Regulatory and market pressures have led to increased responsibilities for corporate audit committees, as well as greater demand for such members to possess financial expertise. Companies have responded by offering a wider variety of compensation packages to attract qualified members. The authors analyzed the available data across industries to ascertain how the compensation for CPA and non-CPA financial experts compares with other individuals.
Following the string of accounting scandals headlined by the collapse of Enron and WorldCom, Congress passed the Sarbanes-Oxley Act of 2002 (SOX). Since SOX, the role of the audit committee has continued to evolve, with greater responsibilities being imposed on the audit committee by regulators, markets, and competitive pressures. In addition to performing its oversight role of management and the financial reporting and assurance processes, audit committees are also charged with:
- Reviewing annual and quarterly statements, Management Discussions & Analysis, and earnings press releases (as required by the NYSE);
- Complying with whistleblower requirements by establishing procedures for receiving and investigating whistleblower complaints (Dodd-Frank Act);
- Reviewing and approving related-party transactions (Nasdaq requirement);
- Monitoring compliance with legal and regulatory requirements and discussing with management the company’s financial risk assessment and financial risk management policies (Nasdaq);
- Compliance with code of ethics requirements (Nasdaq);
- Oversight of the internal audit function and ensuring the audit team reports to the audit committee (NYSE, Blue Ribbon Commission);
- Ensuring that external auditor partners meet mandatory rotation requirements every five years, so auditor independence is not compromised (Nasdaq, SOX);
- Performing a self-evaluation to determine whether audit committee members have fulfilled their responsibilities as delineated in the corporate charter; this includes reviewing the scope, structure, and process of the committee (NYSE);
- Responsibility for cybersecurity oversight to ensure that the accounting information system is functioning properly and that it can report and correct security breaches (NYSE).
Valuing Audit Committees
Given the additional responsibilities imposed on audit committees and the limited supply of qualified audit committee members and financial experts, companies have begun offering a variety of compensation packages in order to attract highly qualified audit committee members. Since 2001, the National Association of Corporate Directors (NACD) has been recommending compensating directors with at least 50% equity in order to align their interests with the long-term interests of shareholders. This recommendation has resulted in companies offering a mix of cash and equity, with equity comprising a majority of total director pay. The practice of compensating audit committee members with greater proportions of equity, however, has raised concerns by governance activists such as Glass Lewis, which has argued that equity compensation may affect audit committee members’ ability to monitor effectively. This concern may have merit, as there is some research evidence suggesting that compensating audit committee members with equity undermines the audit committee’s effectiveness (Archambeault, D.S., DeZoort, F.T., and Hermanson, D.R., “Audit Committee Incentive Compensation and Accounting Restatements,” Contemporary Accounting Research, vol. 25, pp. 965-992, 2008; Campbell, J.L., Hansen, J., Simon, C.A., and Smith, J.L., “Audit Committee Stock Options and Financial Reporting Quality after the Sarbanes-Oxley Act of 2002,” Auditing: A Journal of Practice & Theory, vol. 34, no. 2, pp. 91–120, 2015), whereas cash compensation does not (Rickling, M., and Sharma, D.S., “Audit Committee Cash Compensation and Propensity of Firms to Beat Earnings by a Large Margin: Conditional Effects of CEO Power and Agency Risks,” International Journal of Auditing, vol. 21, no. 3, pp. 304–323, 2017).
In addition, some have questioned the value of audit committees (Klein, A. “Questioning the Effectiveness of Independent Audit Committees?” The CPA Journal, pp. 30–36, March 2018; Radin, A.J. “Are Audit Committees Worth the Cost?” The CPA Journal, pp. 10–11, August 2018) and concluded that independent audit committees are not effective at improving the quality of financial reporting. Using data between 1999 and 2002, S. Kim and A. Klein (“Did the 1999 NYSE and NASDAQ Listing Standard Changes on Audit Committee Composition Benefit Investors?,” The Accounting Review, vol. 92, no. 6, pp. 187–212, 2017) observed that audit committees with at least one accounting financial expert and a busy audit committee did not affect the quality of financial reports. When audit committees began including more accounting experts since the passage of SOX, which requires 100% independence on audit committees, research evidence using a more captive database has revealed clear evidence of a strong positive relation between independent accounting expertise and better quality monitoring of the financial reporting and assurance processes (Hoitash, U., Hoitash, R., and Bedard, J.C., “Corporate Governance and Internal Control over Financial Reporting: A comparison of regulatory regimes,” The Accounting Review, vol. 84, no. 3, pp. 839–867, 2009; Dhaliwal, D., Naiker, V., and Navissi, F., “The Association Between Accruals Quality and the Characteristics of Accounting Experts and Mix of Expertise on Audit Committees,” Contemporary Accounting Research, vol. 27, no. 3: pp. 787–827, 2010). Some studies have gone further and found that audit committee members with a CPA