Board monitoring of the chief financial officer: A review and research agenda

• Author: David Alexander Uhde,Patricia Klarner,Anja Tuschke
• DOI: http://doi.org/10.1111/corg.12188
• Published date: 01 March 2017
• Date: 01 March 2017

ORIGINAL MANUSCRIPT

Board monitoring of the chief financial officer: A review and

research agenda

David Alexander Uhde

1

|Patricia Klarner

2

|Anja Tuschke

3

1

Furnitects GmbH, Türkenstr 53, 80799

Munich, Gernany

2

Department of Strategic Management and

Entrepreneurship, Rotterdam School of

Management, Erasmus University,

Burgemeester Oudlaan 50, 3062 PA

Rotterdam, The Netherlands

3

Munich School of Management, University of

Munich, Ludwigstr, 28, 80539 Munich,

Germany

Correspondence

Patricia Klarner, Department of Strategic

Management and Entrepreneurship,

Rotterdam School of Management, Erasmus

University, Burgemeester Oudlaan 50, 3062

PA Rotterdam, The Netherlands.

Email: klarner@rsm.nl

Abstract

Manuscript Type: Review

Research Question/Issue: Research on how boards govern individual top management

team (TMT) members, i.e., senior executives aside from the CEO, is still scarce and fragmented.

In this study, we review extant research on board monitoring of the Chief Financial Officer

(CFO) –an increasingly influential actor at the top of the firm –synthesize it, and propose an inte-

grative future research agenda on board governing of the CFO.

Research Findings/Insights: Our review of the accounting, finance, and management liter-

atures reveals that extant research emphasizes the board’s need to monitor the CFO as a major

strategic actor in the firm. However, studies have frequently focused on selective aspects of

board monitoring activities, neglecting how central board attributes influence effective gover-

nance of the CFO. We therefore develop a comprehensive model of board monitoring and advis-

ing of the CFO that addresses the role of board attributes in governance activities.

Theoretical/Academic Implications: Our future research program on board governance of

the CFO contributes to developing a better understanding of how board composition, structure,

characteristics, and processes influence different board monitoring and advising activities.

Practitioner/Policy Implications: We offer a framework for boards of directors responsible

for governing CFOs, highlighting the factors they have to take into consideration when selecting,

dismissing, and compensating the CFO and when ratifying her decisions and rendering advice on

her proposals. We also provide CFOs with insights into the factors that influence their dismissal,

compensation, and collaboration with the board.

KEYWORDS

Corporate Governance, Board Attributes, Chief Financial Officer, FunctionalTop Managers

1|INTRODUCTION

Board monitoring is essential for solving conflicts that can arise from

the separation of ownership and control (Adams, Hermalin, &

Weisbach, 2010; Daily, Dalton, & Cannella, 2003; Johnson, Daily, &

Ellstrand, 1996). As suggested by agency theory (Fama & Jensen,

1983b; Jensen & Meckling, 1976), boards need to monitor the top

management team (TMT) on behalf of the firm’s shareholders. While

the TMT is responsible for strategic choices that secure a firm’s finan-

cial success (Carpenter, Pollock, & Leary, 2003; Collins & Clark, 2003;

Knight et al., 1999), typical monitoring activities of the board include

hiring and firing top managers, overseeing strategy implementation,

and rewarding top managers (Hillman & Dalziel, 2003; Johnson et al.,

1996). Examining boards’monitoring of management is thus an impor-

tant area of research in the field of strategic leadership and corporate

governance (Haynes & Hillman, 2010; Johnson et al., 1996).

Prior research has, to a large extent, focused on boards’governing

of the Chief Executive Officer (CEO) (Combs, Ketchen, Perryman, &

Donahue, 2007; Dalton, Daily, Ellstrand, & Johnson, 1998; Haleblian

& Rajagopalan, 2006). However, researchers have only recently sug-

gested the need to study other individual functional TMT members

(i.e., senior top executives aside from the CEO) and their board rela-

tions (Menz, 2012). In this respect, it is in particular the Chief Financial

Officer (CFO) who requires a stronger research attention. While

*The first two authors contributed equally.

Received: 16 July 2015 Revised: 4 November 2016 Accepted: 8 November 2016

DOI 10.1111/corg.12188

116 © 2016 John Wiley & Sons Ltd Corporate Governance: An International Review 2017;25:116–133.wileyonlinelibrary.com/journal/corg

originally being back‐office treasurers or controllers, CFOs have

evolved into the “second‐in‐command”(Zorn, 2004: 360), “watch-

dogs”(Feng, Ge, Luo, & Shevlin, 2011: 22) for the quality of financial

reports, and the key individual for communicating the financial strat-

egy to external stakeholders (Mian, 2001). Thus, CFOs are often

referred to as key leaders responsible for firms’accounting and

finance functions (Baxter & Chua, 2008) and their role in central com-

pany functions has steadily increased over the past decades (Zorn,

2004). Consequently, in addition to CFOs’traditional responsibilities

for finance and accounting, they are increasingly involved in strategy

development, evaluation of strategic alternatives, and strategic

choices (Huang & Kisgen, 2013; Indjejikian, & Matejka, 2009;

Meyer‐Doyle, 2012; Zorn, 2004).

