cfo march 2014 issue

CFOMARCH 2014 | WWW.CFO.COM

HOW CSX HIRES

FINANCE STAFFERS

STATE TAX SURVEY:

TAXING ISSUES

THE PATH OF LEASE

RESISTANCE

THE SEARCH FORSUSPECTACCOUNTING

New analytical tools can detect everything from managed earnings to fraud

14March_Cover_Fin.indd 1 2/26/14 11:51 AM

Job # FilenameSS-131517_M01 131514_131516_M01.indd

Art Director

Artist

Steven Cloud

D.McAvoy

User / PrevUs-/DVW�0RGL¿�HG

CMYK

12-12-2013 4:30 PM

Bleed

Trim

Saftey

8.75” x 11.5”

7.875” x 10.5”

7” x 9.75”

Path Premedia:Volumes:Preme-

dia:Prepress:131514_131516:-

Final:Prepress:131514_131516_

M01.indd

Derrick Edwin / Aileen Boyce

Client

Create

Proof

GMCR/Keurig

12-3-2013 5:07 PM

7UDI¿�F na5-FINAL

Fonts Fedra Sans Std (Book, Bold; OpenType), Helvetica Neue LT Std (55 Roman; OpenType)

Art KEU_131514_01e_SWC_workplace.tif (Arts_Logos:Green Mountain Coffee Roasters:Art:Keurig:2013:KEU_131514_01e_SWC_workplace.tif), KEU_131345_05a_SW_Gradient.tif (Arts_Logos:Green Mountain Coffee Roasters:Art:Keurig:2013:KEU_131345_05a_SW_Gradient.tif), KEU_131514_02c_SWC_K150_S_CUP_SIMP.psd (Arts_Logos:Green Mountain Cof-

fee Roasters:Art:Keurig:2013:KEU_131514_02c_SWC_K150_S_CUP_SIMP.psd), KEU_Logos_01_BTL_Lockup_KO.ai (Arts_Logos:Green Mountain Coffee Roasters:Logos:Keurig:KEU_

Brew a better workday.Employees love Keurig. In fact, when o! ered Keurig Brewed® beverages,87% of employees are more likely to be satisfi ed with their co! ee at work*. After all, they’ll be getting a gourmet cup of co! ee at the touch of a button,with over 200 beverage varieties to choose from.

And that means a job well done.

Client/Product Name: GMCR/KeurigJob Number: SS-131514_131516_M01Description: Away From Home –“WORKPLACE” – PG 4/CBPub/issue Date: Various

Bleed: 8.75” w x 11.50” hTrim: 7.875” x 10.50” Safety: 7” x 9.75”

FULL PAGE - BLEED

This advertisement prepared by:HAVAS WORLDWIDE NY200 Hudson StreetNew York, New York 10013

Creative: Steven Cloud/Jamie PerruquetAE: CJ Abell/Matt LibbeyProd/Traf! c: Linda Pino

BILL LABOR TO JOB NUMBER: SS-131514BILL OOP TO JOB NUMBER: SS-131514

TIME JOB NUMBER FOR PRODUCTION & PROOFREADING: SS-131397

Keurig.com/workplaceCall 800.223.6768

*Source: Carbonview

Research–

Employee M

orale Survey©

2014 Keurig, Incorporated

S:7”S:9.75”

T:7.875”T:10.5”

B:8.75”B:11.5”

Keurig.indd 8 1/22/14 12:39 PM

Cover by Xavier Bonghi/Getty Images. This page, clockwise from top left: Thinkstock (2), Flowizm/Flickr

24The Search For Suspect AccountingAnalytical models from academia and the SEC could help expose everything from poor-quality earnings to outright fraud. By Vincent Ryan

30ii�The 2014 CFO State Tax Survey

Taxing IssuesDiscretionary authority, economic nexus, and the taxing of services loom large in the state tax landscape. By Edward Teach

36The Path of Lease ResistanceMany CFOs now agree that companies should put leases on the balance sheet. It’s the how that has them up in arms. By David M. Katz

FEATURES

COVER

STORY

36

42 ii�Special Report: Finance Hiring

Working On The Railroad Railroad company CSX finds top-notch finance staffers by using a case-study approach to hiring. By David McCann

March 2014 Volume 30, No. 2

1cfo.com | March 2014 | CFO

Ê

“We’ve seen more and more states using discretionary authority, because they don’t like the answer they get when the rules as written are applied.”

ii�Harley Duncan, KPMG

14Mar_TOC_Fin_Rev.indd 1 2/25/14 4:47 PM

From top: Thinkstock (3); Courtesy TripAdvisor

CONTENTS

Up Front4 ii�From the Editor6 ii�Letters

8 ii�Topline Z�Big banks continue to ease underwriting standards Z companies aim to reduce their cash hoards—again Z finance benchmarking’s miss-ing ingredient Z and more.

March 2014 Volume 30, No. 2

48 ii�FIELD NOTES Perspectives from CFO Research

Machine DreamsFinance executives have no trouble imagining how new technologies will make their companies more competitive. So why can’t they make that vision a reality? By Josh Hyatt

By the Numbers

14 | ACCOUNTING & TAX

Mind the Non-GAAPNontraditional financial metrics can shed valuable light on a company’s op-erations—or obscure its true condition. Z By Marielle Segarra

HP CFO Fought Autonomy DealCatherine Lesjak’s opposition to the ill-advised acquisition proved prophetic. Z By David M. Katz

16 | GROWTH COMPANIES

Patent MedicineWill proposed patent reform legis-lation do more harm than good for small companies? Z By Marielle Segarra

Behind GlassdoorTransparency is the heart of the job and career website’s business model. Z By David McCann

18 | HUMAN CAPITAL

Engineering a Finance CareerDon’t tell these CFOs they should have

majored in accounting. Z By David McCann

20 | RISK MANAGEMENT

In the Wolf’s DenCorporate investigator Bo Dietl talks about working for Jordan Belfort, and why fraud won’t go away. Z By Josh Hyatt

Halliburton Ruling Could Slash Class ActionsA Supreme Court decision in favor of the oil services giant could drastically reduce class-action risk exposures. Z By David M. Katz

22 | STRATEGY

Kicking the HabitBy stopping the sale of tobacco products, CVS gains a reputational and strategic boost. Z By Marielle Segarra

Foreign ComplicationsInternational markets are enticing but can be hazardous. Here are six risks to watch out for. Z By Vincent Ryan

14

46 ii�DEEP DIVE CFO Takes the Pulse of American CFOs

More Than Just A Number An aging workforce is on the minds of finance chiefs in the latest Duke/CFO Business Outlook Survey. By David W. Owens

22

18

52

52 ii�Take-Away

Global AmbitionsAlthough TripAdvisor is the largest travel website in the world, there’s plenty of room for more growth, says CFO Julie Bradley.Interview by Marielle Segarra

2 CFO | March 2014 | cfo.com

14Mar_TOC_Fin.indd 2 2/25/14 4:29 PM

Creative:

Account:

Production:

Proofreader:

Client– Shell438-020 Shell Fleet Navigator Print Ad - 2014FP

Pub: CFO, FF, AFMaterials Due: varies

Trim: 7.875 x 10.75Live: 7 x 10Bleed: 8.25 x 11Colors: 4/CProd designer: NS

Backed by more than 50 years of experience, the nation’s most extensive service

network and customized reporting to fi t your needs, the Shell Fleet Navigator Card

delivers unprecedented control and customization over the information you receive,

your routes and drivers. It’s fl eet management that offers the ultimate flexibility to

improve your bottom line.

The Shell Fleet Navigator

SM

Card

THE POWER OF

CHOICE PUTS

YOU IN CONTROL

SM

.

TO FIND OUT MORE AND SIGN UP, CALL 888-212-8916

OR VISIT WWW.SHELL.US/FLEETNAVIGATOR.

ShellFleet Navigator

VEHICLE CARDFUEL & MAINTENANCE

LOCATIONS ONLY

FLEE

T

CORPORATE

SM

0123456789876543210FUEL ONLY CARD FPOEXPIRATION DATE FPOPERSONALIZATION LINE1PERSONALIZATION LINE2

01234567898765432100123456789876543210FUEL ONLY CARD FPOEXPIRATION DATE FPOPERSONALIZATION LINE1PERSONALIZATION LINE2

The Shell FLEET NAVIGATORSM MasterCard® is issued by Regions Bank, pursuant to a license by MasterCard International Incorporated. FLEET NAVIGATORSM is a service mark of STMBV.

438-020_Shell_FleetNAV3-2014_CFO_AF_FF_FP_v4.indd 1 2/20/14 12:22 PM

Shell.indd 11 2/20/14 1:43 PM

CFO, Vol. 30, No. 2 (ISSN 8756-7113) is published 10 times a year and distributed to qualified chief financial officers by CFO Publishing LLC, 51 Sleeper St., Boston, MA 02210 (executive and editorial offices). Copyright ©2014, CFO Publishing LLC. All rights reserved. Neither this publication nor any part of it may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior permission of CFO Publishing LLC. Requests for reprints and permissions should be directed to FosteReprints, (866) 879-9144; E-mail: [email protected]; website: www.fostereprints.com. Subscriptions: U.S. and possessions: 1 year $65; 2 years $100; 3 years $130; foreign, 1 year $120 U.S. funds only. Periodicals postage paid at Boston, MA, and additional mailing offices. POSTMASTER: Send address changes to CFO, P.O. Box 1233, Skokie, IL 60076-8233. CFO is a registered trademark of CFO Publishing LLC. SUBSCRIBER SERVICES: To order a subscription or change your address, write to CFO, P.O. Box 1233, Skokie, IL 60076-8233, or call (800) 877-5416; or visit our website at www.cfo.com/subscribe. For questions regarding your subscription, please contact [email protected]. To order back issues, call (617) 345-9700, ext. 3200. Back issues are $15 per copy, prepaid, and VISA/MasterCard orders only. Mailing list: We make a portion of our mailing list available to reputable firms.

THE BUSINESS OF SPORTThe beginning of the 2014 Major League Baseball season is set to begin later this month (in Austra-lia, of all places). The sport may be timeless, but the business of baseball has changed a lot dur-ing the past three decades. The general manager of the New York Mets describes how in “Sandy Alderson on the Modern Busi-ness of Baseball,” in Knowledge@Wharton (http://knowledge.whar-ton.upenn.edu/article/new-york-mets-sandy-alderson-modern-business-baseball/).

PLANNINGIf you work in the high-tech indus-try (or would like to), make room in your schedule for the FP&A for High-Tech Summit in San Fran-cisco, on April 8–9. Planned speak-ers include directors of finance at companies like Microsoft and Google, and presentations will cover the particular challenges of forecasting and planning at high-tech companies. For more information, go to http://theinno-vationenterprise.com/summits/fpa-hightech-sanfrancisco2014.

FROM THEEDITOR

EDITOR’S PICKS

The lesson of this sad story is all too familiar, writes David Katz in “HP CFO Fought Autonomy Deal” (page 15): don’t buy without doing thorough due diligence (and don’t ignore the CFO, for that matter).

But it isn’t easy to spot accounting shenanigans, and companies and investors alike yearn for tools to help them do so. Cue academia: as Vincent Ryan reports in our cover story, “The Search for Suspect Accounting” (page 24), university researchers are developing analytic models to detect accounting irregularities and earnings management. The Securities and Exchange Commission, meanwhile, has introduced its own Accounting Quality Model, a.k.a. RoboCop.

An accounting scandal lies at the root of the multiyear effort to revise lease accounting. Aside from the tricks Enron played with revenue recognition and mark-to-market accounting, its main claim to infamy was its use of special-purpose entities to keep billions in debt off its balance sheet. The exposure of that practice led regulators to investigate off-balance-

sheet arrangements in general—such as leasing. Today, standard-setters are close to issuing a final new standard that will require all leases to be put on the balance sheet. But as Katz reports in “The Path of Lease Resistance” (page 36), many CFOs disagree as to how, exactly, that should be done.

There is, of course, a legal way of portraying a company’s results in a better light: non-GAAP metrics, such as EBITDA and free cash flow. Recently, however, companies have pushed these metrics too far, earning the scorn of investors and the scrutiny of the SEC, as Marielle Segarra reports in “Mind the Non-GAAP” on page 14.

Elsewhere in this issue, we present the latest edition of CFO’s State Tax Survey (page 30). And in a special report on page 42, David McCann reveals how railroad company CSX makes sure it hires the best and brightest finance staffers.

Edward Teach

Executive Editor

ii�Three years ago, Hewlett-Packard paid $11 billion to buy Autonomy, a British software company. In Novem-

ber, HP wrote down the acquisition’s value by $8.8 billion, charging that some Autonomy managers had “used account-ing improprieties, misrepresentations and disclosure failures to inflate the underlying financial metrics of the company.”

Funny Numbers

Kory Addis4 CFO | March 2014 | cfo.com

14Mar_EdLetter_Fin.indd 4 2/25/14 2:50 PM

CODE: ETR-GEN-14-2A PUB/POST: Workspan, Wired, Fortune, PRODUCTION: Andre Hadjioannou LIVE: 7” x 9.875”

DESCRIPTION: Strength in Numbers WORKORDER #: 006103 TRIM: 7.875” x 10.5”

Delivery Support: 212.237.7000 FILE: 07A-006103-06A-ETR-GEN-14-2A.indd SAP #: ETR.ETRBRD.14010.K.011 BLEED: 8.625” x 11.125”

Art: print-background-Swop3.tif (CMYK; 300 ppi; Up to Date), ETR-Asterisk-Glossy-4C.ai (Up to Date), ETR- ETRADE Corp Services-Glossy KO-4C.ai (Up to Date)

STRENGTHIN NUMBERSE*TRADE’s Stock Plan Management.The numbers speak for themselves:

#1 Overall Satisfaction and Loyalty Rating for Equity Edge OnlineTM1

2 Easy-To-Use Flexible Service Models

1 Million+ Participants in Almost Every Country

1400 Corporate Clients Including 22% of the S&P 5002

Contact us to learn how our products can meet your equity compensation needs.1. Equity Edge Online™ was rated #1 in Overall Satisfaction and Loyalty in the 2012 and 2013 Group Five Stock Plan Administration Study Industry Report. Group Five, Inc. is not af!liated with E*TRADE Financial Corporate Services, Inc. or the E*TRADE Financial family of companies.2. Data as of 9/30/13.The E*TRADE Financial family of companies provides !nancial services that include trading, investing, banking, and managing employee stock plans.E*TRADE Financial Corporate Services, Inc. and E*TRADE Securities LLC are separate but af!liated companies.The laws, regulations and rulings addressed by the products, services and publications offered by E*TRADE Financial Corporate Services, Inc. are subject to various interpretations and frequent change. E*TRADE Financial Corporate Services, Inc. does not warrant these products, services and publications against different interpretations or subsequent changes of laws, regulations and rulings. E*TRADE Financial Corporate Services, Inc. and its af!liates do not provide legal, accounting or tax advice. Always consult your legal, accounting and tax advisers.©2014 E*TRADE Financial Corporation. All rights reserved.

ETRADE.COM/CORPORATESERVICES1-800-783-3388

Etrade.indd 9 2/20/14 11:59 AM

LETTERS


Ë�The issue of auditor rotation has come full circle. In February the Pub-lic Company Accounting Oversight Board gave up on its three-year effort to mandate that U.S. public compa-nies switch their auditors every few years, as Vincent Ryan reported in “PCAOB Abandons Auditor Rotation” (February 6). One commenter said au-ditor rotation would have failed any-way: “Rotating audit firms doesn’t ad-dress the real conflict in the auditor/audited relationship, and that is that B pays A and A is always bidding for more work from B.”

Another reader, however, offered a historical perspective. “I am re-minded of the ‘old’ J.P. Morgan,” he said. “Fifty-plus years ago, it rotated its auditors routinely. It ‘footed’ its balance sheet to the nearest penny. It also quietly refused to bank one of the 100 largest companies in America;

EditorialVP AND EDITORIAL DIRECTOR Z�Celina Rogers

CFO Magazine/cfo.comEDITOR-IN-CHIEF, CFO MAGAZINE Z�Edward Teach ([email protected])

EDITOR-IN-CHIEF, DIGITAL PLATFORMS Z�Vincent Ryan ([email protected])

MANAGING EDITOR Z�Deana Colucci

DEPUTY EDITORS: Z�David M. Katz ([email protected]) Z�David McCann ([email protected])

EDITOR Z�Marielle Segarra ([email protected])

CONTRIBUTING EDITORS: Z�Russ Banham Z�Randy Myers Z Alix Stuart

DIRECTOR OF DESIGN Z�Jeof Vita

it banked the other 99.” Here’s a thought: If the old ways are indeed best, does that include auditor ro-tation?

Ë�Speaking of the old ways, noth-ing seems to generate as much criticism as the budgeting process. In “Ugh! It’s Budget Approval Time” (January 15) Gregory Milano advised companies to stop linking budgets to performance measurement, arguing that doing so encourages managers to play the “budget negotiation game” and lowball their targets. “We are paying them to plan for mediocrity,” wrote Milano.

