Interview with Susan F. Shultz and Cheryl de Mesa Graziano

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The Board Institute, Inc.

Two governance experts discuss the evolving role of the CFO and therelationship with boards of directors.

CFO: How is the role of the CFO changing relative to the board?

Susan F. Shultz: The role really escalated quite dramatically after Sarbanes-Oxley for any number of reasons: 1) the transparency on the board, 2) the focus and attention paid to the board, 3) the increased accountability, and 4) the lesser role played by the outside auditor in terms of advising the board and the CFO. So I think of the CEO as a generalist and the CFO as the one who brings the performance into perspective, so that the board knows and understands where the company is going relative to the vision of the CEO, and so that the board understands their fiduciary responsibility.

The CFO is the one who is responsible for the financials, which are really the translation of the CEO’s vision. He or she is very pivotal and increasingly responsible.

CFO: Is assessment of board and committee effectiveness necessary?

SFS: It strikes me as ironic that the one organization, the board, with the life and death responsibility for success of a com- pany, is the organization that tends to be randomly assembled, rarely evaluated and almost never held accountable, but this is changing. The only way that the shareholders and other constituencies can know if a board is, indeed, effectively serving their interests is by having some measure. So the evaluation of effectiveness is both best practice and necessary.

CFO: And is that necessary, too, for some of the reasons you cited earlier – the new regulations, SarbOx and so on?

SFS: Right. The New York Stock Exchange, the SEC and D&O insurers are now requiring companies and funds to assess annually the effectiveness of their boards and their committees. And that’s why we joined with FERF to create the content for The Audit Committee Index – to provide an objective, information-rich, easy-to-use, Web-based measure. It is essential that the board and the CFO and CEO focus together on the same key objectives and can demonstrate the effectiveness of the board.

CFO: Does that also extend to how a company chooses its board members?

SFS: Absolutely; assessment must address director selection. The overall board, as well as the governance committee, which has responsibility for assessment, is key because, as you know, the majority of directors today are required to be independent in fact as well as in spirit. And it’s up to the board and the officers to validate that that’s the case. They’re required, in their publicly filed statements to verify that the directors are appropriately independent. That also gets a bit to diversity: the fact that there needs to be a response to the diverse interests of a board that pertain not only to ethnicity and gender, but also to age and industry and geography and so forth.

Further, the board should make clear how the directors are selected, whether by refer- ral from a friend on the board, for example, or by an objective, proactive process. NYSE issuers are required to disclose how directors are brought on board. The criteria and the process for nominating a director should also be disclosed.

Cheryl de Mesa Graziano: And certainly, going back toward the requirements for audit committees and having a financial expert, Sarbanes-Oxley and other recent regulations have called for independent evaluation of audit committee performance. The onus has been placed on this kind of evaluation from an audit perspective because, as Susan mentioned earlier, there is no longer that relationship with the external auditor, and the company has to be less collaborative and more at arm’s length, so there is true independence. The best way to measure this is to determine how the audit committee’s performance stacks up to what the criteria are.

SFS: Yes, that’s very important. The SEC and Sarbanes-Oxley require that the audit committee assess the effectiveness of the process. That’s a critical point here because it underscores the importance of having objective and independent assessment and evaluation.

CFO: So how can committees and boards be evaluated in a credible and valid manner?

SFS: This is a new thing, and corporations are very slow to change. Two years ago, only 20 percent of companies did any form of director evaluation, although 85 percent of all directors felt that it was necessary. Now that it’s required, most companies are in their first stage and still using questionnaires that were prepared in-house or assembled by officers – often the general counsel or the CFO, or, in some cases, by consultants. Also, a number of companies have turned to consultants to help them develop an action plan and dig deeper into areas that were raised as red flags.

