OUTLINE

Introduction
CFO
power
financial gain

and

personal

CFO power and CEO pressure

CFO power and stock price
crash risk
Conclusion

INTRODUCTION
Agency costs is define as costs arising from the likelihood that
managers place personal interests ahead of shareholders interest.
Agency problems are also related to management compensation
contracts.
According to Jensen and Meckling (1976), the agent-principal
problems can be reduced through the incurrence of monitoring costs
and provision of appropriate incentives for the agent.
Prior studies have proved that agency costs decrease as managerial
ownership increases.

INTRODUCTION
As the compensation contracts are highly dependence on firms
performance, the chances of exercising earning management
practices is even greater.
According to Healy and Wahlen (1999) earning management occurs
when managers use judgement in financial reporting and in
structuring transactions to alter financial reports to either mislead
some stakeholders about the underlying economic performance of the
company or to influence contractual outcomes that depend on
reported accounting numbers (p.368)
Executive stock options allow managers to receive the benefits in
later years where they are given chances to purchase stock at some
future time at a given price.
Corporate failure scandals indicate that CFO has failed in their

CFO POWER AND PERSONAL FINANCIAL GAIN

Feng et al. (2011)
Studies prove that there is a negative association between CFO power
and personal financial gain. However, there is positive relationship
with CEO pressure.
60 percent of CFOs of manipulating firms are charged with stringent
legal penalties by the SEC. Among legal penalties are future
employment restrictions from serving as an officer, director, or
accountant for any public company, fines and disgorgement of the
illegal gains. CFOs also face with the criminal charges which cause
them to serve home detention and in worst case imprisonment.
Therefore, CFOs committing accounting manipulations open
themselves with severe legal costs and in return reap limited
immediate financial benefits via equity incentive compensation.
Results are inconsistent with Jiang et al. (2010) study where Jiang
found mix results for pre and post-SOX period due to enforcement of

CFO POWER AND CEO PRESSURE

Feng et al. (2011)
The findings shows that CEOs of manipulating firms have higher payfor-performance sensitivities and power (i.e., the CEO is more likely to
be Chairman of the Board and a founder, and more likely to have a
higher share of the total compensation of the top five executives).
Accounting manipulation is higher when CEOs hold a higher equity
incentives and thus have the power to pressure CFOs to perform
manipulations.
Further analysis using Accounting and Auditing Enforcement Releases
(AAERs) suggests that CEOs are more likely to coordinate the
accounting manipulations and receive financial benefits than CFOs.
Therefore, CFOs become involved in accounting manipulations under
pressure from CEOs, rather than impelling such manipulations for
prompt financial benefits. Feng, M., et al. (2011) results also shows
that CFOs are more likely to leave the companies prior to the
accounting manipulation period due termination as they refuse to
commit accounting manipulations under the CEO pressure.
The result is consistent with Friedman (2014) but inconsistent

CFO POWER AND CEO PRESSURE

The introduction of Sarbanes-Oxley Act (SOX) in 2002 - higher responsibilities to be
carried out by the CEO and CFO
CFO and CEO are required to certify the accuracy of the firms financial statements
and to reimburse the company for any bonuses received if the company has to
restate its earnings.
SEC also enforced new disclosure requirements on executive compensation whereby
firms have to disclose their CFO pay.
Jiang et al. (2010)
Test the effect of CFO and CEO equity incentives on accruals in pre (1993 2001)
and post-SOX era (2002 2006).
In pre-SOX period they found the level of accruals are higher in CFO equity
incentives compared to CEO equity incentives.
However, they found both equity incentives owned by CFO and CEO and negatively
associate with level of accruals for post-SOX period.
This indicate that the relationship between the CFO equity incentives and firms
accruals management does not only weaken but actually reverses after the
implementation of SOX.
The reason behind the reversal is due to CFOs believe that after SOX investors react
negatively to positive earning surprises by firms whose CFO have higher equity
incentives.

CFO POWER AND CEO PRESSURE

Friedman (2014)
Found that when CEO can pressure the CFO to bias reports at a level
that the CEO desires, an increase in the CFO's personal cost of bias
leads to lower reporting effort.
This will reduce the firm value and provide a weaker incentive
compensation for the CEO and CFO.
The CFO will reduce reporting effort to ease the biasing he is
pressured to provide even though there are stringent punishment
available if they were caught for manipulating the accounting report.
In firms with powerful CEOs, reduction of the CEO power will increase
the reporting quality, incentive compensation strength, and firm
value.
In contrast, for firms with non-powerful CEOs, increasing punishments
to the CFO should have positive effects on reporting quality, incentive
compensation strength, and firm value.

CFO POWER AND STOCK PRICE CRASH RISK

Jiang et al. (2010)
examine the sensitivity of managers equity compensation to the changes in the
firms stock price. The results demonstrate some weak evidence that managers
equity-based incentives (ie: CEOs and CFOs) are more crucial in affecting earnings
management by firms that have a high relationship between earnings and stock
prices.
Mix results were found in Kim et al. (2011).
Kim et al. (2011)
investigate the extent of CEO and CFO equity incentives influence the firm-specific
stock price crash risk.
The results show that CFOs option incentives are significantly and positively related
to future crash risk and also for firms with greater incentives to conceal risk taking.
They also found a weak evidence that the CEOs option incentives cause the crash
risk and this weak effect disappears after the CFO option incentives are included.
This result prove that CFOs are more powerful in firms bad news hoarding
decisions. Furthermore, it was found that CFOs option incentives positively related
to non-competitive industry because product market competition prevent
managerial bad news hoarding behaviour.
Kim, J.-B., et al. (2011) discover only CEO and CFO option incentives have a

CONCLUSION
There are mixed results on CFO power in earning management as there are
various factors that could influence the CFOs decisions.
Furthermore, both CEO and CFO have their own interest in managing the
resources of the firms.
Andergassen (2008)
Suggests conflicts in shareholder and manager can be resolved if focus of
both party is align. Therefore, stock option vesting period shall be increased
as any earning management activities will reduce the managers wealth as
well as the shareholders by assuming manager and shareholder are risk
neutral).
Wu (2011)
replicate the Andergassen (2008) study with the assumption that
manager is a risk-averse type. This study is more realistic as most managers
fall under this category.
Stock options encourage higher effort and higher manipulation. Therefore,
shareholder shall assess the possibility of the event to occur and the
potential damage that it will cause. If manipulation cause higher potential
damage, lower stock option shall be granted.
They also suggest that firm should ensure that less equity compensation in

REFERENCES
Andergassen, R. (2008). "High-powered incentives and fraudulent behavior: Stockbased versus stock option-based compensation." Economics Letters 101(2): 122125.
Feng, M., et al. (2011). "Why do CFOs become involved in material accounting
manipulations?" Journal of Accounting and Economics 51(12): 21-36.
Friedman, H. L. (2014). "Implications of power: When the CEO can pressure the CFO
to bias reports." Journal of Accounting and Economics 58(1): 117-141.
Jiang, J., et al. (2010). "CFOs and CEOs: Who have the most influence on earnings
management?" Journal of Financial Economics 96(3): 513-526.

Kim, J.-B., et al. (2011). "CFOs versus CEOs: Equity incentives and crashes." Journal
of Financial Economics 101(3): 713-730.

Wu, Y. W. (2011). "Optimal executive compensation: Stock options or restricted

stocks." International Review of Economics & Finance 20(4): 633-644.

THANK YOU