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Board Committees, CEO Compensation, and Earnings Management

43 Pages Posted: 3 Mar 2008 Last revised: 4 Mar 2008

Christian Laux

Vienna University of Economics and Business

Volker Laux

University of Texas at Austin - McCombs School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: February 2008

Abstract

We analyze the effect of committee formation on how corporate boards perform two main functions: setting CEO pay and overseeing the financial reporting process. The use of stock-based pay schemes induces the CEO to manipulate earnings, which leads to an increased need for board oversight. If the whole board is responsible for both functions, it is inclined to provide the CEO with a compensation scheme that is relatively insensitive to performance in order to reduce the burden of subsequent monitoring. When the functions are separated through the formation of committees, the compensation committee is willing to choose a higher pay-performance sensitivity, as the increased cost of oversight is borne by the audit committee. Our model generates predictions relating the board committee structure to the pay-performance sensitivity of CEO compensation, the quality of board oversight, and the level of earnings management.

Keywords: Corporate Governance, Executive Compensation, Earnings Management, Board Oversight

JEL Classification: M41, G34, J33

Suggested Citation

Laux, Christian and Laux, Volker, Board Committees, CEO Compensation, and Earnings Management (February 2008). Available at SSRN: https://ssrn.com/abstract=887492 or http://dx.doi.org/10.2139/ssrn.887492

Christian Laux

Vienna University of Economics and Business ( email )

Welthandelsplatz 1
Vienna, Wien 1020
Austria

Volker Laux (Contact Author)

University of Texas at Austin - McCombs School of Business ( email )

Austin, TX 78712
United States

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