure CFOs to manage earnings to help the firm meet, or just barely beat, earnings targets from financial analysts. Those reported earnings and the response in stock prices can then drive up a portion of the CEO’s compensation.”

With CEOs in the study earning a median pay package of $3.19 million a year, a 10% premium for incumbents was more than $300,000, compared to those working with finance chiefs hired by their predecessors.

Chief executives were most likely to see the higher pay during the first three years of the co-opted CFO’s tenure, when the finance leader may have been most amenable to the boss’s influence, Mayew said.

“If you’re a brand new CFO, you don’t want to displease your boss and risk getting fired,” Mayew said. “Over time, a CFO builds up allies in the firm, which might give them more power to voice their opinion and apply accounting rules neutrally rather than pushing the boundary.”

The researchers used nearly 18,000 data points from 1993 to 2015 to illustrate an association between co-opted CFOs and CEO compensation. The data indicated that such finance chiefs helped companies achieve analyst-based earnings targets through earnings management.

Patterns in the data before and after the passage of the Sarbanes-Oxley Act (SOX) in 2002 showed that CFOs “predictably shifted how they delivered benchmark-beating earnings,” said co-author John Heater, a Fuqua assistant professor of accounting.

Prior to the tighter regulations and scrutiny of SOX, finance chiefs had more discretion when reporting earnings, such as adjusting estimates or reported accruals to meet earnings targets.

When SOX increased regulatory pressure on CFOs, accounting practices again shifted, from adjusting estimates on paper to actually making different business decisions to move numbers (known as “real” earnings management), Heater said.

“Managers can decide to run their operations differently, and in a way that promotes short-term earnings, such as cutting spending on research and development, or via overproduction or other methods that boost profits today but can hurt the firm tomorrow,” Heater said.

He added, “This may not be an immediate concern to corporate executives who, based on their average tenure, may not be around in the long run to face the negative implications of their decisions. This is why it’s so important that boards and their hiring committees be cognizant that this power dynamic between the CEO and CFO exists, and to consider that when hiring and overseeing these roles.”

For CFOs who find themselves subject to undue pressure from a CEO, Mayew encourages them to establish support within the company.

“Get connected, make friends, and ask questions in a way that puts your voice out there more broadly within the firm,” he said. “Responses from colleagues can help calibrate who’s willing to listen and who’s willing to stand up against undue pressure in the organization.”

In addition to Mayew and Heater, co-authors of the paper included Shane Dikolli of the University of Virginia and Mani Sethuraman of Cornell University.