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compensation committees is associated with a lower weighting of discretionary accruals,
which might be easier for management to manipulate, and a higher weighting of stock return
measures in compensation contracts. Chandar, Chang, and Zheng (2012) find that firms with
overlapping membership on these two committees are associated with higher financial
reporting quality.
On the other hand, an overlap between audit and compensation committee members
carries potential risks. Committee members’ workload might be the most serious problem.
Among standing committees, the heaviest commitments tend to fall on the audit and
compensation committee members (Larcker, Tayan, and Zhu, 2014). The audit committee is
responsible for monitoring financial reporting and disclosure processes, overseeing choices
of accounting policy and principles, hiring auditors, ensuring regulatory compliance,
supervising internal controls, and even overseeing risk management. According to reports
from the National Association of Corporate Directors (NACD), audit committees meet an
average of eight times per year, either in person or over the telephone. The compensation
committee is responsible for setting the compensation for the CEO, other senior executives,
and the board, including establishing goals and evaluating performance. Compensation
committees hold an average of six meetings per year. Because of over-commitment and lack
of time to carry out their duties, the effectiveness of those serving on both committees may
be limited (Laux and Laux, 2009). For instance, Fich and Shivdasani (2006) find that “busy
directors” (directors that serve on multiple boards) are associated with lower governance
quality. Mendez, Garcia, and Pathan (2014) suggest that firms with overlapping directors
exhibit a higher probability of receiving a qualified audit opinion. Liao and Hsu (2013) claim
a decreasing sensitivity in CEO’s compensation to firm’s performance when there are
overlapping committees members.
Hoitash and Hoitash (2009) further explain the conflicts between the objectives of audit
and compensation committees. The objective of compensation committees is to offer
executive officers compensation packages that reflect their performance. While more
incentive-based compensation should motivate management to work harder, it also gives
management greater incentive to manipulate earnings, or other specific performance
measures, which increases the risk of poor financial reporting quality. The objective of audit
committees, on the other hand, is to oversee the accounting process and the quality of
financial reporting, so the audit committee will favor compensation packages that reduce the
risk of earnings manipulation. The results in Hoitash and Hoitash (2009) suggest that
reducing the overlap in these two committees might improve the effectiveness of board