Accordingly, numerous firms have identified CFOs as being central

to their value creation (Higgins & Gulati, 2006; Zorn, 2004). CFOs pos-

sess the requisite skills that qualify them as advisors and confidents of

the CEO to complement her general management responsibility with

financial and strategic expertise. For instance, in an interview with

the Financial Times in 2010, a board audit committee chairman stated,

“There are pressures on the CEO to do acquisitions, for example. You need

to have someone who is the CEO’s intellectual equal to balance this …In

our company, it’s part of the CFO’s job description and he has personal

incentives to stand up to the CEO”(Goodman, 2010: 1). Further, major

accounting scandals, such as Enron and Worldcom, have increased

the accountability of CFOs –in addition to CEOs –for firm actions

(Burks, 2010; Collins, Masli, Reitenga & Sanchez, 2009). The impor-

tance of CFOs for their companies is also illustrated during leadership

successions: Several CFOs of major listed companies have transitioned

from the CFO position to the CEO role. For example, in 2013, Siemens

AG’s board appointed long‐time CFO Joe Kaeser the next CEO

(Trojanovski, 2013). In addition, PepsiCo’s Indra Nooyi, Harley

Davidson’s James Ziemer, and Duke Energy’s Lynn Good were all

CFOs prior to becoming CEOs.

Due to the CFO’s rising importance in the firm, boards of directors’

governance of this important top manager has become critical for firm

success and long‐term survival. Boards need to monitor the central

decisions in which CFOs are involved, as board status and reputational

capital are at stake for such governance (Fahlenbrach, Low, & Stulz,

2010). Surprisingly, however, little research has examined boards’

monitoring of the CFO. Due to the CFO’s key functional responsibili-

ties (finance, accounting, and strategy), she is more likely to interact

with specific board directors and committees (e.g., the audit commit-

tee) and the CEO. Such specific relationships are not captured by

extant research in corporate governance, which focuses on board

monitoring of the CEO or the entire TMT. Extant research remains

fragmented, as different studies focus on different aspects of board

monitoring, which is exercised through hiring, firing, and compensating

the CFO. For example, some studies have examined the reasons for

the CFOs’firm exit, such as poor firm performance (Mergenthaler,

Rajgopal, & Srinivasan, 2012; Mian, 2001) or accounting problems

(Agrawal & Cooper, 2009; Arthaud‐Day, Certo, Dalton, & Dalton,

2006). Others have focused on CFO compensation, revealing that

superior forecasting abilities positively influence CFO bonuses

(Zamora, 2009) and that Sarbanes‐Oxley caused firms to place more

weight on earnings in CFOs’bonus contracts (Carter, Lynch, &

Zechman, 2009). Burks (2010) finds that accounting restatements

decrease such compensation. Still others have studied the impact of

CFOs on firm outcomes such as mergers and acquisitions (M&As)

and initial public offerings (IPOs) (Huang & Kisgen, 2013; Meyer‐

Doyle, 2012) or reporting strategies (Bamber, Jiang, & Wang, 2010;

Brochet, Faurel, & McVay, 2011).

Despite these important findings, prior research on CFOs has not

explicitly considered the board of directors when studying corre-

sponding governance activities. In particular, it has largely ignored

the role of board attributes –board structure and composition, char-

acteristics and processes –in board governance of the CFO. This is

surprising, as corporate governance studies have long shown the

importance of examining such attributes for gaining a more compre-

hensive understanding of board governance of managers (Zahra &

Pearce, 1989). Yet, even research in corporate governance has fre-

quently ignored the central role of the CFO as a key strategic decision

maker (e.g., Gore, Matsunaga, & Yeung, 2010). In this study, we aim

to fill this void by answering the following research questions: How

do boards monitor their CFOs? How can future research advance our

understanding of the role of board attributes in board governance of

the CFO?

In order to answer these questions, we analyzed all major aca-

demic journals covering research on CFOs. We thereby identified

65 studies published in 26 accounting, finance, and management out-

lets. We review this literature, which depicts the status quo of the

impact of CFOs on the firm and on boards’hiring, firing, and compen-

sating of the CFO as well as board monitoring of her strategy imple-

mentation. In doing so, we make visible the rather implicit role of

boards in monitoring CFOs. Subsequently, we integrate the

fragmented findings into a comprehensive framework. Building on

these findings, we then argue that it is time for a more comprehen-

sive analysis of boards’governance of CFOs and develop a future

research agenda for corporate governance scholars that focuses on

central board attributes. We address the key board roles of monitor-

ing the CFO and rendering advice on CFOs’proposals, thereby

extending the focus of the extant research on monitoring by also

incorporating the critical board role of advising key executives. Our

results encourage new research in the fields of management, account-

ing, and finance to establish a profound understanding of boards’

monitoring and advising of the CFO, which we term “board gover-

nance”in this paper.

The contributions of our paper are threefold: First, we provide an

interdisciplinary review of research on the CFO and highlight prevail-

ing themes. We thereby add to the emerging field of research on func-

tional TMT members such as the CFO and take account of the

increased importance of this top manager (Hambrick, 2007; Menz,

2012). Second, we structure the literature into an overarching frame-

work to visualize important themes. Third, we develop an extended

framework for future research on board governance of the CFO. In

doing so, we put board attributes back into the spotlight to advance

extant research that has frequently ignored such attributes. The

resulting more complete model serves as a guide for future research,

as it helps to develop a better understanding of how board composi-

tion, structure, characteristics, and processes influence monitoring

and advising of the CFO.

UHDE ET AL.117