Compensating for Executive Compensation: The Case for Gatekeeper Incentive Pay

49 Pages Posted: 6 Sep 2008 Last revised: 31 Aug 2010

Sharon Hannes

Tel Aviv University - Buchmann Faculty of Law

Date Written: September 4, 2008

Abstract

A massive wave of corporate fraud at the beginning of the twenty first century exposed the failure of corporate gatekeepers. The Sarbanes-Oxley legislation accordingly targeted gatekeepers, primarily auditors, by imposing strict regulation and enhanced independence guidelines. This legislative remedy is of disputable benefit while its costs have been huge. This paper maintains that a certain type of auditor incentive compensation could work better than regulation. Under such an alternative scheme, auditors would defer a portion of the payment they receive from the client firm, which would be used to purchase shares in the client after their tenure as auditor has ended. Instead of making them simply independent, this compensation structure would cause auditors to fend against inflated share prices. This type of auditor compensation could, therefore, serve to counterbalance recent trends in executive compensation that cause managers to overstate earnings. Modern accounting standards that augment management's scope of discretion make the suggested type of auditor compensation even more beneficial. Thus, the paper advocates calls for the Securities and Exchange Commission to promulgate a safe harbor that would facilitate such compensation schemes, which current independence guidelines do not allow.

Keywords: Gatekeepers, Executive Compensation, Incentive Pay

JEL Classification: K22

Suggested Citation

Hannes, Sharon, Compensating for Executive Compensation: The Case for Gatekeeper Incentive Pay (September 4, 2008). 98 California Law Review, Vol. 98, 2010; Northwestern Law & Econ Research Paper No. 08-19. Available at SSRN: https://ssrn.com/abstract=1263563

Sharon Hannes (Contact Author)

Tel Aviv University - Buchmann Faculty of Law ( email )

Ramat Aviv
Tel Aviv 69978, IL
Israel

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