“Great article,” one reader de-clared. “Straightforward and right to the point.” Said another: “In addition to the obstacles to year-over-year performance incentives addressed in the article, I might add another based

CFO Research/CFO Custom PublishingEDITORIAL DIRECTOR, RESEARCH Z�David W. Owens

ASSOCIATE RESEARCH DIRECTOR AND SENIOR EDITOR Z�Josh Hyatt

SENIOR EDITOR Z�Katherine Teitler

OPERATIONS DIRECTOR Z�Linda Klockner

EDITORIAL DIRECTOR, PRODUCT DEVELOPMENT Z�Mary Beth Findlay

SENIOR WEBCAST PRODUCER Z�Joe Fleischer

CONTRIBUTING RESEARCH EDITORS: Z�Elizabeth Fry Z Ian Mount Z�Christopher Watts

Advertising Sales/Product DevelopmentSVP, CHIEF CONTENT & PRODUCT DEVELOPMENT OFFICER Z�Rich Rivera

SVP, BUSINESS DEVELOPMENT Z�Lissa Short

SVP, SALES Z�Katie Brennan

National Advertising OfficeNORTHEAST Z�Haley Moore (646) 277-6478; fax: (212) 459-3007

MIDATLANTIC/SOUTHEAST Z�Jo Ben-Atar (646) 237-4101; fax: (212) 459-3007

on personal experience: ‘My unit performed so well this year, I maxed out my bonus. How can I possibly top that?’ After the effect of the cur-rent bonus wears off (within 30 days, in most cases), what was once an incentive be-

comes more of a disincentive to some managers.”

But a third commenter came to the defense of tradition. “Can anyone sug-gest a better way to [do] performance evaluations?” he asked. While con-ceding that target setting “is subject to sandbagging,” the reader invited us to “consider the damage to overall corporate performance if the evalua-tion targets are different from budget targets. If performance evaluations are not based on quantitative targets, then negotiating power is even more of a problem.”

MIDWEST Z�Katie Brennan (646) 277-6476; fax: (212) 459-3007

WEST COAST Z�Judy Hayes , (925) 736-7617

LOGISTICS SERVICES GUIDE, MARKETPLACE, FINANCE JOBS Z�Alicia Upchurch (646) 556-7653; fax: (212) 459-3007

ASSOCIATE PROJECT MANAGER Z�Katherine Brennan, (646) 237-4100

CFO ConferencesSENIOR DIRECTOR OF CONFERENCES Z�Deborah Hatcher

CONFERENCE SALES EXECUTIVE Z�Angela Bright

MARKETING COORDINATOR Z�Hannah Smith

Editorial Offices51 Sleeper Street, 3rd Floor Boston, MA 02210 (617) 345-9700

45 West 45th Street, 12th Floor New York, NY 10036 (212) 459-3004

Subscriber Serviceswww.cfo.com/subscribe (800) 877-5416

Send to: The Editor, CFO, 51 Sleeper St., Boston, MA 02210, or e-mail us at: [email protected] Please include your full name, title, company name, address, and telephone number. Letters are subject to editing for clarity and length.

CFO

WELCOMES

YOUR

LETTERS

CHAIRMAN & CEO Z�Alan Glass

THE BUZZ ON CFO.COM

14Mar_Letters_Fin.indd 6 2/25/14 2:50 PM

WE’RE BULLISH 21�<285��%86,1(66�

1 -877-900-0246EULJKWKRXVH�FRP�HQWHUSULVH

©2014 Bright House Networks. Some restrictions apply. Serviceable areas only. Service provided at the discretion of Bright House Networks.

GET THE SUPPORT YOU NEED FROM A PROVIDER WHO’S INVESTED IN YOUR SUCCESS.Financial success and good decisions go hand in hand. Your decision to work with a single provider for all your firm’s

advanced networking and communications will get the best return on your investment. Our Voice, Data, Cloud, and

Managed Services provide the connectivity, security, and support financial firms need. Our privately owned, leading

edge, all fiber network provides the accountability you can trust.

%+B��Z7ULP&URSV�LQGG�� 30Bright House.indd 6 2/20/14 11:51 AM

Reflecting an increased appetite for risk, U.S. banks continued to ease under-writing standards in 2013, especially in asset-based, leveraged, and large-corpo-rate loans, a survey of bank examiners released in Janu-ary found. Partly as a result, examiners expect the credit risk of some business loan categories to rise in 2014.

The report, by the Of-fice of the Comptroller of the Currency, found that there was a continued net easing of loan underwriting standards, with commercial underwriting loosening at 28% of the banks examined, up from 14% in 2012. Large banks reported the highest share of eased underwrit-ing standards across loan categories, the OCC said. (The 2013 survey includes 86 of the largest U.S. national banks and federal savings as-sociations, with assets of $3 billion or more.)

“Examiners reported that banks that eased standards generally did so in response to changes in economic out-

look, an increasingly com-petitive environment, plen-tiful market liquidity and changes in risk appetite in-cluding a desire for growth,” the OCC said. Banks eased commercial loan standards mostly by reducing collater-al requirements and loosen-ing covenants.

In leveraged loans, 53% of the banks originating them eased underwriting stan-dards and 43% left standards unchanged, the third straight year examiners reported significant easing. Partly as

a result, examiners reported, the level of credit risk in lev-eraged-loan portfolios rose at 40% of banks, and they project that the credit risk in leveraged loans will in-crease or remain unchanged this year at 93% of the banks surveyed.

“Examiners will monitor this expected trend close-ly, as such pressures could result in further easing of underwriting standards, lower pricing, and fewer or no covenants,” according to the OCC. The OCC is par-

Topline

Thinkstock

STATS OF THE MONTH

Major acquisitions in February, in $ billions

WHAT’S THEBIG DEAL?


BANKING

As Banks Ease Up, Credit Risk RisesExaminers find U.S. banks reducing collateral requirements and loosening covenants on business loans.

W

Source: news reports

$45 BComcast agreed to buy Time Warner Cable

$25 BActavis agreed to buy Forest Laboratories

$19 BFacebook agreed to buy WhatsApp

14Mar_Topline_Fin.indd 8 2/24/14 2:23 PM

Associated Press 9cfo.com | March 2014 | CFO

ticularly concerned about banks easing standards to improve their margins and win business from com-petitors, and is trying to ensure that financial insti-tutions apply underwriting standards prudently and consistently.

Also reflecting moderately increasing levels of credit risk in banks’ portfolios were international loans. Commercial real estate, large corporate loans, and commercial leases reflected net decreasing lev-els of credit risk.

In small-business lending, only 21% of banks eased standards, but that number was the highest since 2006. The level of credit risk remained stable, examiners found. But they forecast increasing credit risk in small-business loans at 32% of the banks that originate them.

The 2013 survey covered the 18-month period ending June 30, 2013, and covered loans totaling $4.5 trillion, representing about 87% of total loans in the national bank and federal savings association system, the OCC said. Z VINCENT RYAN

CVS Caremark made headlines in February with its decision to stop selling cigarettes and

other tobacco products. The company will lose $2 billion in an-nual sales, but it plans to make some of that money back through smok-ing-cessation programs and other means. (See “Kicking the Habit,” page 22.)

Other companies are hoping to save money on health care by incentivizing their em-ployees to quit smoking (or never to start). But introduc-ing antismoking incentives could be a legal minefield, especially for small firms with modest legal resources.

The Affordable Care Act allows employers and insur-ers to give incentives to workers who are nonsmokers, in particular insurance-premium reductions, points out Tabatha George, an associate with law firm Fisher & Phil-lips. But there’s a lot to consider, including the Health In-surance Portability and Accountability Act, the Employee Retirement Income Security Act, and state laws.

George recommends on Fisher’s website that em-ployers who charge smokers more for health-insurance

premiums do the following: give workers the chance to qualify for a nonsmoker incentive at least once a year; provide smoking-cessation programs so all employees have a chance at the incentive; decide whether occasional tobacco use or e-cigarette smoking is permitted; and determine how to discipline employ-ees who lie about their smoker sta-tus to get the incentive.

Employers should talk to their legal departments about what to do if an employee starts smoking again in the middle of the year, suggests George. They should also decide how much authority they have to police their employees. For instance, if a “nonsmoking” em-ployee steps outside for a cigarette during happy hour, are his co-workers responsible for reporting him to human resources? Does the company have a right to rescind the incentive if someone sees an employee smoking outside a coffee shop? These are the kinds of questions a company should answer before rewarding its nonsmoking employees with cheaper health-insur-ance premiums. Z MARIELLE SEGARRA

Can Companies Charge Smokers More for Insurance?

HEALTH BENEFITS

0%

30%

60%

90%

‘06 ‘07 ‘08 ‘09 ‘10 ‘11 ‘12 ‘13

EASY DOES IT: Overall Commercial Underwriting Standards at Large U.S. Banks

Eased Tightened Unchanged

Source: Office of the Comptroller of the Currency, 2013 Survey of Credit Underwriting Practices


Thinkstock

Topline

Since 2008, banks have increasingly extended loans to corporations based on the borrower’s credit default swap spread. According to new research, this market-based pricing could lower the cost of bank credit.

Such floating-rate loans tie the interest-rate spread to the borrower’s CDS spread or to a credit derivative index over the life of the loan, according to João A. C. Santos, vice president of the Federal Reserve Bank of New York’s statistics group and co-author of a recent study, “The Transformation of Banking: Tying Loan In-terest Rates to Borrowers’ CDS Spreads.”

“Market-based pricing (MBP) has the potential to lower the cost of bank credit because it saves on [banks’] monitoring costs,” Santos explained in Febru-ary on the New York Fed’s website. Those costs include the expenses incurred to screen borrowers for credit quality and to “follow borrowers during the realization of their investment.” Lower pricing could also result be-cause MBP protects banks against increases in borrow-ers’ default risk, noted Santos.

By no means has this kind of loan taken off. Since the

CREDIT

second quarter of 2008, about one-third to one-half of investment-grade bank loans in the syndicat-ed loan market have been CDS/CDX–based loans. “Banks have used market-based pricing predomi-nantly on loans to large corpora-tions,” wrote San-tos. “Even though the number of CDS/CDX-price-based loans issued per quarter rarely exceeds 20, the amount of total debt issued under these contracts has been as high as $95 billion per quarter.”

While these loans often include an interest-rate cap or floor, Santos and his fellow researchers found that

banks charge lower interest rates at origination when they tie loan spreads to borrowers’ CDS spreads. He attributed this to the cost sav-ings mentioned above. Notably, “banks do not seem to use the CDS market extensively to lay off credit risk,” said Santos. That’s good, be-cause positions in credit derivatives are what caused JP Morgan to incur billions in trading losses.

Tying corporate CDS spreads to bank loans definitely has other hazards, however. The most se-vere: the potential to cause spirals in the cost of bank credit. “Adverse shocks to the CDS market could lead to an increase in the cost of bank credit, putting pressure on the financial condition of borrow-ers,” said Santos, which, as bankers know, could lead to “further in-creases in borrowers’ CDS spreads and another wave of increases in the cost of bank credit.” Z V.R.

Market-Based Pricing Could Lower Cost of Credit


0AAA BBB+ BBB BBB- NRAA+ AA AA- A+ A-A

20

40

60

80

100

120

140

Number and Total Size of MBP Loans by Rating, Q2 2008–2012

Credit Rating

Number of MBP loans Total size of loans (billions of dollars)

Note: MBP = market-based pricingSource: “The Transformation of Banking: Tying Loan Interest Rates to Borrowers’ CDS Spreads,” by Ivan Ivanov, João A. C. Santos, and Thu Vo

W


CNTL13-51E_PauseButton_8x10.5_CFO_r1_OUTLINED.indd 1 4/3/13 4:04 PM

CenturyLink.indd 10 8/15/13 2:02 PM

Not many organizations shed cash in the final quarter of 2013, but the first quarter of 2014 could be a different story. Twenty-nine percent of North American finance executives surveyed by the Association for Financial Professionals in January said they would be reducing their cash balances in the quarter, specifically their current cash and short-term in-vestment holdings.

The spread between finance professionals who plan to reduce cash and those who will continue to hoard was small—28% told the AFP their cash balances would increase in the first quarter. Still, lower cash reserves would be a posi-tive sign for the economy, because presumably companies tap cash to acquire businesses, make capital expenditures, buy back shares, and increase payroll, among other reasons.

Another positive economic sign is that finance executives appear to be willing to take on more risk with short-term cash investments to earn greater yields. Ten percent of the finance professionals responding to the AFP survey said they were

more aggressive with short-term cash in-vestments last quarter, compared with 3% who were more conservative. The difference between the two, 7 percentage points (which the AFP calls an “index” reading) was up from zero a year ago, and is the highest since the AFP started tak-ing the survey in 2011.

“Treasurers are seeing some opportunities for invest-ment,” said Jim Kaitz, the AFP’s president and CEO, in a state-ment. “As expectations rise for higher interest rates, they are becoming marginally more aggressive in the ways they invest their corporate cash.”

But finance executives’ plans for using cash don’t always work out. In January 2013 (and the January before it) many finance executives told the AFP that their companies would be cutting cash. But when the year was over, 45% of organiza-tions had greater cash and short-term investment balances than they had on the books a year earlier. Z V.R.

Thinkstock

ToplineCASH MANAGEMENT


Companies Aim To Reduce Liquidity—AgainMore than a quarter of finance execs say they will reduce their company’s cash balances, but there’s reason to be skeptical.

The typical method of establishing a peer group for pur-poses of benchmarking the finance function’s costs is lacking an important ingredient, according to research and advisory firm CEB.

When benchmarking finance costs, companies generally compare themselves with others in their industry (or related ones) that have similar revenue. Many benchmarking tools also take that approach. But the most important comparison point is actually companies’ relative complexity, CEB contends.

CEB quantifies a company’s degree of complexity through use of a proprietary index that incorporates many variables, says Tim Raiswell, a managing director of the firm. Examples include geographic footprint, number of languages spoken where the company has operations, number of currencies supported, degree of IT integration and centralization, and number of legal entities.

Heavily weighting complexity in constructing a peer group “gets you much closer to a benchmark company that

looks and feels like yours from a finance work-flow perspec-tive,” Raiswell says. Using industry and revenue alone as the basis of finance-cost benchmarking is “fraught with prob-lems,” he says. “They’re useful in that they help you triangu-late, but you need that third piece.”

It’s often the case that one company is more complex than another one that has significantly higher revenue. For exam-ple, if Company A and Company B are manufacturers with annual revenues of $8 billion and $15 billion, respectively, conventional thinking would hold that the companies would have similar finance costs as a percentage of revenue.

But Company A may operate in multiple countries where several different languages are spoken, while Company B may operate only in the United States and Canada. In that case, says Raiswell, Company A’s finance costs as a percentage of revenue could be far higher than Company B’s, and the com-panies should therefore not be viewed as peers. “It’s compar-ing an apple to an orange,” he says. Z DAVID MCCANN

Finance Benchmarking’s Missing IngredientBENCHMARKING

WW


The future belongs to the informed.

© Dun & Bradstreet, Inc., 2014 * Expectations of Risk Management Outpacing Capabilities – It’s Time For Action, KPMG International 2013

Platinum Sponsor

The Unsung Hero

At Dun & Bradstreet we understand credit managers are rarely recognized for their true value. We know they are the backbone of every successful business and face the daily task of making confident and informed decisions about risk while finding new opportunities for growth.

With DNBi, a powerful web-based credit risk management solution, we give credit managers the tools to take on these challenges. DNBi delivers 24/7 access to business intelligence on more than 230 million companies worldwide–including information about financial history, company operations, and predictive assessments of future business performance.

Give your hero the power they need to grow and protect your business. To find out more call 1-855-835-0843 or visit www.dnb.com/unsung2.

Every business has one and they’re not hard to find. They’re your credit manager.

D&B.indd 7 1/22/14 12:37 PM

ACCOUNTING & TAX

thought it made the company look like, well, a black box.

Non-GAAP metrics “may be per-fectly understandable to accountants who know what that company is doing but confusing to others,” says Michele Amato, partner at accounting firm Friedman. But companies that use such metrics argue that they often depict financial performance more accurately than GAAP measures do, and afford in-vestors a window to how management sees things.

Excluding HailPublic companies are allowed to dis-close non-GAAP metrics in their SEC filings, press releases, and earnings calls, subject to certain rules. Under Regulation G, mandated by the Sar-banes-Oxley Act, use of a non-GAAP financial measure must be accompa-nied by the most directly comparable GAAP measure and a reconciliation of the two metrics.

Robert Rostan, CFO and principal at financial training firm Training the Street, says there’s nothing wrong with using a non-GAAP metric to provide

an additional perspective about something germane to a company’s perfor-mance—such as its valu-ation, credit standing, or working-capital manage-ment—that can’t be com-municated well through GAAP metrics alone.