The latest and more complete, professional solution that we have espoused is a Web-based, objective, confidential and secure approach. The front end is a questionnaire whose methodology and content is professionally validated. It is completed online or on paper by all the directors and, at the directors’ discretion, others who work closely with the board, such as the outside auditor, the outside general counsel, officers who don’t sit on the board, others who may consult with the board. So that perspective is incorporated into a very rich result that provides scores, ranges of responses, variances, comparisons, strengths and areas for improvement. In addition, it provides continuously updated information on mandates, laws, regulations and best practice. This becomes a platform for benchmarking, internally, against best practice, and against peers. It also becomes a platform for a consultant to come in and drill down to identify actions a board can take to improve. And, it provides a way to deal with individual director evaluations, by providing an objective, 360-degree platform for discussion.

One of the most popular articles in Directors & Boards is “How to Fire a Director.” That’s such a dilemma in the boardroom, and I think one reason is that there has not been an objective tool to measure a director’s contribution in a positive way. I don’t know a director who does not want to continuously improve. The Web-based evaluation is a way to confidentially and privately gain input to allow directors to improve their performance, or for the board to make a decision about bringing on a new member for whatever reason. Maybe the company is going in a new direction or has new initiatives or new needs, such as the need for financial experts on the audit committee or for those with financial expertise.

CFO: Let’s talk a little bit about the new certification mandate and the impact it’s had on the CFO and other officers.

SFS: Directors and officers are legally vulnerable, because they must certify financial results. And of course, this is where special pressure falls on the CFO. It’s the CFO who has the responsibility to ensure the company produces financial statements that fairly represent the financial condition and results of operations at a corporation. And they also are responsible for making any timely disclosures that investors need to assess the soundness and risks of the corporation. That’s an enormous mandate. And the CFO is usually the key communicator between the company and the board and has the responsibility to educate and help the board understand the key metrics, assess the risks and encourage them and collaborate with them in any action and oversight the board may need. So the fact that this is now a legal mandate has great significance.

At the same time, as we mentioned earlier, the outside auditor has pulled back from being a member of the team to being more like another regulator. Often CFOs no longer confer with their outside auditor about potential financial problems until after they are resolved because the auditors feel compelled to report any issues to avoid prosecution or recriminations.

That has put an additional level of responsibility on the CFO as well as on the CEO. The auditor used to help solve problems on the front end and provide valuable perspective. So this certification mandate has really escalated the demands placed on both the directors and the officers.

CFO: Speaking of certification and other kinds of scrutiny that boards and companies have come under in recent years, do you see that as a positive development, an inevitability or ...?

SFS: That’s really the key question in governance today. My fear is that the extreme regulation has resulted in our thinking of governance as compliance and checking the boxes. Those who work on good boards know that their essence is strategic value-add and growing the business and collaborating with various experts in a very synergistic way. I’ve seen so many examples of companies being dramatically improved by the strategic advice and counsel of good boards. For example, Phelps Dodge was going to do a major acquisition in South America, but one of the directors had an awareness of the target company and suggested they hold off. The target company went bankrupt shortly after the discussion was tabled at the next board meeting. There are so many examples of boards being proactive in helping with strategy and counsel.

I know there’s huge resentment against checking the boxes. And rightfully so. However, we do have by far the best governance system in the world, and we’re a model for every other country. I foresee us moving to more principle-based oversight, away from a focus on the minutia of many compliance details. I was just speaking in Japan, and they have embraced J-SOX, Japan Sarbanes-Oxley. It’s com- ing as our markets converge. Our system is really all about investor and shareholder confidence and trust in the markets. That’s the bottom line of the heightened accountability at the board level — a restoration of confidence in our markets and economy.

I’ll make one other comment on that. One of the big problems is that Section 404 has not been applied in a principle-based way, but rather in a rules-based way, so that every item on a balance sheet would have the same weight. I know of a company that had a $75,000 misstatement related to terms of a lease. It cost them $370,000 to hire the auditor to correct it. And it wasn’t an area that impacted the bottom line in any way of significance. If we get back to some balance in the application of Section 404, that will go a long way.

CdMG: Susan talked a bit earlier about the change in goals and how regulation and certification impacted the CFO and other officers. Certainly since Sarbanes-Oxley was enacted in 2002, the CFO has been balancing internal control and objectively looking at the financial statements while trying to work with business to come up with a strategy to grow the business. As the pendulum swings and regulations change from year to year, the CFO is always on the front lines.

