I mentioned the other day that Dupont appointed a new CEO- one that agreed to merge with Dow.  And, Edward Breen was chosen as the interim CEO because he was thought to be the perfect one to turn the company around.   After all, he was the one who turned around Tyco International- as long as you recognized that he did so by selling off the company piece by piece.  (Oops.  Maybe that’s why Dupont chose him, for real, since in essence the Dow-Dupont merger is a process whereby the merged company will be split up into three new companies- and will shed a slew of businesses, to boot.)

And, that’s a key consideration.  When a company (or venture capitalists) have to bring in a new CEO, it’s because the chief executive has failed, the CEO has not trained a successor, or similar reasons.

The problem is that most interim CEO choices want to stay in those positions.  Which is ok- except for the data that indicates that these interim CEO are more interested in massaging the corporate financials than in effecting change and improvement.  SThose manipulations pave the way by which s/he can stay appointed.

Drs. G.  Chen (INSEAD, Singapore), S. Luo (National University, Singapore),  Y. Tang (Hong Kong Poly) and J.Y. Tong (U Western Australia) examined the results for some 138 US public entities (during the period from 2004 to 2008) who were headed by interim CEOs.   Their study, Passing Probation: Earnings Management by Interim CEOs and Its Effect on Their Promotion Prospects , published in the Academy of Management, is a sobering view.   Because their research showed the more the CEO’s fudged the financials, the more likely they would be permanently appointed to their positions.

“Wait a minute!”, you say.   You thought these companies had to report results using GAAP (generally accepted accounting principles).  How can they fudge the results?

Well, just like most American companies prevaricate (that’s a nice way of saying “lying like a dog”) about how much income taxes their firms really pay or will pay (and husband the cash difference overseas for decades), there are other ways companies can lie.  Some accounting data allows estimating- like inventory values, which can be predicted.  (These are called discretionary accruals.)   Moreover, these falsehoods are not prosecuted by the Securities and Exchange Commission- nor are executives ever subject to criminal or civil charges as a result.  (You know, just like the companies that brought down our economies in 2008-2009.)

How much chicanery is involved?  Well, according to this research, which paired these interim/acting CEO’s with an industry peer, discretionary accruals yielded 36% higher bottom lines for the “non-permanent” (like any CEO is really permanent) executives.   And, those that tweaked the numbers more were the ones most likely to get the nod to stay in their jobs.

This is why you need to choose an interim CEO that provides a two or three year contract (like we do when called in to help a company reach its objectives or turn around performance).   And, you need directors who know how to examine the numbers (we also serve on various boards) to discern what may or may not be the true results.   Oh- and you can’t have directors who serve on a dozen boards- because they will lack the time to provide your company the supervision needed.

These findings apply to non-public companies, too.  When a private company is venture funded (corporate angels or more organized private investment funds), it is not atypical for an executive to manipulate the inventory levels to be able to show continued growth throughout the year.  (We’ve had it out with one such executive in the past year.)  Or, to discern what purchases will be capitalized (and therefore not affecting the income statement).

As the authors stated these sort of CEO practices “may not be in the best interests of the shareholders”, because they (these CEOs) may in fact be incapable of leading the firm.

Affording true profits- and growth- is the lifeblood of all corporate entities.  It behooves the board to choose – and train- the right CEO and CFO teams for continued success.

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