Audit Committee Compensation and Audit Quality

The PCAOB has placed the identification of audit quality indicators on their current agenda. Prior research has found that audit committees’ stock options are positively associated with future earnings restatements (Archambeault et al. 2008) and whether firms meet or beat analysts’ forecasts of earnings (Campbell et al. 2015). We add to prior research and examine the association of audit committee compensation and discretionary accruals—another indicator of audit quality that has been used in academic research. We find that audit committee members’ cumulative stock option holdings and annual awards are positively associated with discretionary accrual levels. There is a lack of research that examines the effect of board of director cash compensation on financial reporting quality (Ye 2014). We examine audit committee cash compensation in our research setting and find that the percentage of audit committee members’ compensation that is paid in cash is negatively associated with discretionary accrual levels. This finding supports the incentive hypothesis of Adams and Ferreira (2008). The stock option findings from our study, and the findings from prior research, suggest that audit committee oversight appears to be impaired by stock option compensation. The findings in this study suggest that cash compensation strengthens audit committee oversight in regards to discretionary accruals. We propose that audit committee compensation should be considered in the audit quality indicator discussion.