Can CFOs Keep a Foot in Strategy Post-SOX?

Scratch a chief financial officer and you’re likely to find an accountant. At least that’s the way it used to be, at companies large and small. It’s still true at many small ones, but at larger firms CFOs have gradually taken on more duties, working in partnership with chief executives to chart the future.

But this beneficial trend is threatened, says John R. Percival, adjunct professor of finance at Wharton. The cause: accountability requirements imposed by the Sarbanes-Oxley law (SOX) passed in 2002, during the post-Enron cleanup.

Among the provisions that most directly affect the CFO is one requiring a new raft of reports. The company, for example, must describe its system controlling financial reporting and assess the effectiveness of that system. Then it must explain how it came to that assessment. Complying with those requirements can be an enormous task. Sarbanes-Oxley also curtails the kinds of non-auditing consulting that can be done by a firm’s auditors. Hence, CFOs can no longer lean on auditors for financial advice.

“The CFO thinks, ‘In such a world, maybe I should go back to accounting again,'” says Percival, who has talked to many CFOs attending his executive education courses, Creating Value Through Financial Management and The CFO: Becoming a Strategic Partner.  Although new software and technologies can help to streamline the reporting SOX entails, the balancing act will continue to be a difficult one, Percival contends, as CFOs face continued pressure to raise capital aggressively, meet their forecasts and make their case to the analysts.

Weighing in on Non-financial Decisions

Today’s CFO takes on duties that used to be the preserve of the chief operating officer, consulting with the CEO about the firm’s long-term strategy, Percival notes. Often, the rearward-looking duties — such as accounting — are passed to a comptroller.

Two factors have produced this evolution in the CFO’s role. First, the environment has changed in a number of ways. More and more American companies have overseas operations, and decision-making must therefore take into account foreign exchange fluctuations and non-U.S. financial regulations. In an international transaction, it is possible to make a profit but lose it to an adverse exchange-rate fluctuation when foreign currency is traded for dollars.

Globalization has also put much pressure on margins, Percival says. Relatively small amounts of money that might have been left on the table in the past now may have a significant impact on a company’s result. Beating Wall Street’s earnings expectations by a penny a share can make a stock jump; missing by that much can knock it down.

To succeed, the modern CFO must have “the ability to think of financial implications of non-financial decisions,” Percival says. Would it pay to move some operations overseas? Perhaps wages will be lower in the developing world, but the decision must factor in issues like currency risk, political instability and problems with supply lines and product delivery.

The past couple of decades also have seen the rise of institutional investors such as mutual funds, pension funds, insurers and hedge funds. With growing percentages of stock in the hands of professionals, companies face ever-greater scrutiny, Percival notes. Money managers are attuned to sophisticated financial strategies, and they expect corporations to be as well.

Also, tax and accounting matters have become more complex. A strategic decision may hinge not simply on whether a venture can be profitable but how it will be carried in the books and on the tax return. Tax and accounting treatment is sometimes a matter of choice, so the CFO must be in on the plan before a venture is launched.

A second key factor influencing the role of CFOs is their access to exotic financial tools that would have mystified many of their predecessors. Certain hedging tools have been around for a long time — things like commodities futures, for instance. But the past decade or so has seen the rapid development of new products that allow users to take on or lay off risks involving currency and stock-price fluctuations, interest rates and credit-worthiness. Companies are compelled to use these instruments, because their competitors are, and typically it is the CFO who knows how to use them.

CFOs, then, are involved in key strategic decisions, answering key questions such as: Is the benefit of hedging worth the cost? Will a merger or acquisition pay off? Or is it better to grow internally?

Along Came SOX

According to Percival, many CFOs have been chilled by the post-Enron reforms. One of the chief players in that scandal was the company’s CFO, Andrew Fastow, who used exotic finance products to conceal the company’s mammoth debt. Congress responded to that and the wave of corporate scandals that followed by passing the Sarbanes-Oxley law.

“Along came Sarbanes-Oxley, and it changed everything,” Percival says.

Among its provisions is a requirement that corporate executives personally sign off on the accuracy of their companies’ financial filings. Violations can expose executives to criminal prosecution and prison terms.

The thrust of Sarbanes-Oxley is to make financial accounting more transparent, notes Percival. “A lot of CFOs are saying, ‘We probably should have done that without Sarbanes-Oxley.'” Facing a new degree of legal accountability, many feel they must spend more time on the duties they have gradually delegated to subordinates like comptrollers.

In the wake of SOX, consulting and accounting firms have produced a range of products designed to standardize and streamline the new reporting requirements, and many argue that answering SOX-related questions provides clients with broader business benefits. IBM, for instance, claims that “Using IBM solutions, companies can leverage SOX initiatives to build an on-demand environment that has the flexibility to respond quickly to changes in their business environment.”

IBM’s ClearCase and ClearQuest software products, for example, are used to track and document changes to processes like financial record keeping. It automatically checks to be sure the company meets SOX requirements and that all changes are properly approved and documented, and, in the process gives executives like the CFO better control, IBM says.

Thus, the CFO’s dual roles of strategic business partner and overseer of internal controls can complement one another in some respects. Many CFOs, for instance, are involved in exotic risk-hedging strategies that can reduce volatility from financial results and improve the bottom line. To implement such strategies, the CFO needs a deep understanding of the company’s operations and risks it will face in the future, and that requires answering many of the types of questions required for SOX disclosure. The company must, for example, have a system for keeping abreast of the changing values of instruments like currency-exchange derivatives — both to satisfy SOX and to effectively implement strategy.

But Percival believes SOX-compliance requirements are, on balance, more of a distraction than a benefit.

“I am sure that in reviewing and improving internal control procedures there are a few insights that you can get about how the business is working that can result in forward looking ideas about how to implement strategy better,” he said. “But I am afraid that the more important role is for the CFO to help in formulating future growth strategies, and that is quite different from the time spent on SOX. There are only so many hours during the day.”

There is no ready solution to this problem, he acknowledges. The best CFOs, he predicts, will continue to delegate the old-fashioned accounting duties. But many will find that tough to do, given the career-ending implications of Sarbanes-Oxley violations.

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