Given concerns over CFO pay, especially incentives, and considering the tension between a CFO’s fiduciary responsibility and being a key member of the firm’s executive team, we examine the determinants and effects of CFO compensation amount, incentive intensity, and proximity to CEO compensation in a sample of European companies (FTE 500, 2005–2009). First, we focus on the CFO role as a determinant of CFO compensation. Like prior work, we proxy for CFO roles by using hand-collected public data on education and past professional experience, but we supplement these proxies with proprietary data to more directly capture the firm-specific nature of the CFO job in term of its similarity with that of the CEO. We thus argue how CFOs can have varied roles characterized by different levels of financial expertise and CEO-likeness, and document that it is this latter aspect that is associated with CFO compensation. Second, we study the effects of CFO compensation design on outcomes in the CFO’s realm related to financial reporting. We find that CFO financial expertise is positively associated with financial reporting quality, while a CFO’s pay long-term incentive intensity and a CFO’s incentive compensation proximity with the CEO are negatively associated with financial reporting quality. Overall, then, our results suggest that CFOs get rewarded for their CEO-likeness, and particularly for their being similar to the CEO in terms of tasks and decision making authority. But it is their financial expertise that is positively related to financial reporting quality. At the same time, using compensation that is more incentive intensive and more similar to that of the CEO appears to be potentially detrimental to the quality of financial reporting. These results are relevant for boards involved in selecting highly expert CFOs, and their compensation committees charged with defining subsequently effective incentive compensation plans for those CFOs.
In many companies, CFOs are second in command to the CEO,1 where both commonly appear in public together to comment on company developments beyond the required periodic disclosures of financial performance (Hoitash et al., 2016). This is not surprising as nowadays companies often seek CFOs who are actively involved in major business decisions and not just in financial reporting and other CFO functional duties. Unlike other finance and accounting positions who are mainly in charge of the technical aspects of accounting and financial reporting, CFOs are increasingly becoming involved in shaping and executing corporate strategy (Datta and Datta, 2014). They participate in decision making as members of the senior executive team, are involved in strategy and operations as business partners of the CEO, and also often sit on the board.2 At the same time, due to their specialized expertise and unique technical knowledge, CFOs have more influence than CEOs over the firm’s financial reports (e.g., Mian, 2001; Aier et al., 2005, Geiger and North, 2006) and they are expected to be the gatekeepers or watchdogs of financial information accuracy. This is akin to characterizing the CFO role as a peculiar mix of fiduciary duties over financial reporting and managerial involvement in decision-making (Indjejikian and Matějka, 2009). Given that firms inevitably must handle such CFO “role duality” judiciously, our study contributes to the literature by considering CFO role characteristics as well as the determinants and effects of CFO compensation. Specifically, we address two research questions. First, we investigate whether differences in CFO role characteristics are associated with differences in CFO compensation, including CFO compensation relative to that of their CEO. Second, in line with prior work (e.g., Graham et al., 2005; Mergenthaler et al., 2012), and echoing concerns of policy makers and regulators, we examine whether CFO compensation has an effect on the propensity of CFOs to monitor and fulfill their fiduciary obligations (Li, 2014), which we proxy in terms of financial reporting quality. In this second part, we also include in our tests the effect of CFO role characteristics directly on financial reporting quality. Our operationalization of “CFO role” constitutes an extension of prior work. As in prior work, we proxy for CFO roles by using hand-collected public data on education and past professional experience and skills, but additionally, we supplement these proxies with proprietary data to more directly capture the firm-specific nature of the CFO job and responsibilities. These data were entrusted to us by one of the major global compensation consulting firms and allow us to consider different manifestations of firm-specific CFO jobs and tasks through a “CEO-CFO distance” measure of the extent to which the CFO job is more or less similar to that of their CEO. In this way, we identify two key role dimensions through factor analysis which we label “financial expertise” and “CEO likeness”.