New Terrain

Post-Enron reforms have made dramatic alterations to the landscape of corporate governance. Boards, their committees, and internal auditors now have greater responsibilities and powers. How will these reforms change the CFO's job?

As former Enron CFO Andrew Fastow negotiated the plea bargain that has landed him a 10-year prison sentence, many finance chiefs were quietly hoping that some stern justice would help restore investor confidence. “Jail time will be an effective way to inhibit fraud,” says Regina Sommer, CFO of Netegrity Inc., a Waltham, Massachusetts-based software firm.

Punishment isn’t the sole answer to Corporate America’s problems, of course. Those in government hope that regulation, rather than incarceration, will provide a lasting deterrent to corporate misconduct. But while the post-Enron regulations affect everyone from board members to executives to shareholders, CFOs find themselves at the nexus of these changes—and apparently quite ambivalent about it all.

A CFO magazine poll of more than 300 senior finance executives finds them split on whether the governance reforms enacted in the past 18 months are worth the considerable effort of implementing them. They are also divided about whether CFOs should work merely to satisfy the letter of the law or go further and embrace its spirit.

On one point they are agreed: despite the shift of responsibility mandated by the Sarbanes-Oxley Act of 2002, which gives the authority to hire external auditors to the board’s audit committee—and takes it away from the CFO—fully 70 percent of finance executives believe the CFO’s standing ultimately will be enhanced. Talks with nearly two dozen finance executives, academics, activists, and experts in the governance field indicate that this belief reflects more than just wishful thinking. Yet the interviews also strongly suggest that the emergence of these more-influential finance chiefs will depend in large measure on how they respond to a new corporate world in which power is more diffuse and penalties are substantially increased.

“These reforms represent a sea change for CFOs,” says Charles Elson, Edgar S. Woolard chair of corporate governance at the University of Delaware. The most conspicuous example, he says, involves the new dynamic between CFOs and audit committees. “Whereas the CFO and the audit committee of the board once worked together collegially, it has now become an oversight relationship, with power moving to the audit committee.”

Upbeat Uncertainty

Many CFOs say the greatest impact of the new regulations is that they establish uniform governance practices across all firms; few seem concerned about any potential loss of influence. “It’s not a zero-sum game,” says Hilton Hotels Corp. CFO Matthew Hart. “An increase in the responsibilities of one party [the audit committee] does not decrease the influence or power of the CFO. There is simply more for everyone to do. For the most part, these new rules create a more proper alignment of responsibilities.”

The CFO survey finds that 35 percent of respondents agree with Hart, and consider the audit committee’s external-audit hiring responsibilities a positive development. Some 55 percent are more blasé, expecting little or no impact on audit quality or improved governance, while only 10 percent see the switch as potentially harmful.

But opinions diverge more radically on questions of whether regulations have improved corporate governance in general. Just one finance executive in six gives them a ringing endorsement, saying the rules have largely addressed important issues and corrected shortcomings. One in four believes the rules head in the right direction but don’t go far enough, while another quarter of the respondents take the opposite view and dismiss the regulations as distracting and costly. The most common response? Uncertainty—more than a third of respondents say it’s too soon to tell whether reforms will work.

But don’t write off that uncertainty as being downbeat, advises Hart. “CFOs are doing much of the scut work to implement these new rules. That will inevitably inspire some grousing,” he says. “That so many are taking a wait-and-see attitude is in fact positive.”

And scut work abounds. “There is a lot of paperwork; it is voluminous,” says Hart, primarily in support of the attestation process that culminates with the CEO and CFO vouching for the accuracy of quarterly financial results.

As CFO has reported previously, the costs of compliance are substantial for most companies, with 7 of every 10 finance executives believing the benefits fail to outweigh the costs (see “Sticker Shock,” September 2003). Lately, though, CFOs seem more inclined to see a silver lining—in the added status that accrues to the CFO as co-signatory along with the CEO. “The very fact that the CFO is one of only two people who must now attest to financial results underscores the CFO’s importance in providing leadership, in establishing the tone at the top,” says Debra Smithart, former CFO at restaurant company Brinker International Inc. and now a member of the audit committee of Denny’s Corp.’s board.

CFOs could be forgiven for dismissing the phrase “tone at the top”—coined by the Treadway Commission when it proposed a number of corporate reforms in the 1980s—as hollow, New Age management-speak completely at odds with the current drive for no-nonsense rule-making. “There was a time when I would have laughed it off,” says David Steiner, CFO of Houston-based Waste Management Corp. “But I’ve come to see that within large corporations it’s the only thing that matters.”

