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Article
Publication date: 10 July 2017

Guy D. Fernando and Alex Thevaranjan

This paper aims to study the impact of audit quality on the components of executive cash compensation. It is predicted that as audit quality improves, greater emphasis will be…

4694

Abstract

Purpose

This paper aims to study the impact of audit quality on the components of executive cash compensation. It is predicted that as audit quality improves, greater emphasis will be placed on the incentive components of cash compensation, and lower emphasis on the salary (fixed) component. Specifically, it is predicted that as audit quality enhances, greater emphasis will be placed on earnings and sales revenues in determining executive cash compensation. Using auditor specialization as a proxy for audit quality, empirical support is provided for all of our predictions.

Design/methodology/approach

This paper provides empirical support with agency theoretic predictions.

Findings

This paper developed the following hypotheses: H1 – in executive cash compensation, more weight is being placed on earnings-based measures as auditor specialization improves; H2 – in executive cash compensation, more weight is also being placed on sales revenues as auditor specialization improves; H3 – in executive cash compensation, salary levels decrease as auditor specialization improves; and H4 – the impact of auditor specialization on the weight on earnings, sales and the salary levels is lower in the post-Sarbanes–Oxley Act (SOX) period compared to pre-SOX period.

Research limitations/implications

First, the article limits itself to cash compensation, while current executive compensation is largely made of equity. Second, the measure of audit quality used, ‘national level auditor specialization’, may not be as effective in the post-SOX era.

Practical implications

Compensation committees should pay attention to audit quality (in whatever way it may be proxied by) in determining executive compensation.

Originality/value

This is the first paper to show that audit quality not only improves the earnings response coefficient in firm valuation but also enhances the weight placed on earnings (and sales revenues) in executive compensation.

Details

Journal of Centrum Cathedra, vol. 10 no. 1
Type: Research Article
ISSN: 1851-6599

Keywords

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Article
Publication date: 1 May 1997

Rajiv D. Banker and Alex Thevaranjan

The impact of accounting earnings based compensation contracts an effort allocation is analyzed using an agency‐theoretic model. In this model, the CEO of a publicly traded firm…

105

Abstract

The impact of accounting earnings based compensation contracts an effort allocation is analyzed using an agency‐theoretic model. In this model, the CEO of a publicly traded firm expends effort on operational short‐run activities and strategic long‐run activities. The shareholders desire the CEO to expend more effort in the strategic long‐run activities because the return to shareholders depends more on long‐run than short‐run activities. More specifically, they desire the effort to be allocated between these two activities on the proportion of the sensitivity of stock returns to these two activities. Compensating the CEO based on the stock returns performance measure is shown to induce the CEO to exert the desired proportion of effort in the long‐run activities. Unlike stock returns, accounting earnings are believed to focus more on the short‐run performance of the firm and not reflect the full impact of a CEO's long‐run effort. Compensating the CEO based on accounting earnings, in addition to stock returns, is shown to induce the CEO to expend less than the desired proportion of effort in long‐run activities. As the emphasis placed on accounting earnings relative to stock returns increases, the CEO decreases the proportion of effort expended in long‐run activities. On the positive side, including accounting earnings in the contract increases the total effort that the CEO exerts in short‐run and long‐run activities. The benefit accruing from the increase in total effort more than offsets the dysfunctionality caused by the short‐run focus. More specifically, adding accounting earnings to the incentive contract is shown to increase the expected return to the shareholders. In summary, while accounting earnings cause the CEO to be short‐run focused, their use in the incentive contract improves the firm's performance by motivating the CEO to work harder overall.

Details

Managerial Finance, vol. 23 no. 5
Type: Research Article
ISSN: 0307-4358

Available. Open Access. Open Access
Article
Publication date: 10 July 2017

Vincent Charles and Rajiv D. Banker

255

Abstract

Details

Journal of Centrum Cathedra, vol. 10 no. 1
Type: Research Article
ISSN: 1851-6599

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