Overlapping Membership on Audit and Compensation Committees, Audit Committee Equity Holdings, and Financial Reporting Quality

Abstract

This paper examines whether audit committee members of a board improve financial reporting quality if they are also on their organization’s compensation committee. Audit committees are responsible for overseeing the financial reporting process of organizations and have been urged to broaden their understanding of business risk and of the incentives provided by their firms’ executive compensation structures. Acknowledging the interrelationships among executive compensation, risk taking and financial reporting quality, members of audit and compensation committees have been advocating more information-sharing between the two committees. Using archival data on a sample of Australian Stock Exchange listed companies, and discretionary accruals as a proxy for financial reporting quality, this study finds that firms with overlapping committees have better quality financial reporting than those without such overlap. Our evidence for this is stronger in cases where managers tend to manage earnings upwards in order to meet or beat earnings benchmarks. We also find that the beneficial effect of the existence of overlapping committees is adversely affected by the equity holdings of directors with overlapping memberships.