The CFO role is also subject to change when there’s a new CEO, because the CEO and CFO really need to work together, primarily due to the fact that they have to certify the financial statements along with the other strategic goals they have for the organization, interacting with the board, etc. It’s a collaborative relationship.

Hopefully now there is more of a balance, as the Public Company Accounting Oversight Board has proposed Accounting Standard No. 5 (AS5), a revised standard on internal control audits. With some of that stabilizing, at least for large multinational public companies, the CFO could move more toward business and technology aspects of their role.

This is reflected in a recent survey of 200 members of Financial Executives International (FEI) on Section 404 compliance costs. The results of this sixth Sarbanes-Oxley compliance survey found that Section 404 compliance cost corporate America less in year three of adoption than in each of the first two years. According to the FEI survey, which included 172 “accelerated filers” – companies with market capitalizations above $75 million – total average cost for Section 404 compliance was $2.9 million during fiscal year 2006, which represents a 23 percent decrease from 2005 totals. The data also shows reductions in internal and external costs of compliance, with internal staff time decreasing by 10 percent. The lower costs can be attributed to companies’ increased efficiencies in complying with Section 404.

Overall, now you’re looking at a CFO position with more responsibility than ever before. You have to be a partner and, at the same time, you have to be able to independently assess whether or not the financial statements are accurate. And you also, as a CFO, have to be able to attest to the audit committee, which, in turn, has to attest to the external auditor and to the shareholders, that the financial statements are indeed sound and represent what the regulations require. You have this steady stream of new accounting standards and interpretations that you have to deal with from the Financial Accounting Standards Board. You have to meet regulations from the SEC, if you’re a public company. On top of all that, you have to do it with fewer resources.

CFO: What are the compensation trends for CFOs?

CdMG: We surveyed over 1,800 professional members of Financial Executives International on what the compensation trends are this year. We asked 27 questions in five key areas: demographics, compensation, long-term incentives, retirement benefits and other compensation perks.

What we found is that compensation is proportionate to the size of the company. Looking at the private company CFOs, their pay was a lot lower than their public company counterparts, but their job responsibilities were more diverse, particularly in areas such as treasury, tax, human resources, admin and risk management. For private companies, the job responsibilities were more diverse and less specialized than their public company counterparts, and this showed up in their average median pay.

If you looked at the base salaries of private company CFOs, for example, you found that their median annual base salary was in the $176,000 to $200,000 range, while that of a public company CFO was in the range of $251,000 to $275,000. If you look at company size, there are more specifics. For privately held companies with annual revenue of less than $25 million, none of their CFOs earned more than $275,000. Meanwhile, in the large private companies, they all earned more than $300,000. Likewise, that pay grew exponentially for public company CFOs. If you looked at annual bonuses, anywhere from 31 to 40 percent of CFOs for small public companies were making more than $300,000; at large public companies, almost 100 percent of CFOs earned that much. Again, that percentage was proportionate for private companies.

CFO: Was there anything else we didn’t hit upon that either of you wanted to mention?

SFS: I’d like to reinforce Cheryl’s comments about how the CFO position has grown to that of a business and strategic partner with the CEO. Traditionally, one of the problems was that the CFO has been looked upon as a technician, producing a set of formulaic numbers. Really, the CFO’s role is translating the corporate vision into reality through the financials and exercising a high degree of informed judgment.

Another thing that’s really driven a greater appreciation for the CFO’s responsibility is the increase in regulation of corporate boards. Directors now understand that they have a real responsibility; they’re not just coming to lunch and golf. That’s a very significant change. Another change is the time commitment required of everybody. When PeopleSoft was acquired by Oracle, there were 90 meetings of the audit committee over the course of 18 months. They weren’t all in-person meetings, but it gives you a sense of what the commitment level can be in a situation involving change, whether it’s an ownership change or an acquisition or another key shift in the business direction. The good thing is that we have a better understanding of the opportunities and roles and responsibilities. I see an overall improvement in the climate and in the commitment of officers and directors.

The surveys on Section 404 and financial executives’ compensation can be found at the FEI/FERF website www.ferf.org/bookstore.