For CFOs, helping establish the tone at the top can take several forms. “At one company I’m familiar with,” says Hart, “the governance policies weren’t all they could be, and the CFO refused to sign off until things were improved.” The Hilton executive says that the CFO in question “made sure the company was in compliance, and then some, which entailed not getting just the troops to follow better procedures, but other senior executives as well.”

Indeed, adds Don Barger, CFO of Overland Park, Kansas-based Yellow Roadway Corp., CFOs need to foster a state of mind at the company in which “anyone who has a question on anything feels free to raise it, and any potentially problematic situations are fully assessed.”

Internal Audit to the Fore

Many of those questions are likely to be raised by internal-audit staff, who now pose a managerial dilemma for CFOs, given their more-direct reporting relationship to the audit committee. Rather than chafe at this new reality, the finance chief can be a positive influence in making sure internal auditors get the respect and cooperation they need. If there are fears that the solid-line reporting between internal audit and the audit committee could lead to perceptions of internal auditors as institutionalized whistle-blowers—perhaps even prompting up-and-coming finance staffers to avoid internal-audit assignments—CFOs can allay such concerns.

The way for CFOs to promote a healthy atmosphere, some say, is to support internal audit’s greater visibility and help promote corporate respect for auditors in the reform environment. Some experts point to internal audit’s necessary closed-door meetings with the audit committee as a major step toward the kind of free and open corporate communication that most executives say is at the heart of better governance. “By requiring certain kinds of closed-door meetings to take place,” says Bengt Holmstrom, a Massachusetts Institute of Technology economist who has studied corporate-governance issues, “the new regulations actually nurture the relationships that shape governance, because now CFOs don’t have to question why such meetings occur or wonder whether they’re a sign of trouble.” Many companies have held such meetings as a matter of course, but the new rules now mandate that the best practices in evidence at well-governed companies be practiced by all.

“Internal audit has always walked a fine line,” says Barger. “But it’s their job to look for weaknesses and fix them, and we absolutely want them to do that.” Adds Paul Schmidt, controller at General Motors Corp., “We have 200 people in internal audit, and it’s now a more exciting place to work. Our audit committee values them, and even when we downsize, they keep a close eye on the size of internal audit to make sure we have the resources there that we need.”

Pitney Bowes Inc. CFO Bruce Nolop goes a bit further. “[Internal] auditors are rock stars now,” he says. “This is their day in the sun.”

Rock stars or no, internal-audit staff may find a measure of tension and even conflict of interest because of their peculiar location in this new regulatory terrain—caught between the CFO and the audit committee. H. Stephen Grace Jr., chairman of Financial Executives International and head of an advisory services firm in Houston, says FEI has joined with the Institute of Internal Auditors to study how “internal audit has been misused and distracted [from doing its job] in the past.” The goal, he says, will be to raise awareness of potential conflicts and to clarify the roles of internal audit and finance.

Complicated Yet Narrow

As CFOs confront the managerial complexities wrought by new regulations, they are seeking ways to simplify and clarify what’s expected of them.

In November, writing on behalf of the Business Roundtable, Pfizer Corp. CFO David Shedlarz sent a letter to the Public Company Accounting Oversight Board, asking that it reconsider aspects of its proposal addressing Section 404 of Sarbanes-Oxley. Section 404 requires, among other things, that companies document, test, and assess the effectiveness of their system of internal controls, and have their external auditor attest to the efficacy of such controls. Shedlarz urged the PCAOB to revisit the actual legislative directive, and require an external auditing firm to attest only to a company’s assessment of its internal control over financial reporting, rather than conduct an “audit” of the preparation, assessment, and testing of such controls. In addition, he emphasized the benefits a principle-based approach to standard setting would have in achieving governance objectives. “We believe that a standard that more appropriately focuses on the significant issues around business risk, fraud prevention, and detection would better serve the needs of investors, rather than the very prescriptive detailed testing approach in the [PCAOB's] proposed standard.” Shedlarz says he is firmly committed to the PCAOB’s success in establishing itself.

Shedlarz’s letter captures the concern that many in finance have about reform efforts in general. Do they, in the words of The Corporate Library chairman Nell Minow, a leading advocate for better governance, “lose the forest of good governance for the trees of a checklist approach to satisfying new regulations?” While recent changes certainly move things in the right direction, she says, more work needs to be done.

