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6 June 2019 CFA Institute Journal Review

How Do Chief Financial Officers Influence Corporate Cash Policies? (Digest summary)

  1. Marla Howard, CFA

In a UK sample, firms with a strong chief financial officer (CFO) hold substantially less cash than similar firms with weak CFOs, regardless of CEO leadership. Influential CFOs access external financing more easily in financial downturns and thus do not have the precautionary motive to accumulate cash. Strong CFOs perform a monitoring function, reducing cash holdings in firms with high agency costs.

What Is the Investment Issue?

Following documented concern about a spike in UK companies’ cash holdings, the authors investigate the role of UK chief financial officers (CFOs). They believe that UK CFOs might have greater authority over financial policy than CFOs elsewhere: 85% serve on their own company’s board, compared with 11% in the United States, and 25% are on other companies’ boards. Past research had mostly explored only the CEO’s impact on cash holdings of the firm.

The authors contemplate whether a dominant CEO would be less willing to delegate liquidity decisions to the CFO. They find that strong CFOs influence cash holdings in both high- and low-power CEO subsamples.

With a better understanding of CFO impact on cash holdings, the way a strong CFO can use cash policy to monitor high agency costs, and the CFO’s ability to access external financing, practitioners might more effectively evaluate a firm’s liquidity level in accordance with indicators of CFO influence.

How Did the Authors Conduct This Research?

The authors develop a CFO index to capture a CFO’s ability to influence key financial policies. Six CFO-specific characteristics are combined using principal component analysis to develop the index: board membership, outside board directorship, seniority, financial expertise (financial certifications), pay status (whether or not the CFO is one of the three top-paid executives), and relative pay status (compared with the CEO).

The authors identify CFOs from 1,564 firms listed on the London Stock Exchange from 1998 to 2011, resulting in 8,509 firm-year observations. They then break out the sample by strong (i.e., more influential) CFOs and weak (less influential) CFOs.

The authors use propensity score-matching analysis on 3,122 observations, whereby the top third of firms (in terms of CFO strength) are matched with similar firms in the bottom third (weakest CFOs) according to exact industry and year.

What Are the Findings and Implications for Investors and Investment Professionals?

The authors’ results show a negative relationship between strong CFOs and cash holdings, even when controlling for CEO dominance and other firm, board, ownership, and managerial characteristics. They find that when firms switch from a weak to a strong CFO, cash holdings subsequently decrease, and vice versa. The results are economically and statistically significant.

The authors offer two possible explanations. Strong CFOs have better access to external financing and thus have a weaker precautionary motive to hoard cash. They show that strong-CFO firms had greater net debt issuance during 2008–2009 than weak-CFO firms, which supports the idea that influential CFOs have better access to financing during times of economic stress. The second possible explanation is that strong CFOs play a monitoring role. The results indicate that in firms with higher agency costs, a strong CFO has a more pronounced effect on reducing cash.

The average cash holdings are 13.09% for strong-CFO firms compared with 14.45% for weak-CFO firms. When CFOs have a tenure of three years or more, the average cash holdings are 9.29% in strong-CFO firms compared with 11.26% in weak-CFO firms. All differences are statistically significant. In subsamples of financially constrained and unconstrained firms, strong CFOs help increase the value of cash holdings—but only when their firm is likely to face financial constraints.

Abstractor’s Viewpoint

The authors show that strong-CFO firms in the United Kingdom have greater net debt issuance than weaker-CFO firms during 2008–2009. Does the same differential access to external financing occur in other markets during financial crunches?

Additional questions arise about the importance of board memberships by the CFO as well as the potential monitoring role of strong CFOs in other markets where agency costs are high.

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