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

Abstract

PurposeThe purpose of this paper is to examine 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.Design/methodology/approachThe paper uses archival data on a sample of nonfinancial S&P 500 firms representing 1,032 firm years over the period 2003‐2005, and discretionary accruals as a proxy for financial reporting quality.FindingsFirms with overlapping audit and compensation committees have higher financial reporting quality than those without such overlap. In addition, there is an inverted U‐shaped relationship between overlapping magnitude and financial reporting quality, suggesting that there are costs as well as benefits to overlapping committees.Practical implicationsThe findings on this paper have implications for recent policy deliberations on the composition of board committees in general and audit committees in particular, as they clarify the benefits of overlapping committee members.Originality/valueUnderstanding the costs and benefits of the board committee structure is particularly important as boards typically operate through the use of committees. This paper contributes to this area by considering the effect of overlapping memberships on two of the most active and important board committees – the compensation and audit committees – on the monitoring effectiveness of the audit committee.