Getting Back to Basics: Challenging Complexity and Accountability in the Boardroom

This paper investigates the dynamics of complexity and expertise in the context of compensation committees (ccs). Drawing on semi-structured interviews, mostly with cc members and consultants, we bring to light two axes of subordination that impact the mindset of corporate governance participants, and may ultimately undermine directors’ degree of accountability to shareholders. The first axis involves cc members’ subordination to consultant expertise, which tends to be considered as an indispensable ally in dealing appropriately with the webs of complexity that allegedly characterize executive compensation. Nourished partially by the first axis, the second implies subservience to these webs of complexity, which are widely presumed and naturalized by cc members and the consulting experts they employ. One of our main contributory statements is to question the ascendancy of complexity in the boardroom, casting doubt on one of the key assumptions upon which practices and expertise in contemporary corporate governance institutions are built and promoted. We also question the extent of epistemic dependency in many compensation committees, where much of the knowledge necessary to properly operate the repertoire of practices (deemed necessary to address the problem of executive compensation determination) is not primarily in the hands of cc members, but rather in those of consultants.

CEO pay sensitivities in innovative firms

PurposeThis study aims to investigate whether compensation committees provide the chief executive officers (CEOs) with incentives to undertake “income-decreasing” but potentially “value-enhancing” innovation expenditures. The authors specifically analyze pay–performance relationships for innovative firms relative to all other firms. This study is critical because innovation is expensive and has uncertain outcomes.Design/methodology/approachUsing alternative accounting performance measures and market performance measures, the authors estimate an econometric model of CEO compensation in innovative firms that incorporates the interaction of endogenous innovation and firm performance.FindingsThe authors document an incremental positive association between changes in accounting performance measures and CEO compensation changes in innovative firms relative to other firms. This sensitivity of executive pay to firm performance is higher for firms that innovate. These results support the hypothesis that compensation committees provide incentives to carry out risky innovation by tying executive compensation more closely to firm performance. This finding survives a battery of sensitivity tests.Practical implicationsThe implications of this study are significant. Capital needs to support risky research and development investments (Tidd and Besant, 2018; Baldwin and Johnson, 1995) form the basis of innovative firms' operations. Considering these expenses, if CEOs, who play a critical role in the scanning, adapting and implementing innovative needs in a firm, are not protected and compensated for making risky choices, the entire investment itself will be threatened. Hence, the findings reiterate and support earlier findings that speak to the importance of compensating CEOs to make high-risk investments that will lead to long-term economic and financial gains for the firm when the innovative behaviors result in competitive market shares and profits.Originality/valueThe original work is related to the investigation of pay–performance sensitivity in the presence of innovation, which has not been fully investigated in prior literature.

Director Attendance at Board Meetings and Executive Compensation Evidence From Malaysia

This chapter attempts to examine the effect of directors' attendance at meetings on the board's effectiveness in mitigating executive expropriation practices, especially excessive compensation. For this end, the authors employ a multiple regression model within a sample of Malaysian firms over the period 2008-2013. The results show that the attendance of directors at board meetings affects the executive compensation negatively. Board members who attended meetings frequently are more able to monitor managers' practices continuously and effectively. Hence, they can diminish the possibility of expropriation and decrease the excessive pay. The findings also show that increasing board meetings frequency and strengthening nominating and compensation committees' independence reinforce the board's monitoring effectiveness in reducing executive expropriation behavior.

Can compensation committees effectively mitigate the CEO horizon problem? The role of co-opted directors

Purpose This study aims to examine whether compensation committees dominated by co-opted directors are less effective in mitigating the CEO horizon problem. Design/methodology/approach The author uses a sample of 7,280 firm-year observations from 1998 to 2011. Findings In this study, the author finds evidence of opportunistic research and development (R&D) reduction and accruals management in firms with retiring CEOs and compensation committees dominated by co-opted directors. Moreover, it is found that R&D reduction and income-increasing accruals are less discouraged when determining the compensation for retiring CEOs by compensation committees that are dominated by co-opted directors. The results suggest that compensation committees dominated by co-opted directors are less effective in adjusting CEO compensation to mitigate the CEO horizon problem. Originality/value The study reveals that co-opted directors are weak monitors. Moreover, the study adds empirical evidence to the debate of organizations’ CEO horizon problem. Finally, the study adds to the literature on corporate governance, revealing that compensation committees play an important role in mitigating an organization’s CEO horizon problem by adjusting CEO compensation.