At the same time, however, Ros-tan understands that some nontradi-tional metrics can be misleading and erode a company’s credibility. He cites one firm that excluded hail damage in calculating adjusted income from continuing operations (a non-GAAP

Mind the Non-GAAPNontraditional financial metrics can shed valuable light on a company’s operations—or obscure its true condition. By Marielle Segarra

Normalized adjusted EBITDA less capex. Adjusted consolidated segment operating income. Adjusted

EBITDA (as adjusted). ¶ The practice of using financial re-porting measures that do not comply with generally accept-ed accounting principles is as popular, and controversial, as ever. Of course, a small number of non-GAAP measures, like free cash flow and earnings before interest, tax, depreciation, and amortization, enjoy widespread acceptance among com-

ii

company, got some bad press in January, when it included the metric “ad-justed EBITDA (as adjust-ed)” in its quarterly earn-ings release. The metric subtracted from net in-come ordinary expenses such as a $2.7 million loss on a joint venture, creating EBITDA (as adjust-ed), then further excluded stock-based compensation expenses to create the redundant-sounding measure. Black Box said the metric demonstrated its ability to service its debt, but others

panies and investors alike. But even ardent advocates of non-GAAP metrics have to admit that some measures, like the ones cited above, sound a little far-fetched.

The Securities and Ex-change Commission has shown little patience for the wilder va-rieties of non-GAAP measures. In December, David Woodcock, chairman of the SEC’s Finan-cial Reporting and Audit Task Force, told a meeting of the American Institute of Certi-fied Public Accountants that his group was “looking at non-GAAP measures,” according to the Wall Street Journal. But the commission has long subjected such metrics to scrutiny.

For example, Groupon, the propo-nent of “adjusted consolidated seg-ment operating income,” took heat from the SEC in 2012 because the met-ric excluded online marketing expens-es (a critical part of the firm’s business model) from company performance. The daily deal company eventually dropped the metric from its initial pub-lic offering filing, although it absorbed further criticism for its post-IPO use of other non-GAAP measures.

Black Box, a telecommunications

“Adjusting GAAP underestimates the intelligence of institu-tional investors.”ii Anthony Catanach, professor, Villanova University

Thinkstock14 CFO | March 2014 | cfo.com

14Mar_Acct_Fin.indd 14 2/25/14 9:23 AM

metric) in the second quarter, even though the firm was located in an area that regularly experienced hail in the spring. “Is that really a one-time item that you should take out when talking to analysts?” asks Rostan.

Some say companies shouldn’t use non-GAAP measures at all. Anthony Catanach, a professor at Villanova University, has long railed against the practice on his blog, “Grumpy Old Ac-countants” (grumpyoldaccountants.com). “What disturbs me is that adjust-ing GAAP underestimates the intel-ligence of institutional investors,” he says. “Are you telling me that good re-search analysts can’t subtract a couple of numbers from earnings?”

Non-GAAP metrics also may be a red flag, he says. “In my experience, companies that have strong earnings year after year, that have strong oper-ating cash flows and are good at what they do, don’t report non-GAAP met-rics,” says Catanach. “It’s only the ones where the business model is a bit sus-pect, and where the company’s market-ing has gotten out in front of its perfor-mance.”

From Non-GAAP to NonfinancialRostan says CFOs can find a middle ground by leaving non-GAAP metrics out of investor presentations and pub-lic filings but including the “building blocks” in their financial-statement disclosures so that investors can “do the calculations on their own,” Rostan says.

Catanach says CFOs who want to be more transparent in how they measure success could supplement financial metrics with nonfinancial ones, like new accounts opened or a breakdown of sales volume by corporate custom-ers versus individuals. “Tell me some-thing about your business model and how well it’s working,” he says.

Companies could also include mea-sures that show how they are invest-ing in the future—through employee training and education, for example. “Why are we focusing on a financial-

statement number from which you subtract one or two amounts, when the universe is so wide open with so many other measurements that could really would help the investment communi-ty?” Catanach asks. CFO


publicly reported financial statements and about 25 sales contracts. About a year after the acquisition, HP an-nounced it was taking an $8.8 billion write-down because of accounting improprieties at Autonomy, and its share price began to plummet. In the interim, both Apotheker and Lynch departed, the latter after allegedly earn-ing $800 million in cash on the sale of his company.

Faced with probes of the merger by U.S. and U.K. regulators, HP has placed

the blame squarely on its subsidiary, asserting that much of the revenue Autonomy was claiming didn’t derive from soft-ware, but from the resale of hardware. “While HP eventually learned that a portion of Autonomy’s revenues were related to hardware sales, we knew nothing of the accounting improprieties, misrepre-sentations, and disclosure failures related to such

sales until after a senior Autonomy ex-ecutive came forward and HP conduct-ed an extensive investigation,” HP said in a February 19 statement in response to a question from CFO.

HP’s own probe showed that “Au-tonomy often resold generic hardware at a loss in the last few days of the quarter with the sole purpose of mask-ing its real financial performance,” ac-cording to the statement. Further, the firm allegedly “engaged in improper transactions with certain value-added resellers to create the appearance of software licensing revenue at the end of each quarter.”

The lesson for CFOs? Do thorough due diligence on the product a target company is selling and on the account-ing documenting those sales, says George Victor, a partner at accounting firm Giambalvo Stalzer in Great River, N.Y. And the lesson for CEOs? Pay attention to what your CFO is telling you. Z DAVID M. KATZ

If there was a hero in the accounting scandal involving Hewlett-Packard’s acquisition of Autonomy, it may well turn out to have been HP’s CFO, Catherine Lesjak.

According to court documents, “Lesjak vehemently opposed the acquisition to the full HP Board in July 2011[,] stating, in part, ‘I’m put-ting a line down. This is not in the best interests of the company.’”

The CFO was one of only a few board members who spoke out against the proposed acquisition of Autonomy, a British software company. But the die appears to have been cast when HP tapped Léo Apotheker as its CEO in September 2010. Apotheker soon de-clared his attention to “transform” HP from a computer hardware producer into a software and services supplier.

By April 2011, Apotheker was meet-ing with Autonomy founder and then-CEO Michael Lynch to discuss a pos-sible acquisition of the software firm. “Apotheker aggressively pushed the acquisition on the Board over Lesjak’s objections,” according to the plaintiffs in one of three class-action suits later filed against HP. The $10.2 billion deal was announced in August 2011.

Unfortunately for HP, its due diligence had proceeded at breakneck speed, allegedly limited to Autonomy’s

HP CFO Fought Autonomy DealCatherine Lesjak’s opposi-tion to the ill-advised acqui-sition proved prophetic.

ii Catherine Lesjak, CFO of Hewlett-Packard

14Mar_Acct_Fin.indd 15 2/25/14 9:23 AM

But the legislation proposed so far is controversial. In their current form, opponents say, the bills may hurt the small firms they are de-signed to protect.

Patent trolls—also known as patent assertion entities or non-practicing entities—are individu-als or shell companies that amass portfolios of patents on broad technologies, but never manufac-ture products related to the patents. Instead, they demand licensing fees from alleged patent infringers, threatening to sue nonpayers. Fre-quently the targets of their demand letters are not the makers of infringing products but rather the users of the products.

Companies could simply ignore such letters, but not if they’re trying to attract investors, says Peter Kunin, deputy managing partner at law firm Downs Rachlin Martin. (Kunin does pro bono work representing small and midsize firms sued by patent trolls.) “You have to disclose to your inves-tors—angels, private capital—what the threats of litigation are, and that you aren’t being sued or being threatened with a lawsuit,” he explains. As a result, many small companies agree to pay licensing fees just to get trolls off their back, Kunin says.

Some letters, in fact, do progress to

More than two years after President Obama signed long-awaited patent reform into law, the fight against

“patent trolls” continues on Capitol Hill. A number of trade organizations, including the National Restaurant Associa-tion, the Consumer Electronics Association, and the National Retail Federation, are lobbying for more patent reform, and several bills designed to protect small businesses are pending.

ii

GROWTH COMPANIES

Patent MedicineWill proposed patent reform legislation do more harm than good for small companies? By Marielle Segarra

a lawsuit. A 2012 study by James Bessen and Michael J. Meurer at Boston Uni-versity School of Law found that 59% of the defendants in cases brought by pat-ent trolls were small or midsize firms.

Buried under LawsuitsA search of the S&P Capital IQ data-base returns a number of small-cap public companies that have faced such litigation. Travel deal website Travel-Zoo, a firm with $158 million in annual revenues, warned in its 2013 10-K filing that it “may face liability from intellec-tual property litigation that could be costly to prosecute or defend and dis-tract management’s attention with no assurance of success.”

TravelZoo wasn’t speaking hy-pothetically. Nonpracticing entity

Metasearch Systems filed a lawsuit in September 2012 claiming that the search service on TravelZoo website Fly.com infringed on its patents. Since Metasearch sought unspecified dam-ages in the lawsuit, the travel website can’t be sure how much it might have to pay if it loses. TravelZoo added that if it loses such lawsuits, it may have to

pay the trolls and buy licenses to use the technology. It expects pat-ent infringement claims in its in-dustry to jump as new participants enter the markets.

FireEye, a malware protection software provider with about $161 million in annual revenue, has also struggled under patent litigation. In its November 2013 10-Q report, it disclosed that it was currently fighting a lawsuit against a non-practicing entity that claims Fire-Eye violated its patents. As a result, the software provider will likely face legal fees and could have to pay damages or licensing fees.

What’s more, it might have to dis-close its confidential information in or-der to beat such a lawsuit. And though FireEye is a small company itself, it has even smaller customers who may face lawsuits for using its software. FireEye stands to lose money directly when its customers get sued; in its contracts, the software provider agrees to com-pensate customers for any costs due to claims by third parties alleging that the customer is infringing its patents by us-ing FireEye platforms.

Fee ShiftingIn December, the House of Representa-tives passed a patent reform bill called The Innovation Act, by a vote of 325 to 91. The White House has signaled


14Mar_GrowthCos_Fin.indd 16 2/24/14 9:59 AM

its support for the legislation. Among other things, the bill requires patent plaintiffs (including trolls) to file more-specific lawsuits. Plaintiffs would have to name the parent company of a patent owner, along with any person who has a financial interest in the patent, so they couldn’t hide behind shell companies.

In addition, technology vendors would be able to fight lawsuits against patent plaintiffs on behalf of their cus-tomers, as long as they are being sued for infringing the same patents. The bill would also require the losing party in patent lawsuits to pay the winner’s fees (a so-called fee-shifting provision) except in certain cases, at the discretion of the court.

Several bills in the Senate also ad-dress patent reform. One, introduced in November by Sen. Patrick Leahy (D–Vt.), would require plaintiffs to name any person with a financial interest in the lawsuit or in either party. It would also allow manufacturers to fight patent lawsuits on behalf of their customers. The bill has been referred to commit-tee. A second bill, introduced in Octo-ber by Sen. Orrin Hatch (R–Utah) has also been referred to committee. Like the House Innovation Act, it would require the losing party to pay the win-ner’s fees.

The Inventor’s PlightSome worry, however, that patent re-form legislation that limits trolls would also make it harder for small inventors and businesses to enforce their pat-ent rights. For instance, if a small firm knows it will have to pay the defen-dant’s legal fees if it loses a case, it may never bring a lawsuit to begin with.

Boston University’s Bessen acknowl-edges this concern, but adds that the success of a fee-shifting provision will depend on how it is designed. Cur-rently, it’s next to impossible to get the losing party to pay the fees, he says. “It’s very clear that right now the stan-dard to get fees shifted is extremely high,” says Bessen. “It happens maybe

10 times a year.” Patent trolls argue that they work to

protect the patent rights of small inven-tors. But Bessen and Meurer found that only 5% of the out-of-pocket payments made by defendants in cases brought by publicly listed nonperforming entities goes to small inventors.

“One of the things with patent law is you always hear a complaint that this will make patents weaker,” says Bessen. “The reality is that small inventors are helped by having a healthy patent sys-tem, not necessarily one that’s rigged in their favor. I would say the [current] patent system is much more tilted to-ward large firms than small ones. By making it more restrained, you’re actu-ally helping small inventors.” CFO


Behind GlassdoorTransparency is the heart of the website’s business model.

Z�Are you familiar with Glassdoor.com? If not,

you should be. On Glass-door, present and past em-ployees can publish anon-ymous reviews about a company. But be prepared: It might not be all roses and chocolate.

In fact, comments about employers can be fairly scathing. Wouldn’t one expect that the site would disproportionately draw malcontents, those with axes to grind? CFO Adam Spiegel is happy to respond. “It’s a good question that gets asked all the time,” he says. “We have 22 million members, and among every-one who has shared a review, 70% are either OK with or satisfied in their jobs. Which sounds about right.”

But what Glassdoor really wants to interest employers in is its talent and employer-branding solutions. It aims to help job seekers find what they’re look-

ing for, primarily through user-generat-ed content. The website contains 6 mil-lion pieces of such content on 300,000 companies, Glassdoor says. Site users not only post company reviews but also their salaries (also anonymously), and they can upload work-site photos.

Why would visitors divulge how much money they make? “We have what we call a give-to-get model,” Spie-gel says. “If you’re a product manager and want to find out about product-manager salaries at Cisco [Systems], the site will give you a little bit of infor-mation. But it’s going to ask for your in-formation, too, and once you give it to us, you get unfettered access to all our data. That’s what feeds our engine.”

Glassdoor also uses this informa-tion to supply recruiting capabilities to employers. It currently has about 1,500 customers, including Enterprise Rent-A-Car, Nordstrom, and Wal-Mart.

In December, Glassdoor landed $50 million in new venture funding, for a

total of $93 million—rea-son enough to hire Spiegel as its first finance chief. “It came down to the com-pany being at a phase of development where it had proven enough of the busi-ness model,” he says. “The growth ahead will intro-duce complexity to the business. Anytime a com-pany gets to that point in its evolution, it’s natural to bring in someone with my background.”

That background includes nine years as an investment banker and CFO stints at three start-up companies. Two didn’t pan out, but the third, RPX, a provider of subscription-based patent-risk solutions, executed a successful initial public offering.

“I love hypergrowth companies,” says Spiegel. “There is a constant stream of challenges, a lot of interest-ing, complex things to deal with.”

��Z DAVID MCCANN

ii Adam Spiegel, CFO of Glassdoor.com

14Mar_GrowthCos_Fin.indd 17 2/24/14 9:59 AM

There are many unconventional paths to the CFO position, but one of them—engineering—may be as

good as, if not better than, business school. ¶ Undoubtedly they are good with numbers, but do engineers really have what it takes to be a finance chief? Just ask one of the 1,466 company CFOs with engineering degrees recently listed in S&P Capital IQ’s database.

ii

HUMAN CAPITAL

and every day there are 10 things I’m trying to solve that are basically new problems,” he says.

The same mind-set helps with finding flaws in arguments, says Miquelon. “CFOs are often labeled as skeptics, the people who say no, which may be a little unfair,” he says. “The CFO is the one who has to be able to vet things, to say, ‘What has to be true for this other thing to be true? And what are the consequences if we’re wrong?’

“Engineering teaches you to think logically in different ways, to question

“If you think about what people say a CFO should be or what a good CFO is,” says Vasant Prabhu, finance chief at Starwood Hotels & Resorts Worldwide, “you’ll hear things like he or she has got to be strategic, analytical, fact-based, willing to deal at a detailed lev-el, objective, results-oriented. All that is what you learn when you become an engineer.”

Prabhu should know: he has a degree in mechanical engineering from the Indian Institute of Technology. “It taught me how to think and was excel-lent training for finance,” he com-ments. But is engineering strategic? “Engineering is about conceptualizing problems and how to solve them,” an-swers Prabhu. “I call that strategic.”

An ability to solve problems is probably the skill CFOs rely on most, notes Wade Miquelon, chief financial officer of drugstore giant Walgreen. Miquelon, who earned a civil engi-neering degree at Purdue University, is leaning heavily on that experience right now while working on a merger with Alliance Boots, one of the largest European pharmaceutical retailers. “It’s a sort of an unprecedented deal,

assumptions and to cross-check facts,” says Miquelon.

A New Career Takes OffShannon Hyland had been a senior engineer at United Airlines for two years before taking a leave of absence to earn an MBA from New York Uni-versity, in 1994. Why? “Any project I

was developing always had to go through finance for approval,” he says. “I was intrigued by that decision process, and I wanted to understand what those guys knew that I didn’t know.”

Following a stint in corpo-rate planning at Amerada Hess, Hyland’s finance career began in earnest at America West Air-lines, where he was senior di-rector of finance. Hyland left the airline to take senior finance positions at several companies, ending with five years as CFO

of Radius Travel, where he became CEO in 2013.

Hyland says his engi-neering training helped him through a tough de-cision-making process during his two years as CFO of a company called Groople. It was pursu-

ing two business lines: making group bookings at hotels and other facili-ties for commissions, and developing group bookings technology enabling other entities to fulfill group travel. The two sides of the business had very different margins and timelines for becoming a strong player in the mar-ket. Groople’s CEO, Hyland says, had a business-to-consumer background and

Engineering A Finance CareerDon’t tell these CFOs they should have majored in accounting. By David McCann


“The CFO is the one who has to be able to vet things. Engineering teaches you to question assumptions and to cross-check facts.”ii Wade Miquelon, CFO, Walgreen

14Mar_HumCap_Fin.indd 18 2/20/14 3:57 PM

ter 14 years as finance chief. When the privately held paint and coatings busi-ness installed an enterprise resource planning system, Ragazzini had to un-derstand how each type of data affect-ed other information in the system. “I had to under-stand things like how the way a chemist put together a formula for a paint would impact inven-tory and cost of goods sold,” he says. “That was driven by my engineering background. It helped me be a better CFO.”