Knowing Your Food Chain

The key to a positive outcome, in the view of many CFOs, may be the ability of finance chiefs to help their companies set a course ensuring that both the letter and the spirit of the law are met. That can be achieved, they suggest, by working more closely and supportively than ever with the full board and the audit committee.

“As a CFO, I know people down the food chain,” says Hilton’s Hart. “The audit-committee members really don’t; they just deal with the CFO and controller.” In becoming a conduit not only for financial data but also for broader business context and operational details, the CFO provides the sorts of information that the board and its committee members need in order to provide the more-substantive guidance that reform efforts intend.

Hart understands audit committees well; he heads one for Kilroy Realty Corp., a real estate investment trust based in Los Angeles. A new attitude pervades such committees, he says, where “what once might have been seen as trivial now gets explored. It’s no longer written off as a ‘management issue.’ ” And that exploration requires expanded contact between the audit committee and the CFO.

There seems little question that the frequency, duration, and intensity of discussions between CFOs, audit committees, and full boards of directors have increased substantially in the months since Sarbanes-Oxley was passed. In a perfect world, says Smithart, the talks would focus on “achieving a greater understanding of business risks and issues.” She says that the Denny’s audit committee reviews monthly management and operating-results reports and quarterly-earnings releases via teleconference. It also holds committee meetings at each of the five regularly scheduled board meetings, and has other ad hoc communications that involve the CFO, Andrew Green. A number of CFOs, however, admit that the greater face time they enjoy with audit committees and boards is largely spent addressing new governance requirements.

“We spend a lot of time studying and discussing best practices in governance and how to implement them,” says Netegrity’s Sommer. “We try not to overdose on it, but we have had to extend our meetings to allow time to also talk about actual business issues.”

Experts say communication has certainly become a bigger part of most CFOs’ jobs lately. “A CFO now needs to be fully engaged with the board,” says Harvard Business School professor Jay Lorsch, co-author of Back to the Drawing Board: Designing Corporate Boards for a Complex World. He sees a broader role for CFOs, in which they do far more than simply recap the numbers. “CFOs who are explicit about financial objectives; risk factors; and one-, two-, and three-year targets perform a critical service,” he says, particularly in an environment in which there is continued pressure for short-term results. Add to that a sometimes-delicate educator’s role for the CFO. “Board members typically believe they understand financial principles, even when they don’t,” says Lorsch. “And even if they do, they may not make a connection to the company’s specific line of business.”

All that communicating can be time-consuming, particularly at smaller companies. At Netegrity, for example, Sommer says she has been spending about 10 percent of her time on governance issues, while the company’s general counsel has spent about 25 percent of his time on them. Netegrity hired an outside firm to document its internal controls, in order to get the task done quickly and more efficiently. While some value has come from the company adopting a number of best practices, “it does seem like the pendulum has swung too far,” she says, “and you have to wonder whether the shareholder benefit equals the amount of work that’s gone into this.”

MIT’s Holmstrom jokes that the post-Enron regulatory environment has been like “a fire department trying to devise a fire code that’s so all-encompassing that they’ll never have to put out another fire.”

Most in corporate finance believe the rule-making has largely subsided. Now it’s up to the companies to make governance reforms work. “A new standard has been set,” says Smithart. And “even if things relax a little, governance has been transformed.”

Scott Leibs is editor of CFO IT.

Corporate Governance Survey

CFO conducted a Web-based survey between 12/18/03 and 1/5/04. Results are based on 310 respondents, 90% of whom are CFOs, VPs of finance, or other senior finance executives. All respondents worked for companies with annual revenue of at least $500 million, with 68% working for publicly traded companies, 21% for private companies, and the balance split among nonprofit, academic, and government institutions. Margin of error is +/- 5.1%. Totals may not equal 100% due to rounding.

Changes to corporate-governance policies/procedures have:

Moved in the right direction but not far enough. 23.5%

Proved distracting and costly, to little advantage. 22.1%

Largely addressed key issues and corrected shortcomings. 16.9%

Too soon to tell/not sure. 37.5%

Ultimately, efforts to improve corporate governance will:

Enhance the CFO position. 70.8%

Weaken the CFO position. 6.5%

Have little effect on the CFO position. 22.7%

When it comes to corporate governance, the CFO should:

Take the lead in ensuring that the letter of the law is met. 38.9%

Push the organization to make changes above and beyond those required. 39.5%

Play a supporting role in making sure that the letter of the law is met. 16.3%

Focus on financial reporting and leave structural issues of corporate governance to others. 5.2%

How have more-stringent requirements regarding how corporate boards operate changed your attitude toward serving on other companies’ boards?