Audit firm tenure and perceived audit quality: evidence from CEO incentive contracts

Purpose This paper aims to examine how compensation committees perceive audit quality as indicated by audit firm tenure. Using the contracting weight attached to earnings and cash flows in chief executive officer (CEO) compensation as proxy for the compensation committee’s perception of audit quality, the study examines whether compensation committees perceive performance metric informativeness as being affected by auditor tenure. Design/methodology/approach The paper regresses CEO cash compensation on accounting-based performance metrics and on interactions between auditor tenure and accounting-based performance metrics while controlling for other factors previously shown to affect CEO pay. Auditor tenure is measured using continuous and dichotomous variables. Findings Auditor tenure is associated with a reduced (positive) weight on earnings (operating cash flows), which suggests lower perceived audit quality as tenure lengthens consistent with the auditor closeness argument. This relation is asymmetric, i.e. the negative effect of longer auditor tenure on incentive contracting is more pronounced for positive earnings. The results are robust to using CEO total compensation as the compensation measure, as well as using level and change specifications. Research limitations/implications The inability to control for audit partner tenure in assessing the effect of audit firm tenure on incentive contracting and the potential endogeneity between auditor tenure choice and incentive contracting are the main limitations of this study. Given the lack of information on US audit partner tenure, the study could not control for the audit partner tenure issue. However, the study has attempted to mitigate the endogeneity issue by using a Heckman selection model that includes in the first-stage a regression of auditor tenure on various firm, performance measure and CEO-related governance characteristics, based on existing models (Li et al., 2010). Practical implications Compensation committees view auditor tenure as an indicator of accounting quality in setting CEO pay. Further, long auditor tenure is perceived as detrimental to financial reporting integrity, particularly when earnings numbers suggest positive managerial performance and innovations. Originality/value This study provides empirical evidence that auditor tenure matters in setting executive pay. Further, this study shows evidence on the link between auditor tenure and audit quality from an internal user’s perspective. Prior studies have focused either on external users (investors, creditors) or on the preparer (using measures such as discretionary accruals or meet/beat analysts’ forecasts or forecast guidance).

The effect of a golden parachute on managed earnings

Purpose The purpose of this paper is to investigate the influence of executive compensation on the propensity to manage earnings. In particular, the authors examine an executive contractual clause known as a golden parachute (hereafter GP is interchangeably used). Usually, the triggering of a GP occurs for the following reasons: in a takeover, in termination of employment, and if the executive remains with the company through a recessionary cycle. Specifically, the authors ask the following questions: for firms that their CEO have a GP, do these firms manage earnings more? Does the age of the CEO matter for firms that have adopted a GP concerning the managing earnings? Design/methodology/approach The sample is based on a review of the literature on GPs and managed earnings. the authors’ data come from COMPUSTAT, CRSP, EXECUCOMP and Risk Metrics, and consist of 1,184 US firms from 1992 to 2011. A GP is binary, whereas the authors represent managed earnings through accruals and real activity. Findings The authors find that the propensity to manage earnings varies on the type of methods strategically used. However, controlling for the effect of SOX reveals that GP firms are more likely to manage earnings. Younger CEOs are less likely to exacerbate earnings upward. Research limitations/implications The authors are limited to small sample based on when the data were collected. Practical implications The evidence shows that GP alleviates CEOs’ concerns on short-term profits. However, it entrenches CEOs. Particularly, CEOs with a GP are more likely to exacerbate earnings. Thus, there is a need for compensation committees to give considerable attention to how GPs are assigned. Originality/value To the authors’ knowledge, this is the first study that explores the effect of a GP on a firm’s propensity to manage earnings.

Overlapping membership on audit and compensation committees, equity holdings of overlapping members and audit outcomes

PurposeThis paper aims to examine the question of whether external auditors incorporate equity holdings by overlapping audit committee members as a priced governance factor and tests whether this attribute, as a mechanism for ensuring good governance, affects the propensity for external auditors to issue modified audit opinions.Design/methodology/approachOverlapping membership in this context refers to the arrangement where at least one audit committee member also sits on the compensation committee. Both ordinarily least square and logistic regression are used to capture the impact of overlapping committee members and equity holding of those overlapping committee members.FindingsUsing archival data from Australian Stock Exchange listed companies, the authors find support for the beneficial effect of having overlapping audit committee members with equity holdings. The authors also find that auditor propensity to issue modified audit opinions is lower for firms with equity holdings by overlapping audit committee members.Practical implicationsThe finding has practical implication to the investors and regulators as overlapping audit committee members with equity holdings may provide especially effective oversight by monitoring opportunistic accounting policy choices for maximizing compensation pay. To the extent that this occurs, audit risk will decrease, requiring less audit effort and lower audit fees than would otherwise be necessary. Similarly, such oversight is likely to make financial reporting more credible and will reduce the possibility of receiving modified audit opinions by reporting organizations.Originality/valueBoth audit and compensation committees are equally important in modern organizations. While both of the committee have distinctive responsibilities, questions remain on the desirability of overlapping audit committee. Also, this is the first study to the authors’ knowledge that incorporates overlapping membership on audit and compensation committee as an important component of auditor risk perception which regards in pricing the audit fees.