The Changing Role of the CFOPublished: May 08, 2002 in Knowledge@Wharton
Old-school chief financial officers would barely be able to recognize deposed Enron chief financial officer Andrew Fastow as one of their own. Nonetheless, Fastow personified the media caricature of a late-model CFO – a flamboyant wheeler-dealer who tossed aside traditional notions of balance-sheet integrity in order to concoct indecipherable partnership arrangements and deceive Wall Street analysts. Suddenly, like dot-com roof parties, Fastow looks like a relic of the 1990s.
That’s because following the Enron meltdown, as well as high-profile failures at places like Global Crossing and Tyco International, companies are revisiting what they expect of their CFOs. Nobody wants to be the next Enron, which means that hand-in-hand with a renewed emphasis on ethics, companies are once again demanding hardcore accounting, financial reporting and risk-management skills. This represents a shift back to the roots of the CFO position.
“Companies will be looking for integrity,” says Wharton finance professor Franklin Allen. “They will be looking very closely at people’s records for any kind of manipulations … They will probably spend more time asking other people about them and maybe choosing more people from within the company.”
Barry Bregman, head of the CFO specialty practice at Heidrick & Struggles, one of the nation’s largest executive-search firms, says he is already seeing this among Heidrick clients. For example, he’s currently doing a CFO search for a publicly traded financial-services company. An otherwise strong candidate for this job once worked at a banking firm that had liability-management issues during the 1990s. Bregman’s client refused to even talk to the candidate until they had assurance that he wasn’t employed anywhere within the company at the time of the crisis. “Companies want to make sure a person is squeaky-clean, not just from an ethical standpoint but also an appearance standpoint,” says Bregman.
According to Wharton accounting professor David Larcker, renewed ethical concerns will also affect where CFOs come from. For example, he anticipates that fewer companies will recruit CFOs from their auditing firms, noting that a number of people in the finance function at Enron came from its auditor, Arthur Andersen. Other companies, he suggests, will want to avoid a similar stigma. “The claim is that these people were tight with Andersen and brought these ties with them to Enron,” Larcker says. “I don’t know if that’s true, but you might nonetheless see more companies that hire CFOs from the accounting profession going to companies other than their auditors.”
Mike Carroll, CFO of Zamba Corp., a customer relationship management consulting firm based in Minneapolis, suggests that auditors, now facing greater scrutiny, will try to distance themselves from their clients’ management. This means CFOs who are used to relying on their auditors to provide occasional financial advice will have to deep-six the practice. “It’s unfortunate,” Carroll says. “There are a lot of strong technical people in some of these accounting firms whom I might otherwise leverage when I don’t have that level of technical skill in-house. Meanwhile, because of scrutiny and insurance at the back end, the cost of auditors will go up, which is a problem for CFOs at smaller companies.”
Workhorse vs. Showhorse
In addition to ethical concerns, companies are also seeking CFOs with the skills that defined that position long before the advent of the dot-com revolution. “If a CFO candidate doesn’t have formal training and experience” in hardcore accounting, financial reporting and risk-management, “they may not be considered for some of the CFO jobs out there,” says Bregman.
This doesn’t mean, however, that the next wave of CFOs will be a bunch of glorified comptrollers. CFOs are still going to be expected to raise capital aggressively, meet their forecasts and make their case to the analysts. But they’re going to have to do so while keeping a vigilant eye and a transparent cover on the books - all of which means the job is only getting tougher and more all-encompassing than ever before. “You’ve got two things happening,” says Larcker. “There’s tremendous continuing pressure to make earnings targets and come up with incredible forecasts. At the same time, perhaps because of Enron and the like, CFOs will be under tremendous scrutiny to justify to the analysts that these are real, hard earnings, not [ones created by] bookkeeping shenanigans.”
Indeed, if you look at the historic evolution of the CFO position, it’s gone from one extreme to another before settling squarely in the post-Enron middle ground. Back in the 1960s and early 1970s, the CFO position was a tactical, bean-counting job. The CFO was primarily responsible for various accounting and internal reporting functions as well as tedious budgeting exercises. At the same time, the CFO had certain “treasury” responsibilities, like raising debt or equity capital and cash management. In essence, the CFO was much more of a “workhorse” than a “showhorse,” says Sven Wehrwein, a financial-industry veteran who started out on Wall Street in the 1980s as an investment banker and later served as CFO of two public companies.
