Correspondence: Xiaochuan Zheng, Bryant University, Smithfield, Rhode Island 02917, USA

¹is an assistant professor of Accounting at Bryant University in Smithfield, RI. He received his PhD from Drexel University. His research activities focus on the role of financial reporting in capital markets, corporate governance and financial reporting quality.

²is a professor of Accounting at Bryant University. His research interests focus on corporate governance and auditing issues. He has a PhD from the University of Kentucky.

Received 22 September 2009; Revised 22 September 2009; Published online 5 November 2009.

Abstract

This study examines the association between director overlap (defined as overlapping membership on the compensation and audit committees) and incentive-based compensation schemes. Using a sample of firms in the S&P 500 over the period 1997–2005, we find that cash compensation plans are not associated with director overlap, while option compensation is negatively associated with director overlap. These results suggest that knowledge of the misstatement-inducing effects of option-based compensation may spill over from the audit committee to the compensation committee, which may lead the compensation committee to reduce the option-based component of executive compensation. This research sheds some light on the association between board structure and corporate governance effectiveness. Its findings have important practical implications. Given the limited number of board members available, the organization must consider how to allocate an individual director among different committees. The findings of this research provide some guidance in this regard. For instance, this study suggests that the overlapping of the compensation committee and the audit committee may be beneficial to the design of compensation schemes because of the knowledge spillover between the two committees.