CFOs who were former financial statement auditors report less aggressively than CFOs without prior … [+]
CFOs who were former financial statement auditors report less aggressively than CFOs without prior audit experience. However, as their audit experiences become a more distant part of their past, CFOs with audit experience report more aggressively, according to a study forthcoming in Auditing: A Journal of Practice & Theory.
Public accounting experience, particularly experience as a financial statement auditor, provides valuable training for high-level financial reporting positions like CFO. CFOs with prior audit experience typically have expertise related to Generally Accepted Accounting Principles (GAAP), as well as a mindset that values objective, transparent, and conservative financial reporting. This mindset and training can lead to more conservative financial reporting decisions when compared to CFOs without audit experience on their resume.
This notion is tested in a study titled “Prior Audit Experience and CFO Financial Reporting Aggressiveness.” Researchers in the study analyzed 30,703 instances of public company financial reporting between 2000 and 2015. Of these annual financial reports, 18% were issued by a company that had a CFO with prior audit experience. The study is authored by Eric Condie from Georgia Tech, Kara Obermire of Oregon State University, Timothy Seidel of Brigham Young University, and Michael Wilkins from the University of Kansas.
“Prior research suggests that CFOs with financial expertise – CFOs with MBA degrees or those holding a CPA – are associated with higher quality financial reporting outcomes. These studies largely imply that the effect of this expertise is constant over time. However, my professional experience provided anecdotal evidence that although former auditors tend to carry their auditor mindset with them into their new industry roles, this mindset gradually moves toward favoring the company’s goals and priorities,” notes Seidel.
Using a host of measures for financial reporting aggressiveness – discretion used in accrual accounting, misstatements of income, meeting or just barely beating analysts’ forecasts – the researchers found that CFOs with prior audit experience were less apt to report aggressively when compared to the financial reports of CFOs without audit experience. “We think this finding may be a result of CFOs with audit experience having a mindset focused not only on complying with GAAP, but also on faithfully reporting their business activities,” says Seidel.
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The study also investigated if the influence of audit experience decays over time. To do so, the researchers examined the financial reporting of CFOs whose audit experience was fairly recent (<10 years ago), less recent (10-19 years ago), and in the distant past (>19 years ago). These tests revealed that CFOs became more aggressive with their financial reporting over time, particularly for CFOs whose experience was in the distant past.
“Our results with respect to decay are driven specifically by aggressive reporting choices – using accruals that increase current period earnings – rather than simply reflecting errors in the estimation of accruals. Interestingly, we also found that the reporting from companies with Chief Executive Officers (CEOs) with prior audit experience was less aggressive as well. However, in contrast, our analyses suggest that the effect of prior audit experience does not decay when CEOs become further removed from their prior audit experience,” notes Seidel.
Last, the study describes how, along with being less aggressive in their reporting, CFOs with prior audit experience should be more likely to prioritize the financial statement audit process. Consistent with this notion, the researchers observed that audit fees were lower for companies that had a CFO with prior audit experience. However, in line with the declining salience of audit experience over time, the study observed that audit fees rise as the CFO’s audit experience becomes more distant.
Seidel concludes, “I think the most important takeaway is for stakeholders to understand that while prior auditing experience often leads to more conservative reporting practices, incentives and reporting behaviors can change over time. Although auditors appear to recognize this, it is important for internal stakeholders, like the audit committee of the board of directors, as well as investors to recognize this as well.”
