The Joint Effect of Linguistic Features of Audit Committee Report, Audit Committee Compensation, and Executive Compensation on Investor Judgment

• In Event: Responses to Audit Outcomes and Disclosures

Abstract

The audit committee (AC) report is the primary channel through which investors learn about the responsibilities and activities of the AC. We conduct an experiment to investigate how the use of first-person plural pronouns (e.g., “we” instead of “the audit committee”) in the AC report interacts with the compensation structures of the AC members and the firm’s top executives to influence investors’ perceptions of financial reporting quality and their investment decisions. We find that, when the firm’s top executives receive short-term oriented compensation, an AC’s use of personal pronouns leads to more (less) favorable investors’ judgments when AC members receive short-term (long-term) oriented compensation. The effects of personal pronouns and AC compensation disappear when the firm’s top executives receive long-term oriented compensation. Our findings have important implications for regulators, managers, AC members, and investors.

Authors

• Yao Yu, University of Massachusetts-Amherst

• Hun Tong Tan, Nanyang Technological University

• Tu Xu, University of Hawaii-Manoa