Seeking RigorSome CFOs knew from their first day in engineering school that they were not destined to be practicing engi-neers. Take Kevin McEnery, a partner with professional services firm Tatum and currently interim CFO at Empire Petroleum Partners, a distributor. He went to Cornell University for indus-trial engineering because he thought it would provide a strong foundation for a business career. McEnery wanted rigor, and he got it: of the 800 engi-neering students in his freshman class, he was one of only 350 who graduated.

“Many of those who decided to leave, or were asked to leave, had decided they didn’t want to be engi-neers,” says McEnery. “I never had that problem, because I was never striving to be one.”

From 1993 until 2004, McEnery was CFO of Scholastic, the educational pub-lisher. In 1998, the company undertook a fundamental reappraisal of its op-erations. It reengineered nearly every activity—purchasing, customer ser-vice, order entry, distribution. “I was the manager of that, and having that analytical engineering background was very beneficial,” says McEnery. The re-

was more interested in the consumer-like bookings business.

“But when [the finance department] looked at all the data,” he recalls, “we saw that we just didn’t have sufficient scale to achieve realistic margins on that side of the business.” So Hyland had to come up with a strategy for abandoning the bookings business and focusing on the technology platform, one that had to win over the CEO.

“I use my engineering background all the time, and this was just one ex-ample,” Hyland says. “As a CFO you’re constantly confronted with situations that are outside the norm. You start out with an annual budget, say, and all the best intentions to achieve targets. Then a couple of months or even weeks in, you see what’s really going on and you have to make changes. As an engineer, you’re taught how to leverage the in-formation at hand to do that.”

How Things WorkWhen John Ragazzini was growing up, his father was dean of the engineering school at NYU, so it’s not surprising that he decided to become an engineer, too. But, “you could say that was a big mistake,” he says.

“My mind was not the mind of an engineer,” explains Ragazzini. “I barely made it out of Princeton.” After college he joined the Navy and was assigned to a missile battery on a destroyer, be-cause he was supposedly an electrical engineer. “Well, not really,” he admits. “After the Navy I said to heck with it,” and he went to Columbia for an MBA.

But as Ragazzini progressed in his finance career, most of which he spent at Ford Motor, he realized that his undergraduate education was a boon. “As an engineer, you like to know how things work,” he says. “Whether it’s a transistor or a diode or an accounts re-ceivable system, you get really zoned in on trying to understand how things link and work together.”

That trait served him well at Spray-lat, from which he recently retired af-

sult was $100 million a year savings in operating costs.

On other occasions, Scholastic pursued complex, alternative financ-ing options. “It’s wonderful to have the discipline not only to break those

things down, but also to describe them in a manner that’s logical to people who are not quite as involved with the numbers and the analytics, like the CEO and the board,” says McEnery.

The same kinds of skills came into play for him in a more recent CFO job, at—fittingly—Omega Engineering, which was a $200 million maker and distributor of scientific instruments before it was acquired in 2011. The in-cumbent finance chief left when the sale was consummated, and the new CEO brought in McEnery two weeks later.

“We had to totally recast how the inventories were done,” he says. “My engineering experience was extremely useful for that,” especially since after Cornell that experience landed him at Arthur Anderson, where he specialized in serving manufacturing clients.

As much as anything else, an en-gineering education taught McEnery not to be afraid. “After the rigor of a program like that, when you get to a situation in business that has a mathe-matical aspect, like looking at cost allo-cations or alternative financing scenar-ios, you have a sense of confidence that you can come to a conclusion that’s accurate,” he says. “I say to myself, ‘If I survived those four years at Cornell, I can certainly get through this.’” CFO


“If you think about what people say a CFO should be, you’ll hear things like he or she has to be strategic, analytical, results-oriented. That is what you learn when you become an engineer.” ii Vasant Prabhu, CFO of Starwood Hotels & Resorts Worldwide

14Mar_HumCap_Fin.indd 19 2/20/14 3:57 PM

RISKMANAGEMENT

it will inspire a new generation of Wall Street wolves? We should not glamorize it—the gor-geous women, the boats and all—and make kids think that by committing crimes you can have all of this. That’s like glamorizing drug dealers.

But the movie doesn’t show any of Belfort’s victims.No, isn’t that funny? There are no vic-tims. But they’ve made great movies about terrible, terrible people. It’s a terrific, entertaining movie.

Before Belfort, there was Gordon Gekko, the fictional corporate raid-er in the movie Wall Street who fa-mously declared, “Greed is good.” Since Belfort was busted, we’ve also seen Bernie Madoff.Madoff I met back in 1990s when I played golf with him. A friend of mine told me, “He gives you a return of 18% minimum. You got a couple of extra bucks, Bo?” And I said, “I got about $2 million.” He said, “No, we’re only taking $15 million at a time.” They wouldn’t let me invest. That’s part of what they do to make you think that they’ve got such a great deal.

By “they,” I assume you mean peo-ple who run Ponzi schemes. Aren’t they the old face of financial fraud? Haven’t financial crimes gotten more sophisticated?No, Ponzi schemes are going on as we’re speaking right now. I’m dealing with people who have gotten some lost money back and are now saying to me, “Suddenly the guy is not returning my calls. I spoke to him four months ago.” I ask them if they ever checked the guy out. People don’t want to spend thou-

Getty Images: Michael Loccisano

Inside the Wolf’s DenCorporate investigator Bo Dietl talks about working for Jordan Belfort, and why fraud won’t go away. By Josh Hyatt

Bo knows fraud—Richard “Bo” Dietl, that is. He’s a former New York City Police detective who now runs a

Manhattan-based private detection firm, Beau Dietl & Associ-ates. (No, that’s not a misprint; Dietl explains that “Beau” is “more sophisticated” than “Bo.”) Among his high-profile cli-ents: Jordan Belfort, the convicted fraudster whose vast stock manipulation scheme is recreated in Martin Scorsese’s hit film The Wolf of Wall Street, in which Dietl appears as himself.

ii

Now that you do know what went on, are you surprised at how Jordan Belfort has behaved since his 1999 conviction on securities fraud?He is supposed to pay back the people he stole from. I said to him, “You keep acting like you’re Robin Hood. Level yourself to the ground. You weren’t exactly Robin Hood. You hurt a lot of people.” I think he got mad at me, but I don’t [care]. If I had stolen $100 million or $200 million, or whatever, it would be my duty to pay back all the money I stole. He should have to pay it back.

Given all the excess shown in the movie, and depicted in the books Belfort has written, do you think

Recently, the 63-year-old Dietl shared his raw observations (sanitized for your protection) about Belfort, why greed isn’t always good, and what “the Google” is keeping from us.

You were part of the security team around the real Jordan Belfort, weren’t you?Yes, I saw all the partying; the movie is pretty much on the mark about all of that. In the 1990s, we were protecting him against hurting himself because he was always stoned on Quaaludes.

Did you totally miss what was going on beneath the surface—the bags of cash and so forth?I honestly never realized that what he was doing was illegal. A lot of people were putting IPOs out, making money and losing money. The criminal part was that he had all of these what I call “felicitators.” They would buy the stock on Monday at $2 and jack it up to $16, then they would sell it on Fri-day. The crime part came in when they [the investors] were kicking back cash. I didn’t know at that time they were doing those things. I was hired for the security side, because you had a lot of organized-crime people that were looking to weasel their way into the company.


14Mar_Risk Fin_V2.indd 20 2/27/14 11:37 AM

sands of dollars on background re-search.

Isn’t it harder to misrepresent yourself in an age when people can check you out on the Internet?People think that what they read on the Google means something. Let’s be hon-

est, you can put anything you want on the Google.

What about employees who embez-zle from their own employers? Can that ever be brought under control?I personally don’t see the economy being as strong as everyone is saying.

The upper percentile of America is do-ing great. But when regular, everyday people have an opportunity to make money, they take chances because they need the money. People are still greedy. If they work around money, they give into temptation. And that’s how they become criminals. CFO

tion suits against companies whose representatives have allegedly made materially false, market-moving state-ments to shareholders.

In the case, the Supreme Court will decide whether it should overrule or make big changes in the longstanding “fraud-on-the-market” presumption. A relative of the so-called efficient mar-kets hypothesis, the theory enables plaintiffs to form a class without hav-ing to prove that each investor suffered financial loss resulting from a compa-ny’s misleading statements. Instead, as the high court ruled 25 years ago in Basic Inc. v. Levinson, courts can pre-sume that the share price set by the stock market as a whole takes into ac-count the effects of such information.

For companies, the stakes of the court’s decision on its previous ruling are high. “If Halliburton prevails, then the entire ecology of the market for class-action securities-fraud litigation is likely to undergo a dramatic change,” said Joseph Grundfest, director of the Stanford Law School Securities Class Action Clearinghouse, in its latest an-nual report on securities class-action filings, prepared with Cornerstone Re-search.

If the court sides with Halliburton, “it will really be fairly devastating for

the plaintiffs’ bar in securities class ac-tions,” says C. William Phillips, an at-torney with Covington & Burling. In the case the Supreme Court will hear, the lead plaintiff, the Erica P. John Fund, which supports the Catholic Archdiocese of Milwaukee, contends that the oil services giant misrepre-sented itself in three ways: its poten-tial liability in asbestos litigation, its accounting for revenue on fixed-price construction contracts, and its po-tential benefits from a merger. The fund maintains that shareholders lost money when Halliburton’s stock price dropped following the release of nega-tive news concerning the alleged mis-representations.

Noting that securities class actions “have been the subject of tightening and limiting by the courts and Con-gress” since the Private Securities Liti-gation Reform Act became law in 1995, Phillips says that if the Supreme Court rules with Halliburton, “you won’t have anywhere near as many” securi-ties class actions based on misrepre-sentation as occur now. (In 2013, about one in 29 companies in the S&P 500 was a defendant in a class-action filed during the year, according to the Stan-ford/Cornerstone report.)

Z DAVID M. KATZ

Halliburton Ruling Could Slash Class ActionsA Supreme Court decision in favor of the oil services gi-ant could drastically reduce class-action risk exposures.

Z�Some months after the Supreme Court begins hearing arguments in Halliburton Co. v. Erica P. John Fund on March 5, CFOs could find that their companies have much smaller legal risks, fees, and insurance costs, attor-neys say.

The reason? If the nation’s highest court rules in favor of Halliburton, it could deal a coup de grâce to a prime theory that plaintiffs’ lawyers rely on to launch federal securities class-ac-

TOP FIVE RISKS Competition and political/regulatory uncertainty are the top risk factors for 2014, according to an Association for Financial Profes-sionals survey of 554 finance executives. Each factor was cited by 48% of respondents. Rounding out the top five are customer satis-faction/retention (37%), interest rates (29%), and GDP growth (27%).

Editor’s Choice


14Mar_Risk Fin_V2.indd 21 2/27/14 11:37 AM

But some predict that the company will reap a reputational dividend from kicking the to-bacco habit. CVS, they say, will forever be known as the first big drugstore to drop cigarettes, in a country where antismoking pub-lic-service announcements are ubiquitous and smoking-ban leg-islation is introduced every week.

Indeed, CVS got an immedi-ate pat on the back from Presi-dent Obama, who thanked the CEO and board of directors for making “a choice that will have a profoundly positive impact on the health of our country.” The American Heart Association and American Lung Association also laud-ed the drugstore chain for its decision.

“I think it’s one of the most brilliant moves from a reputation standpoint that I’ve seen in the last 10 years,” says Paul Argenti, professor of corporate communications at Dartmouth Col-lege’s Tuck School of Business. “There are other organizations that are doing things more quietly, but to have the courage to forgo $2 billion in sales to enhance your reputation and do the right thing—that’s gutsy.”

Strategic AlignmentGutsy, sure. Will it pay off financially? Not right away. CVS said during its February earnings call that it would

Kicking the HabitBy stopping the sale of tobacco products, CVS gains a reputational and strategic boost. By Marielle Segarra

STRATEGY

In February, CVS Caremark made headlines by an-nouncing that it would stop selling cigarettes and

tobacco products, a segment worth $2 billion in annual sales to the giant drugstore chain. Many analysts focused on the financial aspects of the decision, which CVS says will reduce its earnings per share by 17 cents annually.

iiand CEO of Training the Street, a fi-nancial training firm. “Many doctors are saying, ‘We can’t partner with you for patient health initiatives if you’re selling tobacco products in the same store,’” he explains. “So Caremark is going to pick up the gains as it trans-forms itself into a health and wellness

company.” Still, “it’s going to be very hard to quantify that new revenue stream to shareholders,” says Rostan.

Other companies have purged their shelves of tobacco with-out lingering ill effects. “Target stopped selling tobacco in 1996, and they didn’t go away,” points out Rostan. Supermarket chain Wegmans did the same in 2008.

At the same time, CVS has the resources to take this gamble, says Rostan, while smaller com-petitors may not. “That $2 billion in lost cigarette revenue trans-lates to less than 3% of CVS’s re-tail sales, and less than 2% of its overall sales,” he says. “But for a

smaller store, like a Rite Aid, this is a bigger decision.”

While CVS’s finance department may be hoping to measure any short-term gains from the decision, Argenti says businesses “should stop think-ing about the ability to quantify intan-gible assets in the short term. And in the longer term, finance people need to spend more time trying to figure out how to measure reputation and repu-tational risk in the same way that they measure operational and financial risk. They just don’t do it.”

Adds Argenti: “How do you quan-tify the President of the United States and the First Lady coming out and supporting your business on a random

make up the loss in other areas of the business, including smoking-cessation programs. But Argenti thinks it’s all part of a long-term strategy.

“By doing what they did, they aligned themselves more clearly with their strategy as a health company,” he says. “They [got] a bunch of [nongov-ernmental organizations] off their back now and forever. They got first-mover advantage in terms of what they’re try-ing to do with health care. And they made their employees feel good about the organization.”

The part of the business that will benefit most from the decision is CVS’s pharmacy benefits management business, says Scott Rostan, founder


14Mar_Strategy_Fin.indd 22 2/20/14 3:57 PM

day? How do you quantify every news-paper in the country talking about it? What about the customers who will now go there because they’ve done the right thing?” CFO

to the local Chinese partner in ex-change for access to a market.

OPERATIONAL INEFFICIENCIESThese inefficiencies apply to the

governmental bureaucracy in a coun-try. A public pension fund investing in South Africa faces clearance and settlement systems that are more chal-lenging than at home, for example. A corporation that wants to set up a brand-new subsidiary in a foreign country has to meet all sorts of regis-tration filing and regulatory require-ments. “There are lots of delays in approval of licenses and licensing agreements,” says Karolyi. “All of it revolves around central agencies that govern how business is done.”

GOVERNANCE AND TRANSPARENCYCompanies in emerging markets

are often family-owned, and may have controlling interests in a range of indus-tries. They can also be opaque—joint-venture partners or acquirers may have difficulty discovering how a partner or target firm is managed and governed. That makes it hard for a foreign busi-ness to execute any kind of investment.

LEGAL PROTECTIONSWhen a transaction goes awry, any dispute needs to be resolved.

The quality of legal protections for foreign investors varies widely.

POLITICAL RISKSA company setting up a joint venture in an emerging market

can face a very unpredictable, aggres-sive state government. The state could exert its control over an industry and potentially even undermine an invest-ment outright. “There are many in-stances in which there have been soft-er and harder forms of expropriation by a state to dominate markets,” Kar-olyi says. Z VINCENT RYAN


Z�For every company that thrives in a foreign market, probably five com-

panies stumble. The complexities of entering a foreign market can result in many strategic mistakes and missteps. Even businesses that eventually “win” in a geographic region can teeter on the edge for years. Wal-Mart, for ex-ample, stormed Japan in the late 1990s, hoping to export its supply chain prac-tices and “everyday low price” mod-el to a distinctly different consumer shopping culture. The giant discounter struggled until recently.

Cross-border acquisitions in high-growth countries are particu-larly hazardous. Law firm Freshfields Bruckhaus Deringer studied merger transactions valued at $750 million or more since 2008 and found that 38% of the deals over $2 billion encountered some kind of issue, the most com-mon being regulatory probes (51%). About 22% of the deals encountered “disputes such as activist protests and quarrels with landowners and employ-

ees,” Freshfields says.Still, companies go where the

growth is, and many high-growth op-portunities remain in emerging mar-kets and developing economies, despite recent setbacks. The Interna-tional Monetary Fund forecasts 5.1% growth in emerging markets in 2014, compared with 2% for advanced econ-omies. In recent years companies like Yum Brands, Starbucks, and W.W. Grainger have significantly enlarged their franchises through forays in for-eign markets.

