The Effect of Internal Control Deficiencies on the Usefulness of Earnings in Executive Compensation

Posted: 28 Jun 2011 Last revised: 25 Feb 2012

See all articles by Kareen Brown

Kareen Brown

Brock University

Jee-Hae Lim

University of Hawaii, Manoa

Date Written: February 24, 2012

Abstract

Since SOX 404 disclosures are informative about earnings, and due to the widespread practice of using earnings-based measures in executive compensation, this study examines whether reports of internal control material weaknesses (ICMW) under SOX404 influence firms’ reliance on earnings in tying executive pay to performance. Using 391 (366) firm-year observations with reported ICMW and 3,648 (3,138) firm-year observations for CEOs (CFOs) reporting NOMW under SOX 404, we find a decreased strength in the association between earnings and executives’ (CEO and CFO) compensation when the firm reports an ICMW, and as the number of reported ICMW increases. In addition, we find this decreased weight on earnings for the more severe Company-Level than Account- Specific material weaknesses. Our study suggests that the ICMW report under SOX 404 provides incremental information for executive compensation beyond that contained in reported earnings.

Keywords: Sarbanes-Oxley Act; internal control material weaknesses (ICMW); executive compensation; earnings.

Suggested Citation

Brown, Kareen and Lim, Jee-Hae, The Effect of Internal Control Deficiencies on the Usefulness of Earnings in Executive Compensation (February 24, 2012). Advances in Accounting, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1465939 or http://dx.doi.org/10.2139/ssrn.1465939

Kareen Brown (Contact Author)

Brock University ( email )

500 Glenridge Avenue
St. Catherines, Ontario L2S 3A1
Canada

Jee-Hae Lim

University of Hawaii, Manoa ( email )

2404 Maile Way
Honolulu, HI Honolulu 96822
United States
(808) 956-8503 (Phone)
(808) 956-9888 (Fax)

HOME PAGE: http://shidler.hawaii.edu/directory/jee-hae-lim/soa

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