By Vincent Chen, Mak Yuen Teen and Claire Neo Wei Ling
First published in Business Times, 19 June, 2013
Enlightened approach: Companies should provide more information around the cessation of CFOs, such as information that addresses concerns about loss of an experienced CFO or frequent CFO changes. They should also provide more information about how an incoming CFO can be expected to contribute to improved performance of the firm. – PHOTO: YEN MENG JIIN
THERE has been growing attention on the important role played by the chief financial officer (CFO) in ensuring good corporate governance of companies, while helping companies deliver sustainable performance. In 2006, The Business Times, supported by the Singapore Exchange (SGX), launched the corporate governance-focused Singapore Corporate Awards, and one of the five awards recognise the best CFOs in SGX-listed companies.
Over the past few years, SGX introduced several rule changes which are related to the appointment and cessation of CFOs. Not only must companies immediately disclose their appointment and cessation, detailed reasons for cessation must also be provided. The CFO must inform SGX in writing if he is aware of any irregularities in the issuer which would have a material impact on the group, including financial reporting.
Although these requirements also apply to directors and other key executive officers, they indicate that SGX considers that the appointment and resignation of a CFO, and concerns he has with the issuer, is information which is material to investors. Furthermore, SGX requires the Audit Committee to make all reasonable enquiries and provide a negative confirmation on the competency, character and integrity of the CFO at the time of listing.
The CFO’s importance can also be seen in the recommendation of the Committee to Develop the Accountancy Sector in Singapore to enhance CFOs’ professional skills through structured professional development, training programmes and certification. In 2011, the Pro-Term Singapore Accountancy Council launched the Singapore CFO Institute as a focal point for thought leadership and research on CFO-related issues and to facilitate the creation of continuing education programmes to meet the professional developmental needs of CFOs and aid their career progression.
Research we have conducted supports the importance of these developments. In a study of CFO cessations and appointments in SGX-listed companies over the three-year period from January 2009 to December 2011, we found that 263 CFOs left their positions in their companies and 247 CFOs were newly appointed. We examined the characteristics of companies with CFO changes, the characteristics of CFOs who were appointed or who left, and whether the market reaction to changes of CFOs is conditional on company and CFO characteristics. We controlled for factors such as company size, industry and other management changes.
We divided the sample of CFO cessations and appointments into three sub-samples. The first sub-sample involves cases where a CFO cessation is announced without a new CFO being announced within two business days after the cessation announcement (pure CFO cessations); the second sub-sample involves cases where a CFO appointment is announced without a CFO cessation being announced within two business days before the new CFO appointment (pure CFO appointments); and the third sub-sample contains cases where a CFO cessation and CFO appointment are announced within two business days of each other (concurrent announcements).
Dividing into sub-samples allows us to better isolate the determinants and impact of CFO changes. We eliminated from the sub-samples certain cases, such as where a CFO left his position but took on another position within the company, where there were other confounding events around the time of the cessation or appointment (such as an earnings announcement) and where information on share prices were not available.
We discuss only the findings for the first two sub-samples here because the results from the third sub-sample were similar.
For the final sample of 127 pure CFO cessations, we found that slightly more than half of the companies had poor performance (defined as operating income growth below the industry median) prior to the cessation. This suggests that companies that are performing well are almost as likely to lose their CFO as those who are performing more poorly. Male CFOs comprise about three-quarters of CFO cessations, not an unusually high percentage given that a recent KPMG study shows slightly more than 70 per cent of CFOs are men. In other words, adjusting for percentage of male and female CFOs, male and female CFOs are about equally likely to leave a company.
Slightly more than half of the CFOs stayed for less than two years before leaving the company. More than one-third had another CFO leaving the company during the past one year. Therefore, companies often struggle to retain their CFO and have to cope with multiple CFO changes within a relatively short time. This suggests that companies need to look into their recruitment and retention policies for CFOs.
We then examine the share price reaction to the departure of the CFO and found a few factors to be significant in explaining the reaction. First, we found that when prior financial performance was poor, the share price reacted positively to a change in CFO and when prior performance was good, the share price reacted negatively.
Second, the share price reacted more negatively to the cessation of a longer-tenured CFO. This may be due to the perceived loss of institutional knowledge when a highly experienced CFO departed. Companies therefore need to properly plan for the succession of their CFO, especially one who has been with the company for a long time.
Third, the share price reacted negatively when there had been at least another CFO change over the past year. This may be due to investors interpreting frequent CFO changes with weaknesses in the company’s internal control or corporate governance, or its poor recruitment process. However, this relationship only holds for frequent CFO changes within one year. We did not find any gender effect.
Internal appointments
Turning to the final sample of 133 pure appointment announcements, we found that 31 were appointed from within the company to their new CFO role. Therefore, more than three-quarters of all CFO appointments were external. Just over 40 per cent of the newly appointed CFOs had no prior experience as a CFO. Female CFOs comprised 28 per cent of the CFO appointments.
We found that the market reacted positively to the appointment of a CFO from within the company. This is consistent with insiders being perceived to be of greater value to the company due to their company-specific knowledge. We did not find any relationship between prior financial performance and the share price reaction to an appointment, nor did we find that the preference for an inside or outside CFO was dependent on prior financial performance.
Not surprisingly, we also found that the market reacted positively to the appointment of a CFO who had prior experience as a CFO. We did not find any gender effect.
The findings from our study have important implications for companies and for initiatives aimed at enhancing the competencies of CFOs. For example, the finding that the market reacts positively to the appointment of an experienced CFO shows that experience is highly valued by the market. This supports the local efforts to enhance the training and development of CFOs and aspiring CFOs in Singapore and the region. Mentoring initiatives involving highly experienced CFOs are likely to be beneficial in developing CFOs.
The findings also provide some guidance to companies in their cessation and appointment announcements. Companies should provide more information around the cessation of CFOs, such as information that addresses concerns about loss of an experienced CFO or frequent CFO changes. They should also provide more information about how an incoming CFO can be expected to contribute to improved performance of the firm, for example, through his previous experience as a CFO.
Finally, our research suggests that companies should have proper succession planning for the CFO role, and they should preferably groom their future CFO from within the company by facilitating the candidate’s training and development. They also need to pay more attention to their processes for recruiting and retaining CFOs as frequent CFO changes are disruptive and they should focus on getting the right person and retaining this person.
Vincent Chen and Mak Yuen Teen are professors in the department of accounting at the National University of Singapore.
Claire Neo Wei Ling is a student at the university completing a double degree in Bachelor of Business Administration (Honours) and Law. This article is based on research undertaken by Ms Neo under the supervision of the two professors