The problem is, many companies move into new regions or countries without a firm grasp of the culture or the investment environment, or how the companies there operate; there-fore, they get the risk-reward ratio wrong, says Andrew Karolyi, who runs The Emerging Markets Institute at Cornell University’s Samuel Curtis Johnson School of Management. To avoid costly missteps, says Karolyi, companies should account for and measure the following six categories of risk when contemplating a move into another country:

MARKET-CAPACITY CONSTRAINTS Some markets into which a com-

pany sells product, raises capital, or invests capital may be constrained be-cause of their size, lack of liquidity, or degree of concentration. Any one fac-tor may prevent a company from en-tering successfully, says Karolyi.

FOREIGN INVESTABIL-ITY RESTRICTIONSEmerging-market countries have

rules and regulations on foreign ac-cess. These regulations may prevent entry or block the ability to return profits back to a headquarters coun-try, and they are more binding in some countries than others. The restrictions can be costly; for example, China has a longstanding policy of requiring for-eign companies to transfer technology

Foreign ComplicationsInternational markets are enticing but can be hazard-ous. Here are six risks to watch out for.

1

3

4

5

62

14Mar_Strategy_Rev_Fin.indd 23 2/24/14 1:14 PM

14Mar_SusAcct_Fin.indd 24 2/20/14 3:58 PM


of earnings is far outweighed by what they don’t know: Who’s manipulating earnings (legally or illegally) and how widespread is it? What percentage of accounting fraud do regulators and analysts miss? Is there any way to get better at catching the per-petrators?

In a study released in January, a group of nearly 400 CFOs said they believe that in a given period, one-fifth of companies are “distorting” earnings—that, is follow-ing the letter of generally accepted ac-counting principles but not necessarily the spirit. On average, the earnings distor-tion is as large as 10 cents on every $1 of earnings, said the CFOs in the study. (The study, “The Misrepresentation of Earn-ings,” by Ilia Dichev of Emory University and John Graham and Campbell Harvey of Duke University, is based on an earlier survey of finance chiefs conducted with the assistance of CFO magazine.) If the problem is half as prevalent as those fi-nance chiefs think it is, it can represent a hefty premium on the cost of capital and hurt the careers of senior executives É

BY VINCENT RYAN

THE SEARCH FOR SUSPECT ACCOUNTING

ANALYTICAL MODELS FROM ACADEMIA AND THE SEC COULD

HELP EXPOSE EVERYTHING FROM POOR-QUALITY EARNINGS

TO OUTRIGHT FRAUD.

É Financial analysts and regulators know a lot about how companies falsify accounting and misrepresent earnings. For example, if a company is moving items off the balance sheet or reporting earnings that move in the opposite direc-tion of cash flows, it’s time to pay close attention. They also know that a large merger or acquisition is a common back-drop for earnings management. And they are familiar with the notion that a sud-den jump in accruals suggests that a firm’s financial statements may not be a precise portrait of its economic health.

But what they and others know about accounting fraud or the misrepresentation

Th

inksto

ck


But close to 60% of the CFOs said something else—something disturbing: that they and their peers may be mo-tivated to use accounting techniques to paint a rosy picture of earnings “because it will likely go undetected.” Amplifying the answer, one finance

chief told the researchers that, depending on the indus-try, a firm could misrepresent earnings for two to three years without getting caught by an analyst. Indeed, the CFO said, it may take up to five years for anyone to uncover the sleight of hand.

Knowing the ScoreÉEarnings manipulators are hard to spot, even when manipulation turns to fraud (see “Spotted Before the Fall,” page 27). Studying firms that were sub-ject to enforcement actions by the SEC, Dechow and co-authors Weili Ge of the University of Washington, Chad Larson of Washington University in St. Louis, and Richard Sloan of the University of California, Berkeley, found that compa-nies that misreport earnings can look extremely vibrant.

During the period when companies misstated earnings, Dechow and her colleagues found, their cash margins were shrinking but cash sales were ris-ing. Earnings manipulators were also often expanding their capital bases and operations. Finance-raising and related off-balance-sheet activities were also more common during misstatement periods.

In addition, price-earnings ratios and market-to-book ratios were often unusually high, and “misstating firms [had] unusually strong stock-return per-formance in the years prior to misstate-ment,” according to the study.

Considering the sheer computing power available for analyzing data, it seems as if analysts and regulators should be better at catching shoddy ac-counting and outright fraud, even if a firm’s public image doesn’t scream “bad guy.”

Indeed, models are being developed to spot earnings management, mostly in academia. A frequently cited measure of earnings management is the “M-Score,” developed by M.D. Beneish of Indiana

once the shady dealings of such companies come to light. Why do companies falsify or manage earnings? Many

misstating firms trade at high valuations prior to being caught by the Securities and Exchange Commission, so it appears executives are trying to cover up a slowdown in fi-nancial performance, according to “Predicting Material Ac-counting Misstatements,” a 2011 paper by Patricia Dechow of the University of California, Berkeley, and three co-au-thors. Indeed, in the Dichev study, CFOs said “to influence stock price” was the top motivation for manipulating earn-ings within GAAP. Other motivations cited included the pressure to hit benchmarks, senior managers’ fear that poor performance will harm their careers, and the need to avoid violating debt covenants.


Ë�SIGNS EVERYWHEREThe signals that CFOs of public firms think are most indicative of a company manipulating earnings within the confines of GAAP

GAAP earnings do not correlate with cash flow from operations; earnings and cash flow from operations move in different direction for 6 to 8 quarters.

34%

Deviations from industry (or economy, peers’) norms or experience (cash cycle, volatility, average profitability, revenue growth) 24%

Consistently meet or beat earnings targets 17%

Large or frequent one-time or special items 17%

Lots of accruals; large changes in accruals; jump in accruals or sudden changes in reserves 15%

Too smooth or too consistent of an earnings progression (relative to economy, market) 14%

(Frequent) changes in (significant) accounting policies 10%

Using non-GAAP (and/or changing) metrics 8%

High executive turnover; sudden change in top management; sudden director turnover; high employee turnover 8%

Inventory build-up/age of raw materials; build-up in work-in-progress; mismatch between inventory/COGS/reserves 7%

Large volatility (wide swings) in earnings, especially without real change in business 7%

Build-ups of receivables; deterioration of receivables days outstanding; A/R balance inconsistent with cash-cycle projections 5%

Significant use of (aggressive) long-term estimates (including resulting volatility in balances); unusual reliance on accounts requiring management judgment or estimates

5%

Red Flag% of

responses

The Search forSuspect Accounting

Source: “The Misrepresentation of Earnings” (January 8, 2014), Ilia Dichev, John Graham, Campbell R. Harvey, and Shiva Rajgopal


University in the mid-1990s. The M-Score is a composite of eight ratios designed to “capture either financial statement distor-tions that can result from earnings manipu-lation or indicate a predisposition to engage in earnings manipulation,” wrote Beneish in a paper introducing the measure.

Beneish’s ratios are designed to capture unusual accumulation in receivables; un-usual expense capitalization and declines in depreciation; and the extent to which accounting profits are supported by cash profits. Beneish validated the M-Score by correctly identifying 76% of firms subject to SEC accounting enforcement actions during a 10-year period.

Expanding on the M-Score was the F-Score, developed by Dechow, Ge, and Sloan in 2011. They also examined firms that were subject to SEC enforcement actions. The F-Score focuses not just on accrual quality, but also financial performance, nonfinan-cial measures (in particular, abnormal re-ductions in the number of employees), off-balance-sheet activities, and market-based measures for identifying misstatements.

In another recent, notable study, “Fi-nancial Statement Irregularities: Evidence from the Distributional Properties of Fi-nancial Statement Numbers,” Dan Amiram and Ethan Rouen of Columbia University and Zahn Bozanic of The Ohio State Uni-versity created a measure to estimate the degree of financial reporting irregulari-ties for a company in a given year, using “a method used by forensic investigators and auditors.” The measure is based on Ben-ford’s Law, or the law of first digits, which refers to the frequency distribution of dig-its in real-life sources of data. According to Benford’s Law, for example, in a given

require forward-looking information, does not require re-turns or price data, is available for essentially every firm with accounting information, and does not rely on peer group benchmarking.” They believe that it could indeed be deployed on a large scale by investors, regulators, auditors and researchers, “as a ‘first pass’ filter to flag companies that potentially file suspect financial disclosures.”


Ë�SPOTTED BEFORE THE FALLHigh-profile fraud cases detected by the probability of manipulation model (PROBM), a version of the M-Score, as reported by auditintegrity.com

1 The first year the firm was flagged by the PROBM model as a manipulator2 The year in which the fraud was first publicly revealed in the business press3 The market capitalization lost during the three months surrounding the fraud announcement month, as a percentage of market capitalization at the beginning of monthSource: “The Predictable Cost of Earnings Manipulation,” M.D. Beneish and D. Craig Nichols

Adelphia Communications 1999 2002 96.8

AOL Time Warner 2001 2002 32.2

Cendant 1997 1998 38.1

Computer Associates Intl. 2000 2002 36.4

Enron Broadband Services 1998 2001 99.3

Global Crossing 1999 2002 (Delisted due to bankruptcy)

JDS Uniphase 1999 2001 61

Lucent Technologies 1999 2001 24.7

QwestCommunications 2000 2002 41.8

Rite Aid 1997 1999 59.1

Sunbeam 1997 1998 58.8

Tyco Intl. Not flagged 2002 58.2

Vivendi Universal Not flagged 2002 27.9

Waste Management 1998 1999 63.6

WorldCom — MCI Group Not flagged 2002 69.8

Xerox Not flagged 2000 43.8

CompanyYear

Flagged 1Year

Discovered 2Market Cap Lost (%) 3

distribution the number 1 occurs as the leading digit about 30% of the time.

Amiram’s statistically driven measure avoids a basic problem of the M-Score and F-Score: a model for detecting earnings manipulators that is based only on those that have been caught by the SEC is inherently skewed. The research-ers say their measure is also superior because it “does not

Amiram and colleagues say their measure could be deployed on a large scale “as a ‘first-pass’ filter to flag companies that potentially file suspect financial disclosures.”



present-value calculations of assets, which normally appear in the footnotes to financial statements.

As one CFO told the Emory-Duke researchers, “It’s easy to spot changes in the assumptions[,] but the accounting profession does not ask firms to disclose what I call the ‘next sentence’ stating that the effect of the change is to in-crease earnings in the current period and increase risk on the balance sheet.”

What else would be hard for an analytical model to gauge? Academic researchers looking for earnings manipu-lators should analyze the credibility of the management team, one CFO told the Emory-Duke authors, because they “set the tone or culture which your internal accounting function will operate under.”

Models can be improved if researchers uncover more characteristics of companies that manipulate earnings and incorporate them. The F-Score, for example, misses some companies that manipulate sales because it only probes ac-crual-based measures. It skips techniques designed to boost sales, like channel-stuffing at quarter’s end, or “encouraging sales to customers with return provisions that violate the definition of a sale,” according to Dechow’s study. The four researchers see this as a fruitful area for further research and fine-tuning of their model.

“If your financial state-ments are in good order,

but your XBRL is improperly built, the RoboCop may highlight your company as a candidate for further investigation.”

Earnings Cop ÉIt’s still early days, but there are developments at the SEC also. The SEC’s Financial Reporting and Audit Task Force announced it will be using something called the Accounting Qual-ity Model, also known as RoboCop, to detect earnings management. The AQM is a quantitative analytic model—econometric-based—that will spot earnings management by, among other things, determining whether a registrant’s financial statements stick out from other filers’ in its industry.

The AQM will look at discretionary accounting choices by, for instance, examining total accruals and then estimat-ing discretionary accruals, according to Nicolas Morgan and Jennifer Feldman of DLA Piper in “The SEC Sharpens Its Talons” (CFO, February). “The model then classifies the estimated discretionary accruals as risk indicators (factors directly associated with earnings management) or risk in-ducers (strong incentives for earnings management),” wrote Morgan and Feldman.

Another risk indicator could be an accounting policy in which a high proportion of transactions are structured off–balance sheet, says Craig Lewis, chief economist at the SEC, and a risk inducer could be a company losing market share to competitors. The AQM produces a score for each filing and compares it with the filer’s industry peer group, assess-ing the likelihood that fraud is occurring.

The AQM could vastly increase the number of comment letters companies receive from the SEC, although Lewis says the list could be adjusted to accommodate “evolving staff experiences and priorities.” Because it digs into XBRL data, a reporting language that many companies have yet to perfect, and because like any model it has its limits, the AQM is being greeted with skepticism in some quarters.

RDG Filings, a provider of XBRL solutions, says SEC investigations may become more like tax audits in which taxes were paid properly but the tax form was filled out in-correctly. “If your financial statements are in good order, but your XBRL is improperly built, the RoboCop may high-light your company as a candidate for further investigation,” RDG says on its website.

False Positives ÉAny analytical model, of course, can over-report occur-rences. Write Dechow and her colleagues: “One unavoid-able issue in developing models to detect misstatement is that the revelation of a misstatement by the SEC is a rare event. Thus, similar to bankruptcy prediction models, our models generate a high frequency of false positives.” That is, “many firms that do not have enforcement actions against them are predicted to have misstated their earnings.”

Moreover, analytical models can miss such things as the quality of the estimates and assumptions underlying the

Just because models aren’t perfect doesn’t mean that regulators won’t keep them in their tool belts. The SEC’s Lewis says if the commission can keep false positives to a manageable level, the AQM could be a powerful means of improving accounting, not just for identifying fraud but also for helping staff assist corporate filers with disclosing finan-cials in compliance with GAAP.

As we know from the banking crisis and other histori-cal debacles, however, businesses always adapt in relation to what regulators are searching for. RDG is already tout-ing that it can help companies reduce the chances of getting flagged by the Robocop system. One day, analytical models could help identify who is really manipulating earnings and how widespread the practice is. In the meantime, the cat-and-mouse game between businesses that misrepresent or falsify their accounts and the builders of analytical models appears to have just begun. CFO

Z�VINCENT RYAN IS EDITOR IN CHIEF, DIGITAL PLATFORMS, OF CFO.

The Search forSuspect Accounting

14Mar_SusAcct_Fin.indd 28 2/27/14 11:39 AM

�1-855-227-2390 �www.avalara.com/cfo

Get your free copy of the Wakefield Research Report.

52%of accountants would rather

run a marathon than try to crack the code on sales tax laws.

Really, we can’t make this stuff up. Isn’t it time to consider sales tax automation?

Avalara.indd 5 2/20/14 11:50 AM

14Mar_StateTax_Fin_v3.indd 30 2/26/14 11:59 AM

31 cfo.com | March 2014 | CFO

The last time CFO magazine conducted its state tax survey, in 2011, the nation’s fiscal condition was very different. The Great Recession had depleted state coffers, and legislatures were looking to com-panies to pony up more tax dollars. “The states are in a pure ‘money grab’ mode,” one tax director complained at the time.

Today, the situation is brighter. Through the third quarter of 2013, total state tax revenues have grown for 15 consecutive quarters, according to the Nelson A. Rockefeller Institute of Government. Adjusted for inflation, the simple average quarter-ly growth rate over that period was 4.2%.

The return of fiscal stability set the stage in 2013 for attempts to enact comprehensive tax reform. Significant changes were proposed in a half-dozen or so states, including North Carolina, Ohio, Loui-siana, Nebraska, and Minnesota, generally either reducing or repealing income taxes, both business

Discretionary authority, economic nexus, and the

taxing of services loom large in the state tax landscape.

BY EDWARD TEACH

bbb

bbb

Thinkstock

TAXING ISSUES

THE 2014 CFO STATE TAX SURVEY


licensing intellectual property to Wendy’s, the fast-food chain, while ConAgra was licensing the ability to use its brands to food distributors.)

DISCRETIONARY MATTERSb�Some of the states’ aggressiveness can be seen in their growing use of discretionary authority, or alternative ap-portionment. “We’ve seen more and more states using dis-cretionary authority, because they don’t like the answer they get when the rules as written in law are applied,” says Duncan.

“Almost every state has a provision that says if our stan-dard apportionment factor doesn’t fairly reflect the extent of your business activity in our state, we can use our discre-tionary authority to adjust that,” says Lee Zoeller, partner and practice group leader of the state tax group at law firm Reed Smith in Chicago. In some instances states have used their discretionary authority to counter aggressive tax plan-ning on the part of some companies, says Zoeller. But in others they have effectively undone what companies view as normal business transactions, because they produce less tax and are therefore considered distortive.

In recent cases involving subsidiaries of Wal-Mart and Delhaize America, North Carolina required the companies to file a consolidated return with the corporate parent to reflect their “true earnings” in the state. Appellate courts

and individual, and replacing them with sales taxes. For the most part, these efforts failed.

But there is still a fair amount of aggressiveness among the states in collecting additional income tax revenues from corporations, say observers. One way of doing so is by as-serting economic nexus—a threshold of business activity that makes an out-of-state company subject to income tax (as opposed to sales and use tax) even without a physical presence in a state. The most aggressive states in this regard are California and New York, according to the latest edition of CFO’s survey of corporate tax directors, followed by New Jersey, Michigan, and Massachusetts.