I’m less likely to serve due to liability issues. 29.6%

I’m less likely to serve due to time considerations. 21.7%

I’m more likely and/or interested. 12.5%

No change to my attitude. 36.2%

How has the post-Enron focus on coporate governance affected your interactions with your company’s board?

I spend more time with the audit and/or compensation committee(s), but my interaction with the full board is essentially unchanged. 43.4%

My interactions with the full board and its committees are essentially unchanged. 36.5%

I interact with the full board more often and more substantively. 18.8%

How has the post-Enron focus on corporate governance affected your interactions with your company’s board?

I spend more time with the audit and/or compensation committee(s), but my interaction with the full board is essentially unchanged. 43.4%

My interactions with the full board and its committees are essentially unchanged. 36.6%

I interact withthe full board more often and more substantively. 18.8%

My interactions with the board and committees have decreased. 1.3%

Having the audit committee take responsibility for hiring an external auditing firm will:

Have little impact on audit quality or corporate governance. 55.0%

Prove to be a more sensible alignment of responsibilities/reporting relationships. 35.0%

Create potentially harmful lines of communication/responsibility. 10.0%

Compared with 12-18 months ago, the expertise currently found on your company’s audit committee is:

Substantially improved. 12.3%

Somewhat improved. 38.6%

Unchanged. 48.4%

Somewhat weaker. 0.3%

Substantially weaker. 0.3%

Hot Seats

CFOs look warily at serving on other companies’ boards. One indicator of finance chiefs’ mixed feelings concerning the progress of corporate-governance reform: trepidation about filling the role of financial expert on other companies’ boards.

With new regulations requiring at least one member of a board’s audit committee to have newly defined finance expertise, “there’s been unprecedented recruiting of CFOs,” says Beverly Behan, principal at Mercer Delta Consulting LLC and a specialist in the area of corporate boards and corporate governance. But CFO’s survey found that just over half the respondents are less likely to serve now—either because of liability issues or because of the increased time constraints of serving. Indeed, only 12.5 percent said they are more likely to join a board, even though the need for their services is soaring.

This caution about taking on responsibilities at other companies—where the time commitment involved with board membership in some cases has tripled, particularly for the very positions CFOs are being sought to fill: audit-committee directorships—reflects the greater demand on CFOs at their own corporations, of course. And liability concerns have also increased. Says Tim Walsh, president of Audit Committee Advisors, a Greenville, South Carolina, consulting firm: “I’ve heard lawyers say that accepting such assignments is like putting a target on your back. Who’d want to do it?”

Still, CFOs who currently serve on other companies’ boards generally say the experience is worth the extra time and risk. “I encourage CFOs to do it,” says Don Barger, CFO at Overland Park, Kansas-based Yellow Roadway Corp., who also serves as chair of the audit committee on the boards of Quanex Corp. and Gardner Denver Inc. “You benefit enormously from seeing how other companies operate.”

Double-edged Diligence

Even those who are enthusiastic about the opportunity to fill a critical role in the new order of governance caution that today’s environment requires candidates to do serious advance homework about the board they are considering joining, as well as about the company itself.

And expect due diligence to cut both ways. Debra Smithart, a former CFO at restaurant operator Brinker International, and now an audit-committee member at Denny’s Corp., says that companies are looking more carefully than ever at prospective board members. Background checks and even credit checks are not uncommon, she says, and companies not only want to verify a candidate’s character but also make sure that he or she is a proper fit with their culture. Some companies now ask candidates to undergo such assessments as the Myers-Briggs personality test, or even to meet with an industrial psychologist.

“Being on a company’s board is no longer viewed as a perk,” says Smithart, “but as a serious duty that requires a substantial commitment of time and energy.”

A Preboarding Checklist

Things to consider before accepting that directorship.

  • Avoid companies wanting only your financial expertise rather than all your talents.
  • Look for a board that’s “engaged,” without being “overly hands-on.”
  • Check current-member biographies—including average age and tenure—for hints on board dynamics.
  • Talk to the newest members and ask what sort of orientation they underwent.
  • Look at prereadings and agendas for several board and audit-committee meetings.
  • Ask the CEO and CFO how the board adds value, what its chemistry is like, and how it could be more effective.

Source: Mercer Delta Consulting LLC

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