INTRODUCTION

Agency costs is define as costs arising from the likelihood that managers place personal
interests ahead of shareholders interest.

Agency problems are also related to management compensation contracts.

According to Jensen and Meckling (1976), the agent-principal problems can be reduced
through the incurrence of monitoring costs and provision of appropriate incentives for
the agent.
Prior studies have proved that agency costs decrease as managerial ownership
increases.

INTRODUCTION
As the compensation contracts are highly dependence on firms performance, the
chances of exercising earning management practices is even greater.

According to Healy and Wahlen (1999) earning management occurs when managers
use judgement in financial reporting and in structuring transactions to alter financial
reports to either mislead some stakeholders about the underlying economic
performance of the company or to influence contractual outcomes that depend on
reported accounting numbers (p.368)
Executive stock options allow managers to receive the benefits in later years where
they are given chances to purchase stock at some future time at a given price.
Corporate failure scandals indicate that CFO has failed in their monitoring role and to
certain extent has used their power to perform earning management.

CFO POWER AND PERSONAL FINANCIAL GAIN

Feng et al. (2011)
Studies prove that there is a negative association between CFO power and personal
financial gain. However, there is positive relationship with CEO pressure.
60 percent of CFOs of manipulating firms are charged with stringent legal penalties by
the SEC. Among legal penalties are future employment restrictions from serving as an
officer, director, or accountant for any public company, fines and disgorgement of the
illegal gains. CFOs also face with the criminal charges which cause them to serve home
detention and in worst case imprisonment.
Therefore, CFOs committing accounting manipulations open themselves with severe
legal costs and in return reap limited immediate financial benefits via equity incentive
compensation.

Results are inconsistent with Jiang et al. (2010) study where Jiang found mix results for
pre and post-SOX period due to enforcement of SOX and SEC new disclosure
requirement.

CFO POWER AND CEO PRESSURE

Feng et al. (2011)
The findings shows that CEOs of manipulating firms have higher pay-for-performance
sensitivities and power (i.e., the CEO is more likely to be Chairman of the Board and a
founder, and more likely to have a higher share of the total compensation of the top
five executives).
Accounting manipulation is higher when CEOs hold a higher equity incentives and thus
have the power to pressure CFOs to perform manipulations.
Further analysis using Accounting and Auditing Enforcement Releases (AAERs) suggests
that CEOs are more likely to coordinate the accounting manipulations and receive
financial benefits than CFOs.
Therefore, CFOs become involved in accounting manipulations under pressure from
CEOs, rather than impelling such manipulations for prompt financial benefits. Feng, M.,
et al. (2011) results also shows that CFOs are more likely to leave the companies prior
to the accounting manipulation period due termination as they refuse to commit
accounting manipulations under the CEO pressure.
The result is consistent with Friedman (2014) but inconsistent with Jiang et al. (2010)

CFO POWER AND CEO PRESSURE

The introduction of Sarbanes-Oxley Act (SOX) in 2002 - higher responsibilities to be carried out by the
CEO and CFO
CFO and CEO are required to certify the accuracy of the firms financial statements and to reimburse the
company for any bonuses received if the company has to restate its earnings.
SEC also enforced new disclosure requirements on executive compensation whereby firms have to
disclose their CFO pay.
Jiang et al. (2010)
Test the effect of CFO and CEO equity incentives on accruals in pre (1993 2001) and post-SOX era (2002
2006).
In pre-SOX period they found the level of accruals are higher in CFO equity incentives compared to CEO
equity incentives.
However, they found both equity incentives owned by CFO and CEO and negatively associate with level
of accruals for post-SOX period.
This indicate that the relationship between the CFO equity incentives and firms accruals management
does not only weaken but actually reverses after the implementation of SOX.
The reason behind the reversal is due to CFOs believe that after SOX investors react negatively to
positive earning surprises by firms whose CFO have higher equity incentives.
Thus, this prove that the new SECs disclosure requirement on CFO compensation packages might help
the investors and analysts to evaluate the quality of financial reporting