license or experience as former partners in CPA firms are the most effective of accounting and non-accounting experts (Naiker, V., and Sharma, D.S., “Former Audit Firm Partners on the Audit Committee and Internal Control Deficiencies,” The Accounting Review, vol. 84, no. 2, pp. 559–587, 2009; Naiker, V., Sharma, D.S., and Sharma, V.D., “Do Former Audit Firm Partners on Audit Committees Procure Greater Nonaudit Services from the Auditor?” The Accounting Review, vol. 88, no. 1, pp. 297–326, 2013). In contrast, Badolato et al. (Badolato, P.G., Donelson, D.C., and Ege, M., “Audit Committee Financial Expertise and Earnings Management: The Role of Status,” Journal of Accounting and Economics, vol. 58, no. 2–3, pp. 208–230, 2014) found that an audit committee member’s status as a director plays a greater role in effective monitoring of financial reporting quality. When studies examined one of the most visible components of status (a director serving on multiple board seats, as in Badolato et al. 2014), they have found that audit committees comprising members serving on more boards are less effective in monitoring the quality of financial reporting (Sharma, V.D., and Iselin, E.R., “The Association Between Audit Committee Multiple-Directorships, Tenure, and Financial Misstatements,” Auditing: A Journal of Practice & Theory, vol. 31, no. 3, pp. 149–175, 2012). Literature review studies such as Carcello et al. (Carcello, J.V., Hermanson, D.R., and Ye, Z., “Corporate Governance Research in Accounting and Auditing: Insights, Practice Implications, and Future Research Directions,” Auditing: A Journal of Practice & Theory, vol. 30, no. 3, pp. 1–31, 2011) have demonstrated overwhelming support for the position that independent audit committee members possessing accounting expertise rather than general financial expertise are the key to better quality financial reports.
Compensation and Accounting Expertise
Despite the positive benefits of having accounting experts on the audit committee, less than one-third of audit committee members (29%) have some kind of accounting expertise, and even fewer possess a CPA license. This article describes the compensation audit committee members have reportedly received and analyzes whether compensation differs between members with a CPA license, accounting experts without a CPA license, and all other members. The authors believe that one of many reasons why relatively few CPAs serve on audit committees may be the level of compensation offered to potential candidates. Other possibilities–including lack of interest, bad fit, lack of time, and the fact that serving on an audit committee is inherently a social process–are acknowledged but not explored here. [For a discussion of such reasons, see Beasley, M.S., J.V. Carcello, D.R. Hermanson., and T.L. Neal, “The Audit Committee Oversight Process,” Contemporary Accounting Research, vol. 26, no. 1, pp. 65–122 (2009).] To provide some insight on the compensation to expect for serving on the audit committee, the authors analyzed a sample of 69,240 audit committee members for financial years 2009–2017. The data source was BoardEx, a business technology platform that provides information on board structure, remuneration, committee membership, and other corporate governance variables of publicly traded and large private companies. BoardEx collects audit committee member and compensation data from SEC proxy filings such as the 10-K and DEF14A. Audit committee members were classified by their accounting qualifications. Of the 69,240 members, 13,279 (19%) were CPAs, 7,003 (10%) did not have a CPA license, but possessed accounting expertise/experience [e.g., chief financial officers (CFOs), controllers, chief accounting officers (CAO), and auditors], and 48,958 (71%) were neither CPAs nor had any other significant accounting expertise/experience (Other). Most of the CPAs (69%) served in an executive role designated as a vice-president, consultant, advisor, manager, and director. Also, 23% of CPAs served as CFO; 25% served in a role designated CEO, president, or managing director; 6% served in a senior accounting role such as controller, CAO, or accountant; while 6% served as a chief operating officer. An additional 8% of CPAs were partners or senior managers in a CPA firm and 7% of CPAs held academic positions. These data could imply that CPAs work their way up to high levels in senior executive positions (though the data collected do not track when a CPA obtained their license or moved from public accounting to industry). Of the non-CPA accounting experts, 43% were CFOs, 7% were controllers, 5% were CAOs, 7% were accountants and accounting clerks, 3% were auditors, 3% were treasurers, and less than 1% were academics.
Exhibit 1 shows that, since the tail end of the financial crisis (2009), there has been a slight increase in the representation of CPAs and non-CPA accounting experts on audit committees, with a decrease in “Other” back-grounds. Between 2009 and 2017, the data underlying Exhibit 1 show that the proportion of CPAs and non-CPA accounting experts increased by 4.5% and 8.6%, respectively, while others serving on audit committees declined by 22%. These trends suggest the demand for accounting experts is in line with the increasing responsibilities imposed on audit committees. In 2009, the data used shows there was 7,999 members, but this number has declined since then, with 2016 and 2017 showing audit committee members of 7,405 and 6,813, respectively. Such trends suggest that more audit committee members are leaving than joining audit committees. This could be due to increasing workloads and expanded responsibilities, such as cybersecurity risks.
