Equity-based compensation to outside directors and accounting conservatism

Abstract

This paper examines the relationship between equity-based compensation to outside directors and accounting conservatism. Equity-based compensation to outside directors can strengthen the firm's corporate governance structure. Since this strong governance reduces the information asymmetry between managers and shareholders, it is also possible that firms with strong governance use more conservative accounting. To test this prediction, we investigate whether the proportion of the equity-based compensation to total compensation to outside directors has an effect on the level of conservatism and the various measures that are used. We find that there is a positive relationship between the proportion of equity-based compensation and the level of conservatism. The results are robust to additional tests using alternative measures of the equitybased compensation (the amount of the equity-based compensation) and the equity-based compensation to audit committee members instead of the full board of directors. According to our findings, we can conclude that equity-based compensation to outside directors encourages directors to put more effort into reducing the information asymmetry using conservative accounting.