Outside Director Equity Compensation And The Monitoring Of Management

Abstract

Using a sample of firms that are first time users of outside director equity compensation, I examine the effect of outsider director equity compensation on director monitoring by investigating firm performance and earnings management. My results, although lagged and not noticeable until year three, show that those firms that compensate outside directors with a higher percentage of equity compensation have higher stock performance, but lower accounting performance. These same firms also have lower discretionary accruals (i.e., less earnings management). These results suggest that outside directors do increase their monitoring by lowering discretionary accruals and thereby, lowering accounting earnings. In addition, this increased monitoring has a positive effect on stock performance. The results indicate that increased monitoring of accounting earnings results in lower discretionary accruals and thus lower, but more accurate earnings, and stock performance for the same period is not negatively impacted.