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    Audit committee stock options and financial reporting...
    research summary posted July 30, 2015 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.05 Impact of SOX, 13.0 Governance, 13.04 Board/Audit Committee Compensation 
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    Title:
    Audit committee stock options and financial reporting quality after the Sarbanes-Oxley Act of 2002.
    Practical Implications:

    This study contributes to existing literature by re-examining the relationship between audit committee compensation and financial reporting quality. The findings indicate the continuance of a negative relationship between audit committee members’ stock-option compensation and financial reporting quality in the post-SOX era. These results are relevant to regulators, compensation committees, and auditors because they imply that shifting audit committee director compensation away from stock options has the potential to improve financial reporting quality.

    Citation:

    Campbell, J. L., J. Hansen, C. A. Simon, and J. L. Smith. 2015. Audit Committee Stock Options and Financial Reporting Quality after the Sarbanes-Oxley Act of 2002. AUDITING: A Journal of Practice & Theory 34 (2):91-120.

    Keywords:
    audit committee quality, financial reporting oversight, financial reporting quality, independence
    Purpose of the Study:

    The Sarbanes-Oxley Act (SOX) was passed by Congress in 2002 in order to improve the accuracy and reliability of corporate disclosures. The introduction of SOX resulted in a substantial increase in audit committee members’ required level of independence and responsibility. In defining independence, however, regulators did not restrict companies from providing equity incentives for audit committee members. Pre-SOX research has shown stock option incentives to be associated with lower financial reporting quality. This study aims to re-examine the association between audit committee equity-based incentives and financial reporting quality (as proxied by a company’s propensity to meet or beat its consensus analyst forecast) in the post-SOX environment.

    Design/Method/ Approach:

    After removing problematic data, the sample collected for the study consisted of audit committee members’ equity holdings and compensation data for a sample of 2,172 company-year observations from 2006 to 2008. This information was then used in conjunction with a series of probit models in order to examine whether audit committee member’ equity incentives are associated with the likelihood of meeting or beating the analyst forecast. In order to mitigate the effect of outliers, the top and bottom 1% of the selection was winsorized.

    Findings:

    Findings were consistent with stock-option incentives being associated with lower financial reporting quality. Specifically, it was found that:

    • 58.8 percent of the average audit committee members’ pay is in the form of stock options and grants.
    • The likelihood of meeting or beating analyst expectations is positively associated with audit committee members’ stock-option compensation and holdings.
    • There is no association for non-equity compensation and holdings, and meeting or beating analyst expectations.
    • A company whose audit committee holds the mean value of exercisable options (i.e., about $200,000 in exercisable options) is associated with a 10.0 percent increase in the likelihood of meeting or beating its consensus analyst forecast.
    • A high-growth opportunity company whose audit committee holds the mean value of exercisable options is associated with a 17.8 percent increase in the likelihood of meeting or beating its consensus analyst forecast.
    Category:
    Governance, Independence & Ethics
    Sub-category:
    Board/Audit Committee Compensation, Impact of SEC Rules Changes/SarBox