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W&L's Afshad Irani Co-authors Research on CFO Compensation

A study that investigates the compensation of chief financial officers (CFOs) has found that they are rewarded not only when their firms meet or beat analysts’ earnings forecasts, but that they also receive incremental rewards for managing earnings and/or expectations that allow their firms to meet or just beat those targets.

Afshad Irani, associate professor of accounting at Washington and Lee University’s Williams School of Commerce, Economics, and Politics was one of three researchers who completed the study “Impact of Job Complexity and Performance on CFO Compensation.” His co-authors are Steven Balsam of Texas University, who led the team, and Jennifer Yin of the University of Texas at San Antonio.

Their research was discussed in a recent blog on CFOWorld.com where it was called “a groundbreaking paper.” The paper has been accepted for publication in the journal Accounting Horizons.

Irani said that while the compensation of chief executive officers (CEOs) has been thoroughly researched, CFO compensation has not. This study tracked 2,107 CFOs working for 1,477 companies over a 13-year period.

“When firms hold conference calls with analysts, it is both the CEO and the CFO, and many times just the CFO, answering questions regarding the financial aspects of the firm,” said Irani, explaining the researchers’ focus on CFO salaries. “In addition, both the CEO and the CFO are required by law to sign off on financial reports, stating that they fairly represent the financial position of the company as far as they know. Also, in 2006 the Securities and Exchange Commission started to require that firms report both CEO and CFO salaries, plus three others who are highly paid.”

The study initially found that, not surprisingly, CFOs are rewarded with bonuses for meeting or beating market expectation. But, Irani said, they took their research one step further and looked at firms whose earnings were either equal to market expectation or beat it by one cent or less to determine whether or not that had an impact on CFO compensation.

“We found that in those cases, the CFOs received even higher bonuses if they either managed the analysts’ forecast downward or if they managed earnings expectations upwards,” said Irani. In fact, the bonuses for those CFOs who used these methods to achieve a “small beat” were 42 percent higher than for CFOs in companies that failed to meet expectations.

Irani acknowledged that managing earnings and/or market expectations is not necessarily bad. “The stock market doesn’t like surprises and would prefer that firms report a nice increasing trend in earnings. That’s the ideal world,” he said. “So as long as it is kept within limits, it is not bad when CFOs use such tactics to smooth out fluctuations in earnings. But at the same time, once you take it outside acceptable limits, which are subjective, and start hiding things then it becomes a problem and you get fraud cases and investor confidence begins to diminish.”

The study also concluded that CFOs were paid more based on the relative complexities of their job. Complexity was measured by the size of the firm, how many analysts were following the firm, and whether the firm issued debt or equity or was involved in mergers and acquisitions activity.

Irani joined the Washington and Lee faculty in 2010 after 12 years at the University of New Hampshire, where he served as academic director of the Master of Science in Accounting Program. He received his bachelor’s degree from The College of Wooster in Ohio and his Ph.D. from Penn State.

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