The authors analyzed the remuneration of audit committee members from 2009 to 2017. This began with analyzing the compensation of audit committee members for the entire sample across 10 major industries [consumer nondurables, consumer durables, manufacturing, energy, high tech, telecommunications, shops, healthcare, utilities, and other industries (e.g., construction, transportation, hotels, entertainment, finance)]. The authors then analyzed their compensation according to those with a CPA designation, those without a CPA license but possessing accounting expertise/experience, and others who do not possess any type of accounting related expertise. This breakdown provides insight on how compensation varies by expertise and illuminates the compensation CPAs and non-CPA accounting experts can expect if they serve on audit committees.
An increasing demand for accounting experts to serve on audit committees should lead to a commensurate increase in compensation. It is self-evident that financial incentives can influence how experts perform their audit committee responsibilities (Archambeault, D.S., DeZoort, F.T., and Hermanson, D.R., 2008; Campbell, J.L., Hansen, J., Simon, C.A., & Smith, J.L., 2015; Rickling, M., and Sharma, D.S., 2017).
The analysis then charts the average audit committee total annual compensation by year and industry for CPAs, non-CPA accounting experts, and other groups. The average total annual compensation is based on cash, stock options, and stock awards compensation and reflects the total annual compensation an audit committee member receives for serving on one audit committee over our sample period. Exhibit 2 shows that on average, from 2009 to 2017, CPAs received the lowest compensation at $186,723, other groups earned $189,234, whereas non-CPA accounting experts received the highest compensation of $204,882, about 10% more than CPAs. This pattern of compensation generally persisted over the nine-year sample period despite the fact that the demand for CPAs is more than non-CPAs per Exhibit 1. When increases between 2009 and 2017 are considered, average annual total compensation increased quite significantly; by 48% for non-CPA accounting experts, 38% for CPAs, and 42.5% for other groups. Adjusted for inflation (CPI), the increases are 34%, 25%, and 28%, respectively. Two underlying reasons for these significant increases could be strong demand for directors to serve on audit committees and the expanded responsibilities of audit committees.
Average Compensation of an Audit Committee Member per Audit Committee
Exhibit 3 charts average total annual compensation by industry. The energy and healthcare industries stand out as paying the highest level of audit committee compensation, where average total annual compensation ranges between $222,000 and $249,000. The next industry, high tech, pays an average of $205,000 to $228,000, followed by telecommunications, which pays an average not exceeding $204,000. All other industries pay less than $200,000 on average with “other” paying the lowest annual total audit committee compensation. In all industries but one (energy), CPAs receive lower average total annual compensation than non-CPA accounting experts, with the difference reaching about $23,000 or 12% of the average total annual compensation for CPAs. Non-CPA accounting experts tend to receive higher average total annual compensation than other types of audit committee members in all but two industries (energy and telecommunications). The pay gap reaches almost $26,000 (14%) of the average total annual compensation for other industries.
Comparison of Annual Total Compensation of Audit Committee Members
To provide further insight, the authors compared the total annual compensation between each type of audit committee member for each industry in Exhibit 3 and performed statistical tests to rule out that the differences are random. The first four columns list the industry and report the average total compensation by member type. The last three columns report p-values as to whether, on average, the differences in compensation are significant between each pair of member types. (A p-value of less than 0.01, 0.05, and 0.10 suggests that there is a respective 99%, 95%, and 90% confidence that the differences are noteworthy. A blank cell indicates that compensation differences are not important.)
These findings suggest that the total annual compensation paid to audit committee members varies both by industry and whether the member is a CPA or not.
In five out of ten industries (consumer nondurables, manufacturing, high tech, healthcare, other), the average total annual compensation for CPAs is meaningfully lower compared with non-CPA accounting experts. Average total annual compensation for CPAs is higher than others in the consumer nondurables industry, but is lower in the healthcare and other industries groups; in the remaining seven industries, compensation is similar. Non-CPA accounting experts earn more total annual compensation on average than others in four of the ten industry groups (consumer nondurables, manufacturing, high tech, other). These findings suggest that the total annual compensation paid to audit committee members varies both by industry and whether the member is a CPA or not.
