Outside Director Independence, Auditor Independence and Executive Cash Bonus Compensation

Abstract

This paper examines the association between managers’ cash bonuses and discretionary accounting choices in a sample of German stock corporations from 2005 to 2007. We investigate managers’ earnings management behavior with respect to their bonus compensation and the independence of outside directors and auditors in mitigating potential bonus-increasing accounting choices by managers. In line with prior research, auditor independence is proxied by the amount of non-audit service fees received, whereas outside director independence is captured by whether outside directors receive earnings-based bonuses. We find that positive discretionary accruals are more strongly associated with executive cash bonuses if the independence of outside directors or external auditors is impaired. Overall, our results suggest that the effectiveness of monitoring institutions depends on the monetary incentives in place.