Compensation Committee Attributes and the Treatment of Earnings in Incentive Pay

• In Event: Executive Compensation

Abstract

We examine whether the presence of audit committee members on the compensation committee impacts how earnings are rewarded in compensation contracts. We find lower levels of equity compensation and a lower weight on earnings in CEO bonus compensation when at least one audit committee member also serves on the compensation committee, consistent with the committee structuring executive compensation to decrease the monitoring demands associated with increased incentive to manage earnings induced by performance-based compensation. We find this effect of committee overlap is strongest, however, only when the overlapping directors have financial expertise and is greater when the CEO has more power over the board. When we examine performance measures explicitly included in CEO incentive contracts as reported in the proxy statements, we observe that firms with overlapping directors are less likely to use accounting-based performance measures in CEO compensation contracts than firms without overlapping directors. These differences are consistent with compensation committees whose members are also responsible for monitoring management actions (i.e., are also on the audit committee) and have the financial expertise to understand the extent to which earnings can be managed relying less heavily on accounting-based measures that are subject to management discretion.

Authors

• Mary Ellen Carter, Boston College

• Luann J Lynch, University of Virginia-Graduate School

• Melissa Martin, University of Illinois-Chicago