Common Membership and Effective Corporate Governance: Evidence from Audit and Compensation Committees

• Date: 01 January 2013
• Author: Chih‐Hsien Liao,Audrey Wen‐Hsin Hsu
• DOI: http://doi.org/10.1111/corg.12000
• Published date: 01 January 2013

Common Membership and Effective Corporate

Governance: Evidence from Audit and

Compensation Committees

Chih-Hsien Liao and Audrey Wen-Hsin Hsu*

ABSTRACT

Manuscript Type: Empirical

Research Question/Issue: This study examines the factors associated with the presence of the same directors across the

compensation committee and the audit committee in US f‌irms, and whether such common membership enhances or

undermines effective governance.

Research Findings/Insights: Using 4,572 f‌irm-year observations in the US during f‌iscal years 2004–2008, the results show

that common membership is more likely to occur in f‌irms with weak corporate governance and in f‌irms lacking f‌inancial

and committee resources, and is not associated with f‌irms having a high demand for coordination between compensation

and audit committees. We also f‌ind that f‌irms with common membership have poorer earnings quality and weaker

pay-performance sensitivity than other f‌irms.

Theoretical/Academic Implications: Our study is one of the f‌irst to propose theoretical arguments and empirical evidence

on the determinants as well as the consequences of common membership across compensation and audit committees. We

f‌ill the gap in the literature by examining the interplay between these committees.

Practitioner/Policy Implications: This study offers practical implications for corporations. The f‌indings indicate that

common membership is not employed to fulf‌ill the coordinative role between audit and compensation committees and can

put the effectiveness of audit and compensationcommittees at risk. Therefore, f‌irms who intend to strengthen compensation

practices or improve f‌inancial reporting quality should re-examine their committee structures to ensure proper task

separation.

Keywords: Corporate Governance, Audit Committee, Compensation Committee, Common Membership

INTRODUCTION

The literature has intensively explored the costs and ben-

ef‌its of common directorship across f‌irms (e.g., Ferris,

Jagannathan, & Pritchard, 2003; Loderer & Peyer, 2002).1

However, there is comparatively little evidence on the effec-

tiveness of common membership on multiple committees

within a f‌irm. According to corporate governance codes and

principles, no independent director should sit on principal

board committees simultaneously (Higgs, 2003). Delegating

different board functions to distinct committees represents

a separation of tasks and functions and has been strongly

recommended as a suitable mechanism for improving

corporate governance (Kesner, 1988; Spira & Bender, 2004).

However, more than half of S&P1500 f‌irms had a director

serving on multiple committees between 2004 and 2008.2If

specialization enhances board eff‌iciency, expediency, and

f‌lexibility (Bacon & Brown, 1973; Braiotta & Sommer, 1987;

Waldo, 1985), does the popularity of common membership

lead to effective corporate governance?

Our study examines whether common membership rep-

resents an effective monitoring scheme. We examine the

factors and economic effectiveness associated with the pres-

ence of common directors across compensation committees3

and audit committees (hereafter “common membership”).

We focus on the audit committee – overseeing the f‌inancial

reporting process – and the compensation committee –

setting and monitoring executive pay – because the two

committees should be composed entirely of independent

directors for f‌irms listed under major US stock exchanges

(i.e., NYSE, NASDAQ). In addition, compensation structure

decisions directly relateto the risk that audit committees will

*Address for correspondence: Audrey Wen-Hsin Hsu, Department of Accounting,

National Taiwan University,No.1, Sec 4, Roosevelt Rd, Taipei 106, Taiwan. Tel: 886-2-

33661131; E-mail: audrey.hsu@management.ntu.edu.tw

79

Corporate Governance: An International Review, 2013, 21(1): 79–92

© 2012 Blackwell Publishing Ltd

doi:10.1111/corg.12000