Compensation/audit committee overlap and the design of compensation systems

Abstract

This study examines the association between director overlap (defi ned as overlapping membership on the compensation and audit committees) and incentive-based compensation schemes. Using a sample of fi rms in the S & P 500 over the period 1997 -2005, we fi nd that cash compensation plans are not associated with director overlap, while option compensation is negatively associated with director overlap. These results suggest that knowledge of the misstatementinducing effects of option-based compensation may spill over from the audit committee to the compensation committee, which may lead the compensation committee to reduce the optionbased component of executive compensation. This research sheds some light on the association between board structure and corporate governance effectiveness. Its fi ndings have important practical implications. Given the limited number of board members available, the organization must consider how to allocate an individual director among different committees. The fi ndings of this research provide some guidance in this regard. For instance, this study suggests that the overlapping of the compensation committee and the audit committee may be benefi cial to the design of compensation schemes because of the knowledge spillover between the two committees.

Common Membership and Effective Corporate Governance: Evidence from Audit and Compensation Committees

“…Chandar et al () argue that earnings quality can improve if audit committees include directors from compensation committees. Zheng and Cullinan () also find that pay‐performance sensitivity can improve under common membership. However, both studies suffer from some limitations.…”

“…First, directors with common membership can apply knowledge learned from the audit committee (compensation committee) to their oversight roles in the compensation committee (audit committee). The knowledge spillover effect can help improve the monitoring of the financial reporting process (Chandar et al, ) and help design a compensation scheme that will reduce managers’ incentives for misreporting (e.g., Zheng & Cullinan, ).…”

“…On the other hand, common membership can be beneficial because it allows a director to acquire different knowledge from other committees (Chandar, Chang, & Zheng, 2008;Zheng & Cullinan, 2010), which can facilitate the coordination between compensation and audit committees (Hermanson et al, 2012;Moody's Investors Service, 2006). As incentive-based compensation may increase executive incentives to manage earnings, coordination between the audit and compensation committees can contribute to board effectiveness.…”

Audit Committees and Financial Reporting Quality in Singapore

“…Chang et al (2011), Hoitash andHoitash (2009), and Zheng and Cullinan (2010) find that companies with less overlap among audit and remuneration committees are more likely to employ incentive executive compensation such as stock options. Chandar et al (2012) examine the impact of overlapping membership on financial reporting quality, using a sample of non-financial S&P 500 firms representing 1032 firm years over the period [2003][2004][2005].…”

Do Compensation Committees Pay Attention to Section 404 Opinions of the Sarbanes‐Oxley Act?

“…Third, we use overlap between the compensation committee and audit committee as a third measure of a compensation committee's financial expertise. Some research suggests that overlap between the compensation committee and the audit committee is beneficial to the design of optimal compensation schemes (Zheng and Cullinan, 2009). Our inferences that compensation committees consider SOX 404 opinions in CEO/CFO compensation adjustment and that this consideration is more pronounced in firms with higher levels of financial expertise, are robust to all of these variations in methodology.…”