“They want to ensure that companies outside the state, whether they are making sales into the state or are conduct-ing business in the state, are paying what they consider is their fair share of tax,” says Harley Duncan, managing di-rector and state and local tax leader in KPMG’s Washington National Tax Practice. In California, for example, an out-of-state company triggers economic nexus if its sales in the state exceed the lesser of $500,000 or 25% of the company’s total sales. Other states continue to press out-of-state com-panies for income tax nexus in various ways.

Occasionally they overreach. In May 2012, for example, high courts in West Virginia and Oklahoma struck down those states’ attempts to extend economic nexus to Scio-to Insurance and ConAgra Brands, respectively, neither of which had a physical presence in the state. (Scioto was


e What is your overall impression of the tax environment in each state?

Survey respondents ranked states on a scale, with: 1 = very fair and predictable 5 = very unfair and unpredictable.

1 = Not Aggressive 5 = Very Aggressive

r How would you rate each state’s stance on asserting income tax nexus when companies have only an economic presence in the state?

Q VERY FAIR AND PREDICTABLE

1. WY [1.89] 2. AK [2.11] 3. OK [2.26] 4. ND [2.32] 5. SD [2.33]

Q NOT AGGRESSIVE

1. SD [2.20] 2. NV [2.31] 3. VA, WY [2.33] 4. KS [2.42] 5. ME [2.44]

Q VERY UNFAIR AND UNPREDICTABLE

46. MI [3.33] 47. IL [3.62] 48. MA [3.67] 49. NJ [3.69] 50. CA, NY [3.82]

Q VERY AGGRESSIVE

46. MA [3.84] 47. MI [3.88] 48. NJ [4.11] 49. NY [4.30] 50. CA [4.54]

The 2014 CFO State Tax Survey Results The charts on this page and the following pages highlight states ranked best and worst on six key measures.

b|TAXING ISSUES|b


upheld these applications of discretionary authority. Fol-lowing taxpayer and trade group discussions with the leg-islature, the state has since set some parameters for when it can use its discretionary authority, says Duncan.

More than 20 states use unitary reporting, automatical-ly taxing the combined income of the out-of-state subsid-iary, other subsidiaries, and the corporate parent if they are deemed to constitute a unitary business. In November the Alaska Supreme Court affirmed the right of Alaska to tax the worldwide income of Tesoro, a Texas-based petroleum company. Tesoro had argued that some segments, like its pipeline business, should not be taxed by the state.

ARE THEY BEING SERVED?b�One of the biggest current issues in state taxation is sales-factor sourcing. Most states have moved away from three-factor apportionment—equally weighting sales, prop-erty, and payroll—to either using sales alone or weighting

sales at 80% or 90%. “They are effectively exporting the tax to companies outside the home state,” says Zoeller. Doing so lightens the tax burden on in-state companies and takes into account the increase in online sales by companies with no bricks and mortar in a state. “The states were losing a little of their tax base,” says Zoeller, “so they had to try to balance it out.”

It isn’t difficult to determine whether the sale of goods or tangible personal property by an out-of-state business is an in-state sale. But how do you source income from the provision of services? “That’s the hard question everyone is wrestling with,” says Zoeller. The conventional method is cost of performance—where is the work done to make a ser-vice available? If most of the cost of performance of a ser-vice is incurred in a given state, all of the income from the performance of that service is apportioned to that state, no matter where the customers may be.

“There is a lot of litigation around cost of performance,” says Zoeller. “Courts have interpreted it differently. The telecom companies are involved in litigation all over the county to figure out where their costs are for phone calls.”

More than a dozen states have moved to a market-based, or customer-based, approach to sourcing service income, apportioning it to the state where the service is used or the benefits of the service are received. The problem is, with other states hewing to the older approach, companies can get whipsawed, says Duncan.

“If one state is using cost of performance and I have my cost of performance in that state, all of the income from the performance of that service goes to that state,” he ex-plains. “If I sell 10% of my services into a second state using


t How would you rate each state’s stance on asserting sales and use tax nexus?


1 = Not Concerned 5 = Very Concerned

u How concerned are you that your state’s fiscal condition will negatively affect your company in some way in the next 12 months?

Q NOT AGGRESSIVE

1. NH [2.00] 2. AK [2.15] 3. DE [2.17] 4. OR [2.23] 5. ME [2.31]

Q NOT CONCERNED 1. AK, ND [1.85] 2. NH, UT [1.86] 3. SD [1.91] 4. AR, MT, NB, RI, VT, WY [1.92] 5. OK [2.00]

Q VERY AGGRESSIVE

46. NJ [3.78] 47. WA [3.81] 48. TX [3.85] 49. NY [4.25] 50. CA [4.26]

Q VERY CONCERNED 46. MA [3.38] 47. NJ [3.42] 48. NY [3.95] 49. CA [4.17] 50. IL [4.20]

“We’ve seen more and more states using discretionary authority, because they don’t like the answer they get when the rules as written in law are applied.”—Harley Duncan, KPMG



sues deeply,” he says. As for New York, its provision re-garding combined reporting “is different than those in other states,” points out Duncan. “There is more flexibility in who gets combined and when they get combined, and I think that leads to a sense of unpredictability.”

Zoeller says there are “many reasons” why corporate tax directors might dislike California and New York, but adds that they can be summed up as a pervasive “adversarial atti-tude toward taxpayers.” A “no-holds-barred approach to tax administration” is a hallmark of both states, he says, with tax officials “doing everything they can to see that the state gets its last penny.”

But it doesn’t have to be that way, adds Zoeller. He says that in other states—and in pockets of California and New York as well—a different attitude can be discerned: “I work for your government, I’m here as your employee, and I’m trying to find the right answer and do the right thing.” CFO

Z�EDWARD TEACH IS EDITOR-IN-CHIEF OF CFO MAGAZINE.

market-based sourcing, ultimately I’m going to end up with 110% of my service income being taxed between those two states.”

ADVERSARIAL ATTITUDESb�CFO’s latest state tax survey was conducted in October and November in cooperation with KPMG, yielding re-sponses from 78 tax directors and other finance executives. Some of the results were nothing if not consistent with pre-vious surveys: for example, California, New York, New Jer-sey, Massachusetts, and Michigan typically rank as having among the least fair and predictable tax environments, and this time around was no exception.

Why do tax directors perennially give California and New York such low grades? Duncan says he can’t speak for them, but he says California’s “significant audit presence” may be unnerving to some taxpayers. “They delve into is-

i Over the next 12 months, how likely is each state to enact a major reform of its corporate income tax?

1 = Not likely 5 = Very likely


o How would you rate each state’s stance on pursuing clawbacks of business tax incentives granted to individual companies?

Q NOT LIKELY 1. AK [1.58] 2. SD [1.59] 3. WY [1.61] 4. ND [1.63] 5. MT [1.67]

Q NOT AGGRESSIVE

1. AK [2.27] 2. NV [2.45] 3. FL [2.50] 4. ID, KS [2.58] 5. KY, PA [2.62]

Q VERY LIKELY 46. MA [2.60] 47. NJ [2.61] 48. IL [2.68] 49. NY [2.87] 50. CA [3.05]

Q VERY AGGRESSIVE

46. MA, MI [3.21] 47. NJ [3.23] 48. IL [3.36] 49. NY [3.50] 50. CA [3.76]

This survey, conducted biannually since 1996 with the help of KPMG LLP, the audit, tax, and advisory firm, aims to capture tax executives’ impressions about differing tax environments in each state in which they do business. The results presented here represent those opinions, rath-er than quantitative assessments of actual policies, tax rates, or other criteria.

METHODOLOGY

b|TAXING ISSUES|b

A “no-holds-barred approach to tax administration” is a hall-mark of both California and New York, with tax officials “doing everything they can to see that the state gets its last penny.”—Lee Zoeller, Reed Smith

14Mar_StateTax_Fin_v3.indd 34 2/26/14 12:00 PM

Measure What Matters,Make Better Decisions

Find out why the largest firms in a variety of industries have sought our help in making some of their most difficult decisions.

When it comes to making optimal choices in a complex environment with variables that are “intangible” or highly

uncertain, we literally wrote the book on it.

Hubbard Decision Research founder, Douglas W. Hubbard, is the inventor of Applied Information Economics (AIE), the first

truly scientific and theoretically sound method developed for addressing risky decisions even when they are

thought to be too soft or uncertain for rigorous methods.

Ask Hubbard Decision Research about: Consulting - Seminars and Webinars

Performance Metrics - Specialized Analytical Tools

“The theory of Applied Information

Economics is right on target. People

that don’t use these methods will be

missing a lot of opportunities.”

— DR. MARSHALL VAN ALSTYNE, MIT Sloan School of Business

“AIE’s strength lies in its ability to

conduct a true risk/return analysis

based on proven methods that have a

known statistical validity…With its

mathematical, statistical, and economic

underpinnings AIE provides investment

decision-makers with a high degree of

confidence in its results.”

— Forrester Research

Douglas Hubbard is the author of the bestselling business math book on Amazon, How to Measure Anything: Finding the Value of “Intangibles” in

Business; over 60,000 copies have been sold! The newly released third edition includes new measurement methods and examples to show

managers how to inform themselves in order to make less risky, more profitable business decisions.

Check out his other books The Failure of Risk Management: Why It's Brokenand How to Fix It and Pulse: The New Science of Harnessing Internet Buzz

to Track Threats and Opportunities.

“I love this book. Douglas Hubbard helps us create a path to know the answer to almost any question, in business, in science,

or in life . . . How to Measure Anything provides just the tools most of us need to measure anything better, to gain that insight,

to make progress, and to succeed.”

— PETER TIPPETT, PhD, MD, Chief Technology Officer, CyberTrust, and inventor of the first antivirus software

“Doug Hubbard’s book is a marvelous tutorial on how to define sound metrics to justify and manage complex programs. It is a

must-read for anyone concerned about mitigating the risks involved with capital planning, investment decisions, and program

management.”

— JIM FLYZIK, former Government CIO, White House Technology Advisor and CIO magazine Hall of Fame Inductee

[email protected](630) 858-2788

New Technology Threats Customer Satisfaction

Productivity Revenue Forecasts Quality

Company Image

Safety

Innovation Business Risk

Reliability Sustainability User Acceptance Employee Empowerment

Strategic Alignment

IT Security Infrastructure Improvements Catastrophic Failures

Product Benefits

Adoption Rate

Hubbard Speaker.indd 4 2/20/14 11:56 AM

14Mar_LeaseAcct_Fin.indd 36 2/25/14 12:51 PM

The latest chapter in the long-running saga on lease accounting began in January, when the Financial Accounting

Standards Board started to mull the proposals in its May 2013 exposure draft, Leases (Topic 842). If approved, the new rules could add hundreds of billions of dollars to the liabilities on corporate balance sheets. Finance executives have been vocal in their criticisms, and no one is sure what will happen next.

The story proper begins more than a decade ago, in the dark recesses of off-balance-sheet financial arrangements, where regulators found Enron and other scandal-plagued companies hiding billions of dollars of debt. In its quarterly filing of November 19, 2001, for example, Enron reported debt on its balance sheet of about $13 billion. Yet the crumbling energy company told its bankers on that very same day that its debt was about $38 billion. Why the staggering discrepancy? Enron explained that the missing $25 billion was either off-balance-sheet debt or reported on the balance sheet as something other than debt.

While Enron kept about $14 billion of debt off its balance sheet through the use of special-purpose entities—deals that attracted a great deal of attention at the time—the Securities and Exchange Commission took a wider-bore approach in its investigation of off-balance-sheet arrangements. In a 2005 report to Congress mandated by the Sarbanes-Oxley Act, the SEC made recommendations for improving accounting in a number of areas—among them leasing.

Then as now, the problem with leases concerned the companies leasing the land or equipment (the lessees) much more than the financial services companies (the lessors) that lease it to them. In its report, the SEC cited “$1.25 trillion in non-cancelable future cash obligations committed under operating leases that are not recognized on issuer balance sheets, but are instead disclosed in the notes to the financial statements.” All that under-reported off-balance-sheet debt could provide ample opportunities for companies so disposed to cook the books,

Thinkstock 37cfo.com | March 2014 | CFO

Many CFOs now agree that companies should put leases on the balance sheet. It’s the how that has them up in arms.

The Path of

By David M. Katz

LeaseResistance


mortgage arrangements, and the accounting needed to be changed to reflect those nuances, according to the SEC. The commission recommended that FASB launch a leases project to change the system.

Incomplete ConsensusFast-forward seven years, through a half decade of delibera-tions, two exposure drafts, and hundreds of comment let-ters, and FASB and its overseas counterpart, the Internation-al Accounting Standards Board, are in a position to vote on a final new lease accounting standard this month.

With some exceptions, the boards have built a consensus among a diverse group of constituencies—corporate lessees, financial lessors, investors, CFOs, and auditors among them—that the standard should require that corporations report all manner of leases of longer than 12 months on their balance sheets. Yet although the boards have put forth a plan, no consensus yet exists on how, exactly, that should be done.

Indeed, many constituents still contend that the lease-accounting requirements under current generally accepted accounting principles aren’t broken and hence don’t need to be fixed. For their part, individual investors rarely drill down deep enough into their portfolios to care about lease accounting. And since analysts and institutional investors can easily tease out lease-derived debt from existing corporate financial statements, why is it necessary to change the way leases are reported?

FASB’s answer to that has been that it’s the large investors themselves who have asked that the assets and liabilities of operating leases be placed on the balance sheets of financial statements. Yet even shareholders don’t agree with the board’s notion of how that should be done. FASB’s own Investor Advisory Committee, in fact, rejected the board’s most recent exposure draft on lease accounting, on the grounds that it was overly complex.

The IAC hasn’t been alone in making that criticism. Many if not most of the more than 600 comment letters that

misrepresenting their true financial conditions, the rea- soning went.

At the core of the problem has been an “all or nothing” approach to lease accounting. That is, economically similar arrangements can get different accounting if they score a tad differently on a strictly drawn bright-line test. There may be, for instance, almost no real difference between two leases committing companies to pay 89% and 90%, respectively, of the leased assets’ values. Yet that 1% difference can mean that one lease must be placed on the balance sheet and that the other could be kept off.

As a result, many companies engineered their lease ac-counting to stay on the good side of the bright line. What’s more, those companies “have been aided in these endeavors by a large number of attorneys, lenders, investment banks, accountants, insurers, industry advocates, and other advis-ers,” the SEC reported in 2005. “Indeed, lease structuring to meet various accounting, and other goals, has become an industry unto itself in the last 30 years.”

The system distinguished, as it does today, only between operating leases (in which the lessee basically rents the land or equipment from the lessor) and capital leases (in which the lessee essentially agrees to buy the asset with financing help from the lessor). Operating leases were left off the balance sheet, capital leases were put on. Simple as that.

In reality, however, leases can’t be classified so simply. They range from pure rentals to lease-to-buy contracts to

Whatever changes accounting standards-setters may make to the most recent lease-accounting proposal, one thing is nearly certain: the assets and liabilities of what are now operating leases will henceforth be recorded on corporate balance sheets. That, in turn, could make a borrower look much more leveraged than previously.

The changes could also worsen the financial ratios that govern a loan’s covenants, to the point where a borrower is in violation of its agreement with the bank. Key ratios

such as earnings before interest, taxes, depreciation, and amortization; debt to equity; and return on assets are bound to come out a whole lot differently for many companies.

Especially affected by a new system would be companies that retain the right to use equipment or real estate via operating leases. The assets and liabilities of such leases, which are tantamount to rentals, aren’t currently reported on corporate balance sheets.

Oddly, the changes are likely to be favorable for many corporations when it comes to EBITDA. That’s because a large amount of what’s currently operating expense on lessee income statements would be reported on balance sheets as debt and amortization. “If we required minimum EBITDA of $25 million … the customer’s financial


“To implement the new require-ments, preparers will incur signifi-cant costs to develop new systems, modify existing systems and devel-op new processes and controls.”Gregg L. Nelson, VP for accounting policy and financial reporting, IBM

CRACKING COVENANTSPutting all leases on the balance sheet could jar bank covenants.

The Path of Lease Resistance


statement preparers who feel that two types of lease are one too many. Senior finance executives at Koch Industries, Time Warner Cable, Altria, Dell, and other big companies have come out in favor of a system that draws no such distinction.

In a September 11, 2013, comment letter, William F. Osbourn Jr., the chief accounting officer and controller of Time Warner Cable, wrote that “the widely criticized shortcomings of the current lease accounting model, which have focused primarily on the need to bring operating leases ‘on-balance

sheet,’ can be better addressed using a single and consistent model for all leases.”

Like many finance executives who favor a single model, Osbourn prefers the Type A approach, which he said is “similar to today’s capital lease accounting model” and as such “is already well understood by financial statement users and preparers.” Moreover, “financial systems for recording such leases are well-established,” he added.

The “accounting for the asset and liability sides of Type B leases will be far more complex to administer than for Type A leases,” warned Osbourn. “This will also lead to increased costs in order to build and maintain the new Type B lease accounting systems.”

Price Tag in the BillionsNot surprisingly, the possible compliance costs involved in changing the accounting for all the leases used by Corporate America create the most anxiety among many senior finance executives. The lack of clarity on what the final standard will be, much less on the kinds of software and systems that

performance could deteriorate[,] yet it could meet the covenant,” Roger May, president and board chairman of CBI Equipment Finance, a subsidiary of Commerce Bank, wrote to FASB chairman Russell Golden in September 2013.

