Audit Committee Incentives and the Resolution of Detected Misstatements

Abstract

We investigate the role of audit committee economic incentives in judgments involving the resolution of detected misstatements. The results reveal a positive association between audit committee short-term stock option compensation and the likelihood that managers are allowed to waive income decreasing misstatements that, if corrected, would have caused the company to miss its analyst forecast. Complementary results reveal a positive association between the audit committee long-term stock option compensation and the likelihood that managers are allowed to waive income-increasing misstatements when the company reports just missing, meeting, or beating its analyst forecast. These findings illustrate agency conflicts that can arise when compensating audit committees with options. We obtain these results while controlling for CEO option compensation and audit committee characteristics, along with indicators of corporate governance, auditor incentives, and company characteristics.

Keywords: Audit Committees, Book-or-Waive Decisions, Error Correction, Materiality