Is a Restatement a CFO’s Kiss of Death?

Study by U. of Alabama professors finds a far higher turnover rate among restating finance chiefs than among those who don’t restate. But how much higher?

An email from Prof. Cooper, responding to’s request for information about the study, offered yet another set of numbers to explain how much more often CFOs and CEOs leave a company within a year of a restatement. Applying the differential of 10 percentage points for CFOs and 14 percentage points for CEOs in the adjusted numbers, the professor said, a restatement on average “increases the probability of CFO turnover by…24.6 percent…over the usual probability of turnover for CFOs of non-restating firms.” For CEOs, the probability of turnover increases a whopping 45.5 percent.

“The effects are even larger for sub-samples (of companies) where the misstatements were more egregioius,” Prof. Cooper added in his email.

Diluting the results for today’s finance executives under any scenario, however, could be the time period of restatements covered in the study: 1997 and 2002, before the great wave of post-Sarbanes-Oxley restating began to sweep the nation.

There were 919 restatements by U.S. public companies during the five-year period studied, according to the General Accountability Office. The research included 518 of them. After the steady rise in restatements that started in 2002, however, companies made a record 1,420 restatements in 2006 alone, according to a report earlier this year by investor research firm Glass, Lewis & Co., which predicted that the number might be at least as high this year.

The 2006 total was more than 12 times higher than in 1997, and last year represented one of every 10 public companies. In 2002, the first year of Sarbox, there were 330 restatements. Plus, in an April review by CFO, various experts noted that in the post-Sarbox years restatements — often involving inadvertent errors rather than fraud — have been more accepted as a result of the complexity of the system.

The Alabama study by Profs. Cooper and Agrawal does discuss a number of factors to be considered when examining CFO and CEO turnover, as well as the replacement of auditors post-restatement.

Some companies change CFOs or CEOs to regain “reputational capital” that may have been lost, to limit liability from possible classs-action lawsuits, or to help reverse market-value losses.

“On the other hand, there are also reasons why an earnings restatement may not lead to greater management turnover,” the report says. They include the high cost in human capital that may result from replacing executives, and difficulties with internal controls if key individuals are dismissed, “unless the [accounting] problems are directly linked to those individuals.” Further, if the reputational damage is judged to be minor, “the net benefits from replacing managers can be small.”

The benefits associated with replacing the auditor also reflect whether a company needs to “regain its lost reputational capital or limit its liability exposure.” Those costs can be large, however, and may include dealing with “steep learning curves” in replacing an auditor, and complications associated with the narrow choice among audit-firm candidates, especially when the field contains certain industry specialties.

But perhaps the most significant lesson of the study is that a careful reading of academic reports is always warranted.


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