The economic determinants of compensation committee quality

Abstract

PurposeThe purpose of this paper is to investigate the economic determinants of compensation committee quality.Design/methodology/approachSample firms were selected from the IRRC Directors' database. Compensation committee quality is measured as the factor score from a principal component analysis of six compensation committee characteristics. Regression analyses are conducted to test the hypotheses.FindingsIt was found that firms with lower CEO influence, less institutional shareholders, fewer growth opportunities, and that are smaller in size are more likely to have high quality compensation committees.Practical implicationsThe results imply that even in the presence of a requirement to have only independent directors on the compensation committee, the quality of compensation committees can vary cross‐sectionally depending on the firm's economic circumstances. Thus, a one‐size fits all solution for compensation committee quality might not be optimal as different firms have different incentives in composing their compensation committees.Originality/valueThis paper adds to the limited literature on compensation committees by using a new measure of compensation committee quality to examine the economic factors that affect the governance quality of independent compensation committees. This paper also complements the board and audit committee research by examining whether the same factors that affect board and audit committee quality might also affect compensation committee quality.