The Effect of Compensation Committee Quality on the Association between CEO Cash Compensation and Accounting Performance

• Author: Steven Cahan,Jerry Sun
• Published date: 01 March 2009
• DOI: http://doi.org/10.1111/j.1467-8683.2008.00726.x
• Date: 01 March 2009

The Effect of Compensation Committee Quality

on the Association between CEO Cash

Compensation and Accounting Performance

Jerry Sun* and Steven Cahan

ABSTRACT

Manuscript Type: Empirical

Research Question/Issue: We examine the effect of compensation committee quality on the association between CEO cash

compensation and accounting earnings and the moderating effects of growth opportunities and earnings status.

Research Findings/Insights: Using a sample of 812 US f‌irms, we f‌ind that CEO cash compensation is more positively

associated with accounting earnings when f‌irms have high compensation committee quality. We also f‌ind that the positive

effect of compensation committee quality on the association between CEO cash compensation and accounting earnings is

less for high growth f‌irms or loss-making f‌irms.

Theoretical Implications: We contribute to the agency-based research on CEO compensation by: 1) directly examining the

impact of compensation committee quality on the sensitivity of CEO cash compensation to accounting earnings; 2) exam-

ining whether the role of compensation committee quality varies across f‌irms; and 3) developing a broader and richer

measure of compensation committee quality.

Practical Implications: Our f‌indings imply that shareholders and directors should be concerned about the composition of

compensation committees as we f‌ind that compensation committee quality varies depending on compensation committee

size and other characteristics of the committee members. Our f‌indings also imply that for compensation committee

members, there are greater challenges in monitoring CEO compensation contracts for f‌irms with high growth or that incur

losses. Further, our f‌indings imply thateven when all compensation committees are regulated to be fully independent, there

are still quality differences among these independent compensation committees.

Keywords: Corporate Governance, Compensation Committee, Evaluation of Directors, Executive Compensation

INTRODUCTION

Several prior studies have examined the effect of com-

pensation committee quality on the association between

CEO pay and f‌irm performance, where compensation com-

mittee quality is measured by compensation committee

independence (e.g., the proportion of independent directors

on the compensation committee). However, the evidence

has been mixed. For example, Anderson and Bizjak (2003)

do not f‌ind that less independent compensation committees

have a lower association between CEO pay and stock

returns. On the other hand, Newman and Mozes (1999) f‌ind

that the association between compensation and stock returns

is signif‌icantly higher for f‌irms with independent compen-

sation committees when stock returns are negative. Vafeas

(2003a) f‌inds that the pay-performance sensitivity for f‌irms

with less independent compensation committees improved

in the wake of two major regulatory reforms – i.e., the 1992

Security Exchange Commission (SEC) compensation disclo-

sure rules and the 1993 tax limits on certain executive com-

pensation (i.e., Internal Revenue Code Section 162[m]).1

One explanation for the mixed f‌indings is that the propor-

tion of independent directors is an incomplete measure of

compensation committee quality. First, we expect that com-

pensation committee quality would be better measured

using a broader and richer set of variables related to the

structure and composition of the compensation committee.

Second, as a practical matter, compensation committee inde-

pendence is no longer a relevant measure of compensation

*Address for correspondence: Odette School of Business, University of Windsor, 401

Sunset Avenue, Windsor, Ontario, Canada N9B 3P4. Tel: 1-519-253-3000-3122; Fax:

1-519-973-7073; Email: jyksun@uwindsor.ca

193

Corporate Governance: An International Review, 2009, 17(2): 193–207

© 2009 TheAuthors

Journal compilation © 2009 BlackwellPublishing Ltd

doi:10.1111/j.1467-8683.2008.00726.x