CFO POWER AND CEO PRESSURE

Friedman (2014)
Found that when CEO can pressure the CFO to bias reports at a level that the CEO
desires, an increase in the CFO's personal cost of bias leads to lower reporting effort.
This will reduce the firm value and provide a weaker incentive compensation for the
CEO and CFO.
The CFO will reduce reporting effort to ease the biasing he is pressured to provide even
though there are stringent punishment available if they were caught for manipulating
the accounting report.
In firms with powerful CEOs, reduction of the CEO power will increase the reporting
quality, incentive compensation strength, and firm value.
In contrast, for firms with non-powerful CEOs, increasing punishments to the CFO
should have positive effects on reporting quality, incentive compensation strength, and
firm value.

CFO POWER AND STOCK PRICE CRASH RISK

Jiang et al. (2010)
examine the sensitivity of managers equity compensation to the changes in the firms stock price. The
results demonstrate some weak evidence that managers equity-based incentives (ie: CEOs and CFOs)
are more crucial in affecting earnings management by firms that have a high relationship between
earnings and stock prices.
Mix results were found in Kim et al. (2011).
Kim et al. (2011)
investigate the extent of CEO and CFO equity incentives influence the firm-specific stock price crash risk.
The results show that CFOs option incentives are significantly and positively related to future crash risk
and also for firms with greater incentives to conceal risk taking.
They also found a weak evidence that the CEOs option incentives cause the crash risk and this weak
effect disappears after the CFO option incentives are included.
This result prove that CFOs are more powerful in firms bad news hoarding decisions. Furthermore, it
was found that CFOs option incentives positively related to non-competitive industry because product
market competition prevent managerial bad news hoarding behaviour.
Kim, J.-B., et al. (2011) discover only CEO and CFO option incentives have a significant effect on a firms
reporting but not the stock incentives. This findings suggest that option holdings give more opportunities
for managers to boost short-term share prices as their losses from option holdings is limited if stock
price crash took place.

CONCLUSION
There are mixed results on CFO power in earning management as there are various factors that
could influence the CFOs decisions.
Furthermore, both CEO and CFO have their own interest in managing the resources of the
firms.
Andergassen (2008)
Suggests conflicts in shareholder and manager can be resolved if focus of both party is align.
Therefore, stock option vesting period shall be increased as any earning management activities
will reduce the managers wealth as well as the shareholders by assuming manager and
shareholder are risk neutral).
Wu (2011)
replicate the Andergassen (2008) study with the assumption that manager is a risk-averse type.
This study is more realistic as most managers fall under this category.
Stock options encourage higher effort and higher manipulation. Therefore, shareholder shall
assess the possibility of the event to occur and the potential damage that it will cause. If
manipulation cause higher potential damage, lower stock option shall be granted.
They also suggest that firm should ensure that less equity compensation in the optimal
compensation package should be awarded for risk-averse managers. This type of managers will
avoid risky projects and thus reduce the shareholders long term value. A reduction in stock
option will therefore align the manager-shareholder interest.

REFERENCES
Andergassen, R. (2008). "High-powered incentives and fraudulent behavior: Stock-based versus stock
option-based compensation." Economics Letters 101(2): 122-125.
Feng, M., et al. (2011). "Why do CFOs become involved in material accounting manipulations?" Journal
of Accounting and Economics 51(12): 21-36.
Friedman, H. L. (2014). "Implications of power: When the CEO can pressure the CFO to bias reports."
Journal of Accounting and Economics 58(1): 117-141.
Jiang, J., et al. (2010). "CFOs and CEOs: Who have the most influence on earnings management?" Journal
of Financial Economics 96(3): 513-526.

Kim, J.-B., et al. (2011). "CFOs versus CEOs: Equity incentives and crashes." Journal of Financial
Economics 101(3): 713-730.
Wu, Y. W. (2011). "Optimal executive compensation: Stock options or restricted stocks." International
Review of Economics & Finance 20(4): 633-644.

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