Ex-post analyses of corporate scandals often postulate a what-if scenario: Would things have been different (better) had women held the reins of those firms? Variants of this question appear in the media, political speeches, and academic research. Our recent research addresses this question by examining whether the likelihood of irregularities in corporate financial statements is lower if the firm has a female Chief Financial Officer (CFO).
Financial statement information is critical for efficient capital allocation and investment. Misreported financial statements have harmful consequences: companies go bankrupt erasing the jobs and savings of employees; management and directors are fired, tried, and sometimes incarcerated; and confidence in business is eroded. Although financial misreporting is a popular area of multidisciplinary research, empirical inquiry is based generally on firms that are ‘caught’ engaging in fraudulent behaviors. Researchers observe detected fraud, not all fraudulent activity, generally referred to as the ‘partial observability’ problem.
Indeed, although nearly 15% of public firms engage in some type of accounting fraud, less than 1% are actually caught. Consequently, much effort has been directed towards developing tools to detect misreporting. One particularly innovative tool is the Financial Statement Deviation (FSD) score, which compares the distribution of leading digits in reported financial statements with that predicted by a mathematical axiom called Benford’s Law.
Stated simply, Benford’s Law proves that in a natural distribution of numbers, the leading digit 1 is likely to appear about 30% of the time, the number 2 about 17.6% of the time, and so on up to the number 9, which appears as a leading digit less than 5% of the time. Offered originally by 18th century American astronomer Simon Newcomb based on his examination of library copies of logarithm tables, the formal proof was established several decades later by physicist Frank Benford. Since then, Benford’s law has been used to identify manipulated data in various contexts. The distribution of leading digits in manipulated financial statements violates Benford’s Law, resulting in higher FSD scores.
Academic research points to fundamental differences between men and women, with several studies suggesting that women are generally less competitive, more ethical, and more risk-averse than men. From this perspective, firms with female CFOs should have lower likelihood of financial misreporting compared to male CFOs. Yet, it is also possible that gender differences disappear once men and women make it to senior managerial positions because of the strong job-demands of executive roles. Notably, of all senior managers, the CFO has the most impact on a firm’s financial reporting decisions.
We hypothesize that firms with female CFOs will have a lower likelihood of financial misreporting than firms with male CFOs. In addition, we hypothesize that the association between CFO gender and financial misreporting will be moderated by the managerial discretion of the CFO. Considerable evidence indicates that the impact of managerial attributes on firm outcomes depends on how much discretion – or latitude of action – stakeholders allow managers. When there is greater discretion, managerial characteristics are more likely to be reflected in corporate outcomes than when discretion is lower.
Accordingly, we posit that the association between CFO gender and financial misreporting will be moderated by analyst coverage and institutional ownership. When analyst coverage or institutional ownership is low, there is less oversight of managers (i.e., more managerial discretion) by key stakeholders, so that CFO gender will have a stronger influence on financial misreporting. Firms with male CFOs are more likely to misreport financial statements when discretion is high than when discretion is low.
To examine our hypotheses, we draw a sample of U.S-based public firms by merging six different datasets. Our final sample comprises of 18,659 firm-year observations, from 1996 to 2016, covering 2,186 unique firms. We compute FSD Score for each firm-year by generating the frequency distribution of leading digits for all line items reported in the Balance Sheet, Income Statement, and Statement of Cash Flows in the annual report (Form 10-K).
Regression analyses on the full sample (with numerous control variables and accounting for industry- and time-fixed effects) show that firms with female CFOs have 2.6% lower FSD Score (our proxy for financial misreporting) compared to firms with male CFOs. Given that estimates of financial fraud range from $200 to $600 billion annually in the US alone, any action that leads to even 1% reduction in fraud is economically meaningful.
As expected, we also find that the gender main effect is qualified by governance mechanisms. Specifically, firms with female CFOs have significantly lower likelihood of financial misreporting compared to firms with male CFOs when institutional ownership or analyst coverage is low than when institutional ownership or analyst coverage is high.
In robustness analyses, we measure financial misreporting with earnings restatements, a popular proxy used in the literature, and found similar results. We also employ several other analytical approaches, including propensity-score matching, firm-fixed effects, and treatment-effects model, all of which provide general support for our hypotheses. Although women remain under-represented in senior leadership positions, more women now occupy C-level positions than ever in history. As a result, the issue of whether corporate actions differ based on who is ‘at the wheel’ is increasing in importance. We find that firms with female CFOs are significantly less likely than firms with male CFOs to report financial irregularities, and the male-female difference is greater when monitoring from institutional owners and analyst coverage was low compared to when such monitoring is high. As such, our research reveals that gender may have enduring implications not just for executives’ careers, but also for the firms where they are in responsible positions. Overall, our research enhances knowledge about whether and when executive gender affects organizational outcomes.
Gupta, V. K., Mortal, S., Chakrabarty, B., Guo, X., & Turban, D. B. “CFO gender and financial statement irregularities.” Academy of Management Journal 2020.
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