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

Abstract

AbstractManuscript TypeEmpiricalResearch Question/IssueThis study examines the factors associated with the presence of the same directors across the compensation committee and the audit committee in US firms, and whether such common membership enhances or undermines effective governance.Research Findings/InsightsUsing 4,572 firm‐year observations in the US during fiscal years 2004–2008, the results show that common membership is more likely to occur in firms with weak corporate governance and in firms lacking financial and committee resources, and is not associated with firms having a high demand for coordination between compensation and audit committees. We also find that firms with common membership have poorer earnings quality and weaker pay‐performance sensitivity than other firms.Theoretical/Academic ImplicationsOur study is one of the first to propose theoretical arguments and empirical evidence on the determinants as well as the consequences of common membership across compensation and audit committees. We fill the gap in the literature by examining the interplay between these committees.Practitioner/Policy ImplicationsThis study offers practical implications for corporations. The findings indicate that common membership is not employed to fulfill the coordinative role between audit and compensation committees and can put the effectiveness of audit and compensation committees at risk. Therefore, firms who intend to strengthen compensation practices or improve financial reporting quality should re‐examine their committee structures to ensure proper task separation.