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Does Compensating Directors with Stock Options Increase the Likelihood of Internal Control Weaknesses?
Hui Du, The University of Texas - Pan American
Alan Jiang, SUNY at Old Westbury
ABSTRACT. Various professional, regulatory, and legislative authorities in recent years have considered the independence of directors of public companies. The premise is that greater director independence will enhance the effectiveness of the firm’s control environment. We examine whether compensating independent directors with stock options may be associated with an increased probability of internal control weakness. We examined a sample of firms that received adverse internal audit opinions, and a matched sample of similar firms that received unqualified opinions on their internal control systems. Our results indicate that firms with internal control weaknesses are more likely to compensate outside directors with stock options than are firms without internal control weaknesses. These results suggest that compensating independent directors with stock options may decrease director independence and thereby reduce the effectiveness of board oversight of the firm’s financial reporting process.
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