Audit Committee Incentive Compensation and Accounting Restatements*

The Composition and Compensation of the Board of Directors as Predictors of Corporate Fraud

“…Directors may struggle to perform in this monitoring role when the form of their compensation compromises their independence. The literature provides evidence that an improperly aligned compensation scheme, such as stock and stock options, compromises a director's independence and impairs their ability to provide objective oversight (Hamdani & Kraakman, 2007;Archambeault et al, 2008;Cullinan et al, 2008;Boumosleh, 2009;Bebchuk, Grinstein, & Peyer, 2010;Persons, 2012;Bierstaker, Cohen, DeZoort, & Hermanson, 2012 ).…”

“…Proponents of stock option compensation (Jensen 1993) argue that it aligns shareholders' and directors' interests, thereby motivating vigilant supervision of management to enhance the firm's stock price. However, a growing body of literature (Archambeault et al, 2008;Boumosleh, 2009;Cullinan et al, 2008) indicates that stock option compensation actually aligns the interests of directors with those of top managers, instead of shareholders, and thereby reduces director independence.…”

“…They argued that compensating outside directors with stock options weakens independent oversight by creating reciprocal interests between directors and management, rather than between directors and shareholders. Archambeault et al (2008) analyzed a sample of 153 restatement firms and a matched sample of 153 non-restating firms and found a positive relationship between stock option compensation for audit committee members and the incidence of fraudulent or erroneous financial restatement.…”

“…The literature provides strong evidence that stock option compensation encourages short-term manipulation of earnings and weakens independent oversight (Archambeault et al, 2008;Cullinan et al, 2008;Persons, 2012). We measure stock option compensation in thousands of dollars on an annual basis based on the value given in the proxy statement.…”

“…The paper contributes to the existing literature by examining fraud in the post-Sarbanes-Oxley period, while most research (Beasley, 1996;Dechow, Sloan, & Sweeney, 1996;Persons, 2012;Vafeas, 2005) has been based on earlier periods. In addition, our sample is based on all SEC violations during this period, compared to other studies (Archambeault, DeZoort, & Hermanson, 2008;Boumosleh 2009;Cullinan, Du, & Wright, 2008;Srinidhi, Gul, & Tsui, 2011;Vafeas, 2005) that looked at samples of firms with selected violations or financial restatements not necessarily associated with fraud. This study is also unique in that it combines characteristics of both the composition and compensation of the board of directors and the associated audit committee.…”