Abstract
Ever since corporate governance issues have taken the front seat, one of the developments in the corporate governance reform is the sharp increase on the pay to the outside directors. The debate is heating up on whether it is due to optimal contracting or entrenchment. The purposes of this research are twofold. First is to empirically examine if increasing the amount and/or portion of equity-based to total compensation to outside directors would improve the board's monitoring function, which in turn would lead to higher quality of earnings. Second is to assess if the aforementioned relationship is stronger for firms with a more independent board and/or for firms instituting an audit committee with financial expertise. A cross-sectional sample of 963 S&P Super 1,500 companies is analyzed. The results indicate that increasing both the total amount of compensation and the portion of equity-based compensation to total compensation is positively related to higher quality of earnings. Also, when a company separates its chair of the board with CEO, or has an independent board leadership, the incentive effects of having higher equity-based to total compensation on quality of earnings is more pronounced. However, the results do not support the contention that firms instituting an audit committee with financial expertise will enhance the compensation incentive effect on quality of earnings.
Published Version
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