Highlights of Corporate Governance Research: Studies Examine Post-SOX Issues, CEO Pay, Whistleblowing

By Bolt-Lee, Cynthia E.; Farber, David B. et al. | Journal of Accountancy, September 2011 | Go to article overview

Highlights of Corporate Governance Research: Studies Examine Post-SOX Issues, CEO Pay, Whistleblowing


Bolt-Lee, Cynthia E., Farber, David B., Moehrle, Stephen R., Journal of Accountancy


Several corporate governance developments have occurred in the wake of the high-profile scandals of the past decade. Some of these developments are motivated by legislation such as the SarbanesOxley Act of 2002 (SOX). Others are best practices enhancements intended to shore up investor confidence. Academic research has monitored these developments. This article summarizes important academic findings and observations recently published in prominent accounting and finance journals.

IMPROVE INTERNAL CONTROL BY HIRING AN ACCOUNTING-SAVVY CFO

The main goal of SOX was to restore investor confidence in financial reporting. Consistent with this goal, SOX section 404 requires companies and auditors to assess the effectiveness of internal controls. Because adverse 404 opinions have negative implications for company value, understanding how companies can prevent and fix conditions related to weak internal controls over financial reporting is important to understand.

Authors Chan Li, Lili Sun and Michael Ettredge studied the relationship between both CFO turnover and professional qualifications with adverse 404 opinions and the correction of internal control weaknesses. CFOs play a central role in the control environment, and the authors argue that CFOs with more accounting knowledge--either as a CPA or with audit firm experience should better understand internal controls and therefore be in a position to correct control deficiencies.

The authors used a sample of 2,478 companies that disclosed auditors' initial SOX 404 opinions m 2005, including 416 companies with adverse opinions. The authors' main findings were that companies with adverse opinions: (1) had CFOs with weaker accounting qualifications; (2) were more likely to fire their CFOs; (3) were more likely to hire new CFOs with better accounting knowledge; and (4) were more likely to receive better SOX 404 opinions after hiring new CFOs who had more accounting knowledge.

The study "Financial Executive Qualifications, Financial Executive Turnover, and Adverse 404 Opinions" was published in May 2010 in the Journal of Accounting and Economics.

COMPENSATION CONSULTANT BIAS

Large corporations often hire executive compensation consultants to provide objectivity in determining executive salaries. But if these consultants are also paid for consulting services in other areas of the company, is their objectivity diminished? Additionally, are they more objective when they are hired by the board's compensation committee rather than management?

Results of a research study titled "Executive Pay and 'Independent' Compensation Consultants," published in the April 2010 edition of the Journal of Accounting and Economics, suggest that compensation consultants tend to lose their independence when they provide both compensation- and noncompensation-related services to their corporate clients.

Over the past decade, due to the potential for conflicts of interest, the SEC

began requiring disclosures regarding executive compensation consulting arrangements including total fees paid and to whom the consultant reports (that is, management or independent compensation committee members). Authors Kevin J. Murphy and Tatiana Sandino sampled regulatory filings for more than 1,000 U.S. companies in 2006, the first year of the required disclosure. The study also included more than 100 Canadian companies, which have compensation disclosure requirements that are similar to those in the U.S.

[ILLUSTRATION OMITTED]

The authors' research examined two main questions. First, did CEOs receive larger salaries if their compensation consultant provided services other than the compensation study? Second, was the CEO paid more when management had significant influence over the decision to reappoint or not reappoint the consultant in the future?

Results revealed that compensation increases for CEOs in the United States and Canada were 18% and 33% greater, respectively, when compensation consultants provided "other services" compared with compensation increases where the consultants did not provide other services. …

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