Does overlapping membership on audit and compensation committees improve a firm's financial reporting quality?

Abstract

We investigate whether audit committee members of the board prove to be better monitors if they are also on the compensation committee, as they would be more attuned to compensation related earnings management incentives. Analyzing data on a sample of S&P 500 firms over the period 2003-2005, we find that ceteris paribus, firms with overlapping audit and compensation committees have higher financial reporting quality, proxied for by discretionary accruals than those without such overlap. Further, we find that there is an inverted U shaped relationship between overlapping magnitude and financial reporting quality, with an optimum overlap of about 47%. Our findings are robust to controlling for the percentage of CEOs' incentive compensation and using accounting restatements as another proxy for financial reporting quality. Overall, our results suggest that there is knowledge spillover from the compensation committee to the audit committee, as reflected in higher financial reporting quality. We interpret this to suggest that some overlapping of the committee memberships may be beneficial to audit committee monitoring effectiveness.

Audit Committees and Financial Reporting Quality in Singapore

“…Therefore, the findings are not supportive of the fourth hypothesis and there is no statistical evidence to suggest that overlapping membership is relevant for financial reporting quality in Singapore. Unlike Chandar et al (2012) which find positive impact of overlapping membership and Liao and Hsu (2013) which find the opposite, we find that overlapping audit and remuneration committees have no significant impact on financial reporting quality. One possible explanation is that high degree of committee overlap likely leads to the dilution of efforts because of multi-accountability, which might not result in better monitoring of financial reporting process and higher financial reporting quality.…”

“…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]. They find that firms with overlapping audit and remuneration committees have higher financial reporting quality which is measured by accruals quality.…”

“…Opportunistic reporting of firm performance by manipulating financial numbers is detrimental to shareholders' value because shareholders will get false information which may result in higher information asymmetry and higher cost of capital. The effectiveness of corporate audit committee in overseeing the financial reporting process depends on the independence of audit committee members (Klein 2002), the expertise of audit committee members (Dhaliwal et al 2010), and the overlapping membership on audit and remuneration committees (Chandar et al 2012;Liao and Hsu 2013).…”

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

“…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, ).…”

Gender in Audit Committee and Financial Reporting Timeliness: the Case of Unique Continental European Model

“…One of its main functions is to monitor the financial reporting process. The Audit Committee is also a central part of the decision control system to evaluate the board of directors (Fama & Jensen, 1983); a key factor in the process of financial reporting (Chandar, Chang, & Zheng, 2012); and it also helps to detect financial reporting fraud (Vanasco, 1994 The remainder of this work is structured as follows. The next section discusses the theoretical aspects and hypothesis development on the timeliness of financial reporting and gender of the Audit Committee members.…”