Comparing Forms of Compensation
The authors then drilled down into the type of compensation (cash, stock options, and stock awards) received by audit committee members. Exhibit 4 shows that CPAs receive significantly higher cash compensation than non-CPA accounting experts in four of the ten industries, and others in six of the ten. Exhibit 5, however, shows that CPAs tend to receive significantly less of their annual compensation by way of stock options compared with non-CPA accounting experts in the high tech, shops, and healthcare industries. Similarly, CPAs on the audit committee receive significantly lower stock option compensation than other groups in four industries as shown in Exhibit 5. Likewise, non-CPA accounting experts receive significantly less stock option compensation than other in the consumer nondurables, consumer durables, energy, and utilities industries, as shown in Exhibit 5. What is also striking is that CPAs tend to receive significantly lower stock award compensation than both non-CPA accounting experts and other groups in many of the 10 industries, whereas non-CPA accounting experts take home significantly more stock award compensation than other members, as shown in Exhibit 6. Finally, an overall observation from the data in Exhibits 4, 5, and 6 is that equity-based compensation makes up more than 50% of total compensation for audit committee members.
Comparison of Annual Cash Compensation of an Audit Committee Member
Comparison of Annual Stock Option Compensation of an Audit Committee Member
Comparison of Annual Stock Award Compensation of an Audit Committee Member
The authors recognize that setting compensation is an intricate matter, and the approach taken here does not account for other important factors, such as the audit committee member’s status, service on other committees within the same company, the entity’s size, its risk and performance profile, and CEO and board characteristics. To address these concerns, the authors estimated a multiple regression equation to explore how various factors are related to the compensation paid to audit committee members. A multiple regression is a statistical technique that facilitates examining how variations in a dependent variable or explanandum (the phenomenon to be explained, such as audit committee compensation) is related to or explained by a number of different factors, known as independent variables or explanans (the variables providing the explanation, such as CPA license, non-CPAs, director status). The regression also controls for industry differences and time effects, but these are not reported for the sake of brevity. The authors compiled a set of possible determinants based on their knowledge of the director compensation determinants literature and the expertise factors studied here. The charters of eight Fortune 500 compensation committees were reviewed for specific factors to consider. In all eight cases, the charters were very general and offered no specific factors to consider.
Exhibit 7 shows that all the factors are positively (the respective coefficients are positive) related to total compensation except for leverage, which is negatively related. Specifically, members with a CPA license and members possessing accounting experience but without a CPA license receive more compensation than members who do not possess such expertise. Members with greater director status (e.g., number of committees served on) also receive more total compensation. The authors found that members with CPA and non-CPA accounting expertise receive much greater pay than if a member has high status (based on tests of differences in the regression coefficients). When audit committee members serve on other committees in the same organization, they also receive more pay. Because of their complexity, larger corporations, as would be expected, pay more, as do those that are more profitable. More independent boards and more powerful CEOs (measured by whether the CEO also serves as board chair) also are associated with higher total audit committee compensation.
Regression of Determinants of Annual Compensation of Audit Committee Members
When considering the different components of compensation, Exhibit 7 shows that audit committee members with a CPA license and non-CPA accounting experts are paid more (the coefficients are positive) in cash and stock award compensation. Although audit committee members’ director status does not affect how much they are paid in cash compensation, higher director status earns them greater stock award and stock option compensation. Interestingly, members who are accounting experts—both CPAs and non-CPAs—do not receive greater stock option compensation. These findings reveal new information not previously documented and implies that some of the controversy in the academic literature on audit committee effects on financial reporting quality could be explained by specific audit committee member characteristics and the nature and amount of compensation paid. Such analysis, although interesting, is beyond the scope of this article.
Taking these findings in total provides key takeaways and implications for audit committee compensation. From the descriptive results in Exhibits 4, 5, and 6, CPAs earn lower equity-based compensation (e.g., stock option, stock award), but higher cash compensation than non-CPA accounting experts and other groups, probably because they are mindful of the “ownership” incentives embedded in stock-based compensation. Our observations are consistent with the notion that audit committee members who are CPAs are clearly cognizant of professional ethics, as their director compensation is relatively more in cash than in stock, given that stock-based compensation has the potential to create economic incentive effects that could affect their exercise of objective and effective governance. Such findings are in line with the academic research referenced above, which shows that accounting experts and CPAs in particular are more effective in their oversight of the financial reporting process, as are audit committee members who are paid in cash rather than equity.
Given these conclusions from the research, however, is the NACD’s recommendation to compensate more with equity appropriate? If more equity is the “norm,” considering that the above data suggests equity compensation comprises the majority of total audit committee compensation (at least 55%), then should CPAs negotiate for greater equity compensation or should they demand greater cash compensation given the potential independence implications of equity compensation? Or should the structure and level of compensation for audit committees be reconsidered as a matter of public policy? If the required expertise is having an audit committee member with significant accounting expertise, then shouldn’t CPAs—the paragons of accounting expertise—receive greater audit committee compensation? And shouldn’t audit committee compensation be structured to attract CPAs? In the authors’ view, it is time for corporate boards, management, and stake-holders to appropriately compensate accounting experts on the audit committee if they want effective governance. It is also time for CPAs to step up and be recognized as a formidable audit committee member and negotiate higher compensation for their unique expertise, particularly in an era highly focused on risk management.