Precisely because of the appearance of all that debt, however, bankers could be looking at a raft of borrowers with much gloomier debt-to-equity ratios. Thus, “even though the customer’s financial performance has remained the same,” its higher leverage ratio under the proposed lease accounting standard could violate its debt covenant with the bank, wrote May. That would require the borrower to obtain a waiver for breaking the covenant and to redocument the loan request; both actions would involve fees.

The current situation in lease accounting is difficult for

CFOs, because without final guidance from FASB and the IASB, it’s hard to know how to approach bankers. “What we are suggesting to our client base is, ‘Don’t start doing the accounting yet, because it might very well change. But start talking to your lenders and the people who hold your covenants, because you might be able to reach some accommodation with them,’” says Richard Stuart, a partner in the national accounting standards group at McGladrey.

One possibility is for finance chiefs to try to persuade their lenders to allow current lease accounting to apply to their covenants, even if new standards are needed to satisfy generally accepted accounting principles, he says. But that would come at a price: “You still have the cost of having to keep up another set of books,” Stuart notes.—D.M.K.

FASB received in response to its most recent proposal, including abundant correspondence from CFOs, controllers, and senior accounting executives, aired versions of the same objection: The boards have made financial statements more complicated by dividing lease accounting into two new categories.

Two TypesUnder FASB’s plan, instead of classifying their leasing arrange-ments in the current manner as either capital or operating, com-panies would begin their account-ing by separating their leases according to the type of asset they’re leasing: Type A leases (equipment, including anything from aircraft to office copiers) or Type B leases (real estate, including land and buildings). The two types of leases would be accounted for on the balance sheet in different ways.

Lessees would treat the liabilities on their Type A leases as “front loaded.” Much in the way that they account for capital leases today, Type A lessees would assume they have already bought the asset, estimate its amortized costs over the length of the lease, and allot those costs in line with the depreciation of the asset’s value over time. Type A lessees would thus record more expense in the early years of the lease than they would later on.

By contrast, lessees would account for their Type B payments in roughly equal amounts over time. They would recognize the total lease cost on a straight-line basis over the lease term—like recording the same rent expense for office space each month, for instance.

By presenting lessees with this new classification system, FASB triggered an uproar, particularly among financial-


“The sheer volume of our leases will be exceedingly unmanageable without significant changes in our accounting and lease administration systems,” wrote F. Clay Creasey Jr., CFO of Toys“R”Us.

David Shankbone


lease expense, Creasey noted.As a result of that discrepancy, Toys“R”Us wants FASB to

allow lessees to keep the non-core assets and liabilities off the balance sheet, as operating leases currently are. Under the proposal, however, companies would only be able to keep leases with terms of less than a year off-balance-sheet. Creasey contends that this break should be extended to such things as leased laptop computers, “even though lease terms generally exceed 12 months.”

Breaking the LogjamFacing such strong opposition to their exposure draft, the boards met on January 23 to start deliberations on a possible way forward through the apparent logjam. Based on their reading of the comment letters and meetings with financial-statement users, FASB and IASB staffers came to the decision that the boards should revisit where the line between Type A and Type B lessee accounting should be drawn—and, for that matter, whether there should be a line.

At the meeting, the boards began consideration of three different approaches to lease accounting developed by the staff. One would be a single model, in which lessees would account for all leases as they would for Type A leases. The second approach would basically retain the Type A–Type B model. The third approach would return to the current GAAP distinction between capital and operating leases, albeit now including all leases on the balance sheet. Lessees would account for most capital leases as Type A leases and for most operating leases as Type B leases.

As complicated as deciding among those choices sounds, the two boards are actually much closer to putting out a final standard than they’ve ever been. Although it’s anybody’s guess which of the three approaches they’ll choose, and whether they will approve a final rule at their March meeting, the boards are likely to move quickly now on producing a standard that will put all leases on the balance sheet. CFO

Z DAVID M. KATZ IS A DEPUTY EDITOR AT CFO.

could be required, hasn’t prevented some from putting the compliance price tag in the billions of dollars.

Without a doubt, the costs would be many and varied. “To implement the new requirements, preparers will incur significant costs to develop new systems, modify existing systems and develop new processes and controls,” wrote Gregg L. Nelson, vice president for accounting policy and financial reporting at IBM, in a comment letter.

Further, the proposal’s “complexity and the significant judgments inherent in the model” could trigger hefty ongoing compliance costs, said Nelson. The subjectivity of terms like “significant” and “substantially” in FASB’s exposure draft could make it hard—and more costly—for lessees to confirm results each reporting period.

Another source of judgment that will weigh heavily on lessees’ minds and pockets: a proposed requirement to periodically reassess the terms of the lease. Such reassessment could be trickier, and a lot more expensive, in the case of leases that call for such ongoing adjustments as the need to align payments with the Consumer Price Index every quarter, according to IBM’s Nelson.

An even more pressing cost concern, for big lessees like Toys“R”Us, will be the need to account for high volumes of leases of low-value equipment. The toy retailer, which has more than 1,700 stores, has a lease portfolio containing “thousands of operating leases, including a majority of our retail locations and a myriad of equipment worldwide,” F. Clay Creasey Jr., the company’s CFO, wrote in a comment letter.

The company is worried that the standard will cause it to account for cheaply leased equipment in the same way as it does for high-rent stores. “The sheer volume of our leases will be exceedingly unmanageable without significant changes in our current internal processes, accounting and lease administration systems and human capital,” said Creasey.

To avoid such a heavy cost for what he feels is a limited benefit, the boards should treat different kinds of leases differently, said the CFO. Investors “are far more concerned with obligations arising from our long-term leases of real estate assets” than with “obligations arising from those leases that do not have overall significance to our business.”

For example, Toys“R”Us estimates that real estate assets account for over 95% of its total lease expense, but only about 20% of the total number of its leased assets. The remaining 80% of its portfolio, consisting of “non-core assets, such as leases for equipment that are used to support our operations,” accounts for less than 5% of the company’s


Three Paths DivergeUsing the Type A and Type B lease classification, FASB and IFRS staff recently proposed three possible approaches to lease accounting.

Type of lease in ex-isting GAAP (IFRS)

Approach1

Approach3

Approach2

Capital (Finance) Type A Type A Type A

Operating Type A Non-Property Property Type A Type B Type B

Source: Staff of the IFRS Foundation and FASB, January 2014

The Path of Lease Resistance


FP&A for High-TechSummit

San Francisco, 2014

April

8 & 9

SPEAKERS INCLUDE:

[email protected]

+1 (415) 992 5352

theinnovationenterprise.com/summits/fpa-hightech-sanfrancisco2014

For more information contact Zain Yasin

CFO Conf FPA.indd 1 2/20/14 11:52 AM

14Mar_SR_CSX_Fin.indd 42 2/24/14 9:58 AM

Working On The RailroadRailroad company CSX finds top-notch finance staffers by using a case-study approach to hiring. By David McCann

But if you don’t also require applicants to make a live case-study presentation to a panel of evaluators, you may not be hiring the best talent available. Case-based interviews,

according to CEB, a corporate research and advisory firm, are

the best way to identify the softer, nontechnical skills—communication, business acumen, team management, and so on—that drive finance department effectiveness. Yet, according to CEB’s research, only 32% of large companies use case studies as part of their process for hiring finance professionals. Among those that do use a

case-study approach, one of the most outstanding examples is CSX, the Jacksonville, Florida-based operator of the largest railroad in the eastern United

States (2013 revenues: $12 billion). “Very few organizations have the kind of detailed, case study-based approach that CSX does,” says Kruti Bharucha, a CEB senior director. “In fact, we haven’t seen any other company that does it in such detail.”

CSX began working on its finance-hiring program in 2004 and has been continually tweaking it since. Since 2007 it has used the same case study for each candidate for finance jobs—those in the corporate financial planning and analysis area and those dedicated to providing support for the company’s various business lines. (There is a different hiring process for accounting positions.)

Wanted: Communication SkillsCFO Fredrik Eliasson was one of three CSX executives who created the program in a bid to make the finance function more relevant. “We had very smart people, but our

influence was limited back then,” Eliasson recalls. “It was clear to me that it wasn’t enough to be able to analyze and understand the key economic drivers of our business in order to make better economic decisions. We also had to be able to go into staff meetings, at both senior and lower levels of the organization, and articulate why we had to change.”

The railroad industry, notes Eliasson, had a lot of 30-year veterans who had been doing things the same way for a long time, whether it was dispatching trains, repairing locomotives, or putting down track. Technology and processes had to change for financial reasons, putting a premium on finance’s communication and influencing skills.

Says Eliasson: “We had to go to those people and say, ‘I know you’ve been doing it this way for a long time, but if you think through this problem a bit differently with the economics in mind, you will see that perhaps we should do something different.’ That is not an easy thing to do for an operations-based company like CSX.

“But,” he continues, “while you might have the best analysis in the world, if you can’t make people feel good as you try to influence them to do something different, you have accomplished nothing.”

Finance HiringSpecial Report

Flickr: Flowizm 43cfo.com | March 2014 | CFO

How do you go about hiring a finance staffer? If you’re like most finance executives, you screen résumés and choose a number of candidates. You conduct a tra-

ditional one-on-one interview with each, and subject those who survive the first cut to multiple additional interviews. You thoroughly examine their technical skills, and perhaps run them through a battery of cognitive and behavioral tests.


case study, says Pelkey. The case has nothing to do with CSX’s industry, reflecting a key trait of good case studies, according to CEB. In its report on the railroad’s finance hiring program, the research firm observes that “cases on topics unrelated to your industry or function can reduce the influence of the candidate’s expertise and experience, ensuring you are evaluating behavior strength, not knowledge.”

In the case, a fictional company is debating whether to open a new plant in Florida, rebuild one in Southern California that was recently destroyed by a brush fire, or move the Western operation south of the Mexican border.

Candidates are provided with background information on the fictional company and its present circumstances as well as a set of recent financial statements. They are given a few days to prepare a 2-page memo outlining their recommendations and a 10-page PowerPoint presentation to be delivered live to a panel of CSX finance executives. Candidates defend their assumptions and analyses against challenges from the panel.

“People who do very well in the traditional interview may simply not

be able to support the analysis they’ve done when put in front of a group,” says Pelkey. “It’s a real-world situation. We’ve even modified some of our traditional interview questions to get at that.” For example, a few years back, candidates were asked how they thought Apple, AT&T, and Verizon would be affected if Apple’s iPhone were offered on Verizon’s platform (as eventually happened).

The presentation tests candidates’ ability to handle themselves under pressure, observes Bharucha. “It can be stressful, because the panel is firing off questions,” she says. “So it doesn’t just test communication skill, succinctness, synthesis, and analysis, but also the ability to respond in the moment in a high-pressure environment.”

Desired BehaviorsAs CSX’s goal was to hire finance professionals with communications and influencing skills, it came up with a set of 13 desired communications behaviors. But not all of them are valued equally. They are ranked by the extent to which they can be learned through training and how critical they are to communicating insights. CSX believes that the most valuable behaviors, the ones that can produce deep insight, are the hardest to learn.

The company has identified five behaviors it considered most important:Z�Articulates views in a clear and concise mannerZ�Anticipates questions and prepares appropriate responses or answersZ�Uses narratives, like stories and analogies, to communicate messagesZ�Presents compelling arguments to support positionsZ�Constructively challenges business partner assumptions and goals.

Because CSX has done hundreds of case-study interviews since 2007 using the same case, the finance

Finance HiringSpecial Report

CSX’s finance function devotes an enormous amount of time and energy toward hiring its staff. About 50 finance professionals have been hired since 2007. To find them, the department has evaluated about 1,000 candidates in a “multiple touch point” hiring process, estimates Sean Pelkey, CSX’s director of performance analysis, finance, and an overseer of the hiring program for the past several years.

There are about 80 people on the finance team, and with a few moving out into the business each year and a few leaving the company, there is room to hire about 10 new employees a year.

“We want to have a constant pool of people coming through so that when we find one who passes through all the touch points and succeeds, we can bring them on the team,” says Pelkey. “Sometimes that happens when we don’t have a specific need. That means we’re finding the right people and not rushing to hire someone because we need to fill a spot.”

Analyzing the CaseAt least a third and maybe up to half of the hiring decision is based on the candidate’s performance on the


1. Abstract definition of communication competencies

2. Unclear quality bar

3. Behavioral questions not a good proxy of on-the-job communication challenges

4. Difficult to ensure consistency of candidate assessment across all interviewers

1. Documents the desired communication behaviors in detail

2. Differentiates “must-have” from “nice-to-have” behaviors

3. Simulates real-life situations during interviews

4. Deploys a standardized communication competency scorecard

How CSX HiresTypical shortfalls in screening communication skills

How CSX overcomes these shortfalls

Source: CSX, CEB


trait, did they do X, Y and Z? That’s what CSX does,” Bharucha says. “An immediate, specific assessment is more valuable. If you see five candidates in a day and do a subjective, informal evaluation at the end of the day, they tend to blur together.”

The PayoffHow does CSX know whether its hiring process is paying off? An obvious yardstick is the career paths of those who are hired. Among the 50 or so finance staffers hired since the case-study approach began, about 10 have been promoted to director-level positions within finance, and about the same number have management roles in other areas of the company.

That pipeline of talent feeding the rest of the organization is highly valued, says CFO Eliasson. “I think the people we’ve pushed out into the businesses are making their senior teams better economic thinkers,” he says. “Our business partners are better

at making difficult decisions, because they are thinking about problems differently and using financial theories and facts as the foundation for their business thinking.”

Another measure of the program’s success is the reduced “error rate” in the hiring of finance professionals. Eighty percent of those hired through this process are still with the company—a strong indicator of its success, according to the CSX executives. “It shows that we’re able to pick the right candidates,” says Eliasson.

Having confidence in the quality of a new hire enables CSX to provide satisfying work for him or her right away, says Pelkey. “You’re working on meaningful projects from Day One, not just running budgets,” he says. “That has an impact on good, talented people.” CFO

Z DAVID MCCANN IS A DEPUTY EDITOR AT CFO.

executives who sit on the panels have become adept at identifying the prized behaviors during the presentations, says Pelkey.

“We find that many people get stuck in the minutiae,” he says. “They’re like, ‘Here, let me show you 60 different ratios.’ It’s just to show that they know how to calculate them, which may or may not be meaningful. It should be, ‘How do you take the financial information we’ve given you to drill down to only what’s important for the case, and then persuade us to your recommendation?’”

Of course, good persuaders might influence people in the wrong direction. Pelkey says CSX is looking for candidates who can operate in the middle of a spectrum. “At one side are people who drink the Kool-Aid—that whatever the business wants to do is always in the best interests of the company,” he says. “At the other side are people who think decisions should always be managed based on what the calculations say. We want somebody who is more balanced, who is going to challenge assumptions and create a dialogue.”

CSX also uses a scorecard tool that is designed to take as much subjectivity out of the evaluation process as possible. Candidates are graded on the quality of their assumptions, analysis, presentation, and final recommendations; a perfect score is 4.0. Most successful candidates receive between a 3.0 and a 3.5, says Pelkey.

The company “offers a lot of guidance on how to use the scorecard and how to rate people,” comments CEB’s Bharucha. What often happens at other companies that use the case-study approach, she says, is that evaluators will simply trade notes about their impressions. “But they’re not using a specific template and saying OK, on this and that particular


Elements of a Good Case Study

X Forces consideration of qualitative evidence (e.g., customer behaviors, feasibility, core competencies, geographic factors)

X Brings in market dynamics (e.g., customer segments, competitor analysis, pricing pressures)

X Can have more than one correct answer. Cases without obvious solutions truly test the candidates’ thinking skills

X Forces the candidate to make a recommendation based on more than data and financial analysis

X Can be completed in a reasonable amount of time

X Is abstract and unique. Cases on topics unrelated to your industry or function ensure that you are evaluating behavior strength, not knowledge

X Has detailed guidance for interviewers to ensure fair and objective assessments. Creates an objective scale for interviewers to easily map candidates’ answers and behaviors to the corresponding influence sources

Source: CEB


Source for all charts: Duke University/CFO Magazine Global Business Outlook Survey of 400 U.S. firms, Q4 2013

If you’re responsible for the fi-nancial performance of a com-pany, can you afford to avoid thinking about retirement—that

is, your employees’ retirement?In 2013’s end-of-year Duke Univer-

sity/CFO Magazine Global Outlook Survey, we asked about the potential consequences of proposals to extend the full retirement age of Social Secu-rity (which is currently pegged at be-tween 65 and 67 years of age, depend-ing on when you were born). In the survey, 6 out of 10 U.S. finance execu-tives (62%) said that they thought the

More Than Just A Number An aging workforce is on the minds of finance chiefs in the latest Duke/CFO Business Outlook Survey. By David W. Owens

i 62 Percentage of U.S. finance executives who think the Social Security retirement age should be raised

DeepDive

factor influencing retirement deci-sions. According to the Center on Budget and Policy Priorities, a non-partisan think tank, Social Security provides the majority of the income for nearly two-thirds of the retired population in the United States. For an alarmingly high number of retir-ees, it provides practically all of their income.