Then, as financial markets became more transactional and global in the late 1970s and early 1980s, the environment became more strategic. New financial instruments, like mortgage-backed securities and other derivative products, emerged and CFOs had to become more sophisticated in order to deal with them. Later in the 1980s, companies started on a mergers-and-acquisitions binge. Hunting down these opportunities became a big part of a CFO’s job; now he or she was truly helping shape the direction of the company.
By the 1990s, as the stock market soared, the landscape exploded into a bazaar of partnerships, affiliations and strategic alliances – all ways to leverage another company’s success without actually merging. CFOs operating under enormous competitive pressure drove this frenzy, contributing to their image as swashbucklers or “showhorses.” CFOs like Fastow bypassed notions of clean financial reporting and disclosure in their quest to excite analysts and drive up share prices. “Quite frankly, 99% of companies out there were giving shareholders good information,” says Carroll. “[Enron] unfortunately painted a bad picture.”
Extra ethical scrutiny, of course, isn’t the only change CFOs have to contend with. As noted before, they moved from one extreme (CFO as controller/corporate cop) to the other (CFO as dealmaker/Wall Street pitchman). Now companies want them to be almost a “SuperCFO,” placing a full-time effort on each aspect of the job.
It can be a treacherous assignment. Wharton management professor Julie Wulf draws an analogy to large accounting firms. Their core business is auditing financial statements, which calls for extreme conservatism. Meanwhile, many of them provide consulting services, which calls for creativity, producing a natural tension. CFOs face the same problem. There’s more pressure to show that the balance sheets honestly and accurately reflect the company’s net worth. Yet the pressure to find innovative ways to raise capital and make a splash with Wall Street analysts hasn’t gone away. “It takes real skill to balance these conflicting interests, which may create a conflict in the CFO position,” says Wulf. “A solution may, in fact, be to separate these two responsibilities.”
Meanwhile, as pressure from analysts continues, CFOs find themselves wearing yet another hat: business expert and forecaster. P/E ratios for stock shares have been very high for at least the past five years and remain high even after the tech wreck. So if the price is high relative to earnings, what are the other forces driving the price? Larcker says expectations about future cash flow are the major drivers. CFOs now have to articulate these expectations, figure out how they will occur and predict the questions the analysts will ask. This will force them to delve into every segment of the organization, analyze the respective business plans and value them all. “As companies diversify, this is a much more difficult task,” Larcker says.
Plus, the questions analysts ask are going to be tougher than in the past – which makes things more challenging for the CFO, says Isik Inselbag, adjunct finance professor. Because the community of equity research analysts – the Salomon Smith Barneys and Merrill-Lynches of the world – is under fire for overhyping companies they covered, they will now be asking hard questions beyond financial statements, such as how much actual value the company is creating. This means CFOs are going to have to rely heavily on value-based-management techniques like Enterprise Value Added and the Balanced Scorecard. “If the CFO does the job of value-based management, he or she will be able to answer [the analysts’ questions],” says Inselbag.
Meanwhile, the business-strategizing aspect is also becoming a crucial part of the CFO job, says John Percival, adjunct finance professor. Over the past 10 years, companies got burned by decisions to enter new markets without bringing the CFO into the strategy sessions. For example, Percival cites telephone companies trying to become IT companies and falling on their faces. And he has seen manufacturers with a single cash-cow product unsuccessfully try to move into sectors they should be avoiding like the plague. CEOs would rely on marketing and business-development people to make these decisions without taking advantage of the financial analysis tools CFOs had at their disposal. And CFOs were squeamish about forcing themselves into the loop because they didn’t feel it was their place. “They felt politically it would be a problem to question the strategy of the company,” says Percival. “Now they’re going to be more and more of a sounding board on growth strategies and whether they make sense from a financial point of view.”
But at the end of the day, there’s no one-size-fits-all template for today’s CFO. A lot depends on the nature of the company’s business, as well as its size. Smaller companies, for example, don’t have the complicated financing schemes or vast array of product and service lines that require the same level of accounting virtuosity and strategy prowess. And CFOs at Fortune 500 companies don’t have the same constant pressure to raise capital because they’ve already got plenty. Nonetheless, Wehrwein sums everything up with one universal rule: “Any successful CFO has to be a damn good businessman who also knows how to count.”