Does Executive Compensation Incentivize Managers to Create Effective Internal Control Systems?

Posted: 7 May 2007 Last revised: 21 Oct 2008

See all articles by Theresa F. Henry

Theresa F. Henry

Seton Hall University - W. Paul Stillman School of Business

John Shon

Fordham University

Renee E. Weiss

Queens College

Date Written: September 18, 2008

Abstract

Using newly available data from accelerated filers of Section 404 of Sarbanes-Oxley, we examine the degree to which components of executive compensation are related to the effectiveness of firms' internal control systems. We estimate a two-stage regression to examine this possibility. In our first stage, we decompose compensation into its fitted (i.e., explained by firm's economic characteristics) and residual components. In our second stage, we estimate a logit regression of internal control effectiveness on the fitted and residual components of compensation. Overall, we find that internal control effectiveness is related to the fitted components of compensation, but unrelated to the residual components. These findings are consistent with (1) the explained portion of compensation providing managers with the incentives to exert effort towards producing effective internal controls, and (2) consistent with prior evidence, the unexplained portion may represent another form of "pay without performance.

Keywords: internal controls, executive compensation

JEL Classification: M41, G18, G28, G38, J30

Suggested Citation

Henry, Theresa F. and Shon, John and Weiss, Renee E., Does Executive Compensation Incentivize Managers to Create Effective Internal Control Systems? (September 18, 2008). Available at SSRN: https://ssrn.com/abstract=983816

Theresa F. Henry

Seton Hall University - W. Paul Stillman School of Business ( email )

400 South Orange Avenue
South Orange, NJ 07079
United States
973-761-9642 (Phone)

John Shon

Fordham University ( email )

113 West 60th Street
New York, NY 10019
United States

Renee E. Weiss (Contact Author)

Queens College ( email )

Flushing, NY 11367
United States
718-997-5083 (Phone)
718-997-5079 (Fax)

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