It’s not too surprising, then, that 63% of the respondents in the Busi-ness Outlook Survey believe that raising the Social Security retirement age would likely force many of their employees to put their retirement plans on hold. That means that these companies would be dealing with all of the issues associated with manag-ing an older workforce. Those issues are by no means inconsequential.

One aspect, of course, is finan-cial. Two-thirds of the survey re-spondents who believed that their employees would delay retirement placed higher company costs for medical benefits among the top three

government should, indeed, raise the retirement age to help reduce the fed-eral budget deficit. Clearly, the budget shortfall is on their minds.

But the actual impact of the Social Security program on the federal bud-get deficit is the subject of heated de-bate, largely along party lines. Essen-tially, it’s a question of whether money the government borrows from Social Security trust funds to pay its other bills “counts” toward the deficit. If So-cial Security funds become unavailable for funding ongoing operations—say, for example, if the money were needed

to make ballooning benefits payments as baby boomers ride off into their golden years—then the govern-ment will have to replace those amounts from other sources, potentially requir-ing additional increases in the debt ceiling.

While the macroeco-nomic and political conse-quences of working longer are open to interpretation, the potential impacts on workforce management strategies hit much closer to home for finance execu-tives. Despite the fact that Social Security was origi-nally intended to supple-ment retirement savings, not replace them, it has grown into a significant

CFO Takes the Pulse of American CFOs


63%

16%

21%

Yes

Not sureNo

Retirement Decisions in the BalanceWill raising Social Security’s full retire-ment age cause your employees to delay retirement?

14Mar_DeepDive_Fin.indd 46 2/25/14 10:36 AM


consequences of employee decisions to work longer. In addition, a little more than half (52%) were concerned about higher payroll costs for longer-tenured employees. Simply put, the longer employees stay at a company, the higher their compensation tends to be. And approximately one in five respondents expected that their com-panies’ payments into retirement pro-grams would have to increase.

COMPETITIVE CONCERNSBut the Business Outlook Survey shows that “softer” issues figure into finance executives’ calculations, too. Indeed, attracting and retaining quali-fied employees was third on the list of top internal concerns, with 38% of respondents selecting it. That places it right behind the rising cost of health care (43%), which was second only to the ability to maintain margins (64%) as a concern.

For some companies, the man-date to remain competitive is a driv-ing factor in benefits decisions. Mark Verbeck, CFO of Coupa Software in San Mateo, California, notes that “for most high-growth tech companies, it’s very competitive for employees.” He acknowledges “the need to continue attracting employees” as a key to suc-cess. Similarly, Jeff Taylor, CFO at Rahr, which produces and distributes malt and other brewing supplies, says, “If we are trying to hire good talent, we need to offer what everyone else is offering. For us, keeping the status quo has its advantages,” even when con-sidering “the cost-structure point of view,” as he puts it.

In this regard, decisions to delay retirement can pose challenges for workforce management. For the Busi-

ness Outlook respondents who expressed concern about delayed retire-ment, 6 out of 10 (59%) noted that longer retention of more expe-rienced work-ers potentially could block advancement by younger em-ployees. If the younger genera-tion perceives that fewer op-portunities for advancement are available, the more likely they are to seek their fortunes elsewhere.

Yet, a num-ber of the exec-utives surveyed pointed out that the expense and risks of retaining employees can be balanced with the advantages of being able to draw on a more experienced and skilled work-force. One controller from a midsize manufacturing company wrote that “retaining experienced employees lon-ger will be a huge benefit to the com-pany,” while a CFO from the hospital-ity industry says simply, “On balance, we do well when our older employees stay around.”

Other respondents agreed, citing the benefits of retaining workers’ accu-mulated knowledge and skills, as well as the loyalty that long-time employ-

ees tend to develop. In the end, noted the owner of a small manufacturing company, the most important impact of having longer-tenured employees could well be “improved performance and workers.”

Effective management of human resources is as much a determinant of an organization’s success as is run-ning the numbers. CFOs, in their ever-expanding roles as stewards of their companies’ well-being, will need to bring the same level of rigor and dis-cipline to workforce management that they traditionally have provided for financial management. More and more, this will mean providing the perspective, in addition to the analy-sis, that can inform the trade-offs companies will be making as employ-ees enter into a new era of retirement planning. CFO

The Challenges of an Aging WorkforceWhat are likely to be the most significant consequences of delayed retirements for your company?

Higher company costs for medical benefits 67%

Fewer opportunities for other employees 59%

Higher payroll 52%

Higher contributions for retirement benefits 21%

Constraints on new hires 21%

Lower productivity 20%

Note: Multiple responses allowed

Top Internal Concerns of CFOs

Ability to maintain margins 64%

Cost of health care 43%

Attracting and retaining qualified employees 38%

Maintaining morale/productivity 35%

Ability to forecast results 28%

For those who expressed concern about delayed retirement, 6 out of 10 (59%) noted that longer retention of more experienced workers potentially could block advancement by younger employees.

14Mar_DeepDive_Fin.indd 47 2/20/14 3:57 PM

the willingness among their colleagues to embrace new technologies and align them with business objectives.

Such are the findings of a recent survey conducted by CFO Research, in collaboration with American Ex-press. The survey collected responses from 154 senior finance executives in the United States and the United King-dom, representing a wide range of industries. Nearly 8 out of 10 respon-dents (78%) reported that their compa-nies plan to increase real spending on information technology over the next year. Forty percent of all survey-tak-ers, half of whom work at companies with revenue of between $100 million and $500 million, anticipate that they will increase spending by 10% or more. (To learn more about the results of the survey, “Supporting Growth with New Technologies,” please go to http://goo.gl/8B5tG0.)

During the recession, IT was pri-marily seen as a source of efficiency and cost reduction. But as the econo-my revives, companies are evaluating how emerging technologies, from Big Data analytics to cloud computing to mobile platforms, can support growth initiatives. “In past years, everybody talked about investment in technology to run your business. It was all about trying to corral the information from within your business,” said one sur-vey respondent, the CFO of a maker of medical diagnostic systems. “Now we’re interested in technology that brings you the viewpoint from outside of your business to help management

“You go to war with the army you have,” former Defense Sec-retary Donald Rumsfeld fa-

mously remarked, “not the army you might want or wish to have.”

The same can be said of companies today, as they battle to capture market share and profits. But victory in busi-ness often goes to those who secure a technological edge. Looking to drive growth, many finance executives are steering their companies toward in-creased spending on information tech-nology. What may be lagging, though, is

i

Field Notes

Perspectives from CFO Research

figure out where to take the products.”Granted, cost cutting still ranks

high on the finance function’s agenda for new technologies. In the survey, nearly half (48%) said IT could offer the most value to their growth plans by helping to cut costs. However, an iden-tical number said they viewed technol-ogy’s top contribution as improving ef-fectiveness, supplying insights to spur growth.

BIG DATA, BIGGER DECISIONSVirtually all survey respondents said they need to improve their un-derstanding of Big Data analytics. A whopping 95% agreed that their com-panies need to be able to extract much greater value from financial and oper-ating information over the next year (see Figure 1). How do they expect to do so? Primarily by better integrating systems (40%) and by acquiring or de-ploying new applications or analytical tools (38%)

Having the required analytical tools is only half the battle, of course; com-panies also need to enlist and train


Machine DreamsFinance executives have no trouble imagining how new technologies will make their companies more competi-tive. So why can’t they make that vision a reality? By Josh Hyatt

Respondents are equally divided over technolo-gy’s most valuable contribution to growth: cost cutting or improv-ing effectiveness.

Please indicate the extent to which you agree or disagree with the following statement: “Over the next year, my company will need to extract much greater value from financial and operating information.”

54%41%

3%2%

FIGURE 1

Agree Strongly

Disagree SomewhatDisagree Strongly (0%)

Agree Somewhat

Not Sure

14Mar_FieldNotes_Fin.indd 48 2/24/14 9:59 AM

Download these reports now at cfo.com/research

You answered.

77We asked.

77

FINDING THE TARGET In Zeroing in on Value Delivery, CFOs say that competitiveness

may increasingly be defined by specialization: focusing

on the regions, markets, and customers that offer the

greatest value based on each company’s unique mix of

competencies.

3 Sponsored by American Express

FINANCE REINVENTS ITS FUTURE

As CFOs grow into their expanded roles—as key

members of leadership, who need to excel at a broad

range of capabilities—they are assessing the tools they’ll

depend on: big data, cloud computing and mobile

technology. In this report, they share their insights.

3 Sponsored by SAP

WADING INTO NEW REVENUE STREAMS

In Pushing the Boundaries of Business Overseas, finance leaders share the details of

what it’s really like to translate distant customers into plainly visible revenues. Learn about

the challenges they’ve faced— and what tools they needed to

overcome them.

3 Sponsored by High Street Partners

Intelligence for Smarter Decision MakingAt CFO Research, we conduct detailed surveys and interviews with senior finance executives from around the world. Combining their insights with our in-depth knowledge, we produce the intelligence you need to make better decisions.

AUTHORITATIVE.INDEPENDENT. FINANCE-DRIVEN. JUST LIKE YOU.

CFOresearch

CFO Research.indd 4 1/22/14 12:32 PM

of its peers.”None of this, how-

ever, is likely to hap-pen as quickly—or painlessly—as the hype sometimes suggests. “What is happening is evolutionary,” said the medical-compa-ny CFO. “Manage-ment isn’t sufficiently educated to make the transformation. Over time, that will be ad-dressed.” That may explain why just one in five respondents (21%) said that making better use of Big Data analyt-ics will be among their companies’ priorities over the next year.

CLOUD UNCOVEREDA slender majority of respondents (55%)

view cloud technology as offering their companies increased flexibility (offer-ing improved ability to match IT ca-pabilities with changing needs), with lesser numbers seeing the most value in cost savings and improved produc-tivity (34% each) and time savings (27%). Still, only about a quarter of respondents said that their companies would focus on increasing their use of cloud computing over the next year.

Why the disparity between percep-tion and action? Nearly half of respon-dents (46%) said that data security was their largest concern. Said one CFO, who is currently mulling the issue: “I’m not sure a lot of financial folks would like to see their data out in the cloud, with the associated security risks—unless they understand how it can be controlled. I’m not persuaded—not yet.” Such a wait-and-see attitude is likely what’s holding executives from reaching for the cloud.

employees to interpret the data. “The inputs may be perfect, but then there is the skill of interpreting the output in the context of the decisions that need to get made,” said the CFO of a soft-ware company. “Big Data is only useful if it has predictive capabilities. And for it to have that, companies need to un-derstand it better.”

Analyzing Big Data demands a com-panywide effort. Making the data avail-able to the entire enterprise is a key component of shaping a culture that can extract maximum value from mil-lions of rows of data. As one CFO put it: “The challenge lies in people not un-derstanding how to harness that value for their purposes—and that’s where the investment needs to be made.” Nearly half of survey respondents ei-ther agree, or are not sure, about the statement that their companies “will seek to gain a competitive advantage by mastering Big Data analytics ahead

DROPPED CONNECTIONNowhere on the survey is there a wid-er gap between awareness and action than when it comes to integrating mo-bile technology.

An overwhelming portion of re-spondents, 77%, agreed that over the next year, their companies will need to make much better use of mobile tech-nology. Senior finance executives also know what they’d like the technology to help them achieve—namely, im-proved access to and use of financial and business data. A plurality of re-spondents (37%) said that mobile tech-nology can provide users with better data-query and data-retrieval capabili-ties than their current systems do.

And yet, despite their perception of mobile technology’s benefits, only 16% of respondents reported that their company had a formal, enterprise-wide plan for deploying it (see Figure 2). “A lot of us are struggling with what is ap-propriate in a mobile-technology pol-icy,” said the software-company CFO. “‘Bring your own device’ is still attract-ing a lot of debate, and I don’t think companies have settled that.”

When will the debates over imple-menting policy around mobile technol-ogy—or Big Data analytics and cloud computing—subside? One CFO sees the reckoning coming sooner rather than later. “The technology is evolving faster and faster, and there is a genera-tion that is adapting to that technology faster,” he said. “Another generation is holding the purse strings, and they are adapting more slowly.”

No matter how “exposed and vulnerable” the older generation may now feel, added the CFO, over time they will inevitably grow more com-fortable incorporating new technolo-gies and processes into existing ones. Sooner or later, they will see that in the battle for market dominance, new technology can provide a decisive advantage. CFO

Formal enterprise-wide plan for deploying mobile technology \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ �16%

General directive for using mobile technology with flexibility to match the needs of individual business and functional units \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ �33%

Ad hoc approach to deploying mobile technology \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ �35%

None of these statements \ \ \ \ \ \ \ \ \ \ �6%

Not sure \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ \ �10%

FIGURE 2

Which of the following statements best describes your company’s broad strategy for deploying mobile technol-ogy over the next year? (Please select one.)

0% 10 20 30 40%


14Mar_FieldNotes_Fin.indd 50 2/27/14 11:40 AM

MARKETPLACESpecial Advertising Section

CFOvirtual event

Virtual Career Fairfor Corporate Finance Executives

NEW EVENT FORMAT

NOW ON DEMAND

Your future job is calling…

Register today for our virtual career fair and take part in this unique event for finance executives at every level. It is free to attend, and features career-focused presentations geared toward finance job seekers, as well as virtual exhibit booths hosted by top employers, recruiters & staffing firms.

Featured speakers include:

Cindy Kraft, CFO CoachLouise Kursmark, Resume & Careers ExpertLinda A. Hill, Ph.D., Professor, Harvard Business School

Learn more at virtualjobfair.cfo.com

14Mar_Classifieds_Fin.indd 51 2/24/14 1:15 PM

TAKE AWAY

Photos courtesy of TripAdvisor

GlobalAmbitionsNAME ii Julie Bradley

POSITION ii CFO of TripAdvisor, a travel website company with more than 260 million monthly visitors

PREVIOUS POSITIONS ii SVP and CFO, Art Technology Group; VP of finance, Akamai Technologies

NOTABLE FOR ii�Her finance experience at fast-growing companies.


HER TAKE-AWAY: TripAdvisor is the largest travel website in the world, but when it comes to the total number of online shoppers, we’re only about 11% [penetrated]. But we can do a lot from the offices we have today to expand into [new] territories. We don’t need to open an office in Russia, for instance, to increase the revenue gen-erated from Russian consumers. We can translate our site into the local language and set up that URL. ¶ We move at a rapid pace. Our CEO [Stephen Kaufer] has a sign on his door that says, ‘Speed wins.’ We live by that. ¶ We’re also driven by con-

sumers. So our traffic depends on what’s happening in the world over-all: weather patterns, religious holi-days, things like that. A credit crisis, a drought, a heat wave, the Olym-pics—there are [many] inputs to un-derstand where revenues are going to shake out. ¶ We’re constantly looking for new ideas and for top talent. We have an insatiable thirst for the best and the brightest across engineers and product marketers. All those moving pieces keep me on my toes. If [my job] were counting widgets, I wouldn’t be here. I’d be bored.

Z INTERVIEW BY MARIELLE SEGARRA

14Mar_TakeAway_Fin.indd 52 2/20/14 3:58 PM

The Finance Profession has Evolved — Stay On Top with

CFO Learning was built on the editorial foundation of CFO magazine to help address the ever-changing role of senior finance professionals. Going beyond the articles, CFO Learning provides finance professionals with know-how and know-why technical training and best practices education delivered through Online Training, In-Person Training, and Training Publications.

CFO Learning programs cover a wide variety of subjects that are of interest to you and your team:

» Accounts Payable » Auditing, Budgeting & Forecasting » Career Development » Cash Flow Management/Capital Management » Credit » Financial Reporting & Presentation

Visit cfo.com/learning to learn more about our o!erings or contact [email protected].

» Human Capital » Microsoft Excel® » Strategy » Risk Management » Tax

CFO1347840817.indd 2 9/18/12 12:09 PM

CRUCIAL.The winning team is greater than the sum of its people. Everybody matters.

Clients look to us for advanced business technology precisely because we don’t just

offer that. Together we share a vision and provide business solutions that can turn

your next big idea into reality, cutting a straight path to perpetual wins for your team.

windstreambusiness.com

Client: Windstream Creative Director: V. PULLICINO

Designer / Art Director: K. BABB

Largest Bleed: 8.25" x 11.125" Copywriter:

Common Size Build: n/a Proofreader: N. TUCKER

Smallest Live: 7.125" x 9.75" Studio Artist: J. WARD/BSM

Inspected By:

Colors: 4/c Production Manager: C. CAPOSINO

DPI: 300 Project Manager: M. LAMBACO

006350_2_WinningTeamCrew_Mech.inddRevision: 0 Created: 2.12.14 Printed at 100%

MECHANICALComputer World Trim – CFO Trim

BLE

ED

LIVE

BLEED

LIVE

006350_2_WinningTeamCrew_Mech.indd 1 2/13/14 11:38 AMProcess CyanProcess MagentaProcess YellowProcess Black

Windstream.indd 12 2/20/14 11:57 AM