AAA Spark Meeting of the Regions

The Impact of Pay Disparities in the Audit Committee Compensation on Earnings Management

• In Event: Earnings Management

Abstract

This paper investigates the impact of the audit committee compensation on earnings management. While prior studies concentrate on the level and/or the structure of the compensation, this paper explores how the disparities among the compensation of audit committee members affect the manipulation of earnings. Using abnormal accruals and the likelihood of meeting or beating analysts’ earnings forecasts as proxies for earnings management, we find evidence that the pay disparity between the audit committee chair and other members of the committee is positively associated with firms’ level of abnormal accruals as well as their likelihood to meet or beat analyst forecast. Moreover, the evidence in this paper also shows that the pay disparity is negatively associated with the likelihood that the firm misses analysts’ consensus earnings forecast. These findings are consistent with the social comparison theory that pay disparities disincentivize audit committee members to cooperate and work more efficiently and effectively. Overall, the results in this paper suggest that the difference in compensation between the chair of the audit committee and other committee members is associated with a higher level of earnings manipulation. This finding contributes to the literature on the impact of audit committees on earnings management. The results also have important implications for accounting standard setters, the board of directors, investors, and creditors.

Authors

• Justyna Skomra, The Pennsylvania State University

• Trung Huy Pham, University of Illinois at Springfield

• Mai Dao, The University of Toledo

• Benjamin Hoffman, Cleveland State University