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 Audit Committee Compensation and the Demand for
Monitoring of the Financial Reporting Process

Ellen Engela , Rachel M. Hayesb , and Xue Wangc

a University of Chicago Booth School of Business
b David Eccles School of Business, University of Utah
c Goizueta Business School, Emory University

July, 2009

(Forthcoming, Journal of Accounting and Economics)

Abstract

We examine the relation between audit committee compensation and the demand for mon-
itoring of the financial reporting process. We find that total compensation and cash retain-
ers paid to audit committees are positively correlated with audit fees and the impact of the
Sarbanes-Oxley Act, our proxies for the demand for monitoring. Our results are robust to the
inclusion of audit committee quality, measured as the committee chair financial expertise. Our
results suggest a recent willingness by firms to deviate from the historically prevalent one-size-
fits-all approach to director pay in response to increased demands on audit committees and
differential director expertise.

JEL classification: G30, M41, M49

Key words: Audit committees, board of director compensation, audit fees

We thank an anonymous reviewer, Brian Cadman, Jeff Chen (AAA discussant), Mike Lem-
mon, Clive Lennox, Scott Schaefer, Peter Wysocki (discussant), Jerry Zimmerman, and work-
shop participants at the University of Notre Dame, the 2007 Southeast Summer Accounting
Research Conference, the 2008 American Accounting Association Annual Meeting, and the
2008 Journal of Accounting and Economics Conference for comments, and Jeff Wooldridge for
helpful correspondence on econometric methods. We thank Chun Wang for excellent research
assistance.

Electronic copy available at: http://ssrn.com/abstract=1463494

1 Introduction

In this paper, we study compensation of audit committee members of public firms. Specifically,
we examine how cross-sectional variation in the demand for monitoring of the financial reporting
process is associated with compensation for audit committee members. Audit committees
play a crucial role in firms’ financial reporting processes, and thus have attracted considerable
attention from researchers, especially in the wake of recent high profile financial reporting
scandals. While there are large literatures both on audit committee characteristics and on
compensation for directors, research has not, to date, examined how pay for audit committee
members varies with the firm’s financial reporting environment. Recent literature on audit
committees has focused instead on committee characteristics such as size and composition
(Deli and Gillan (2000) and Klein (2002b)), and the relation between these characteristics and
various outcomes.1 Meanwhile, research on compensation for directors has tended to ignore
much of the within-firm heterogeneity in director pay, focusing instead on compensation for a
representative director at a given firm (see, for example, Farrell, Friesen and Hersch (2008) and
Linn and Park (2005)).
We investigate whether firms that face a higher demand for monitoring of the financial
reporting process pay higher compensation to their audit committees. In addressing this ques-
tion, we incorporate the effects of audit committee director quality. A key part of our analysis
also examines within-firm heterogeneity in director compensation — in particular, audit com-
mittee pay relative to compensation committee pay (the audit committee pay premium) — and
how the audit committee pay premium relates to the demand for monitoring of the financial
reporting process.
A greater demand for monitoring of the financial reporting process can arise from a num-
ber of characteristics of the firm and its environment or from external forces. In developing
proxies for the demand for monitoring, we consider both firm-specific and external forces. Firm-

1
For example, Klein (2002a) examines the relation between audit committee independence and earnings
quality, while Carcello and Neal (2000) consider the relation between audit committee characteristics and auditor
reporting behavior.

Electronic copy available at: http://ssrn.com/abstract=1463494

specific forces include the complexity of the business and the firm’s organizational structure,
the strength of internal control systems, financial reporting quality and litigation risk. These
factors are among those that impact the overall transparency and riskiness of the financial
reporting process. We argue that the lower the transparency and the greater the risk of the
financial reporting process, the greater is the demand for monitoring of the financial reporting
process by investors and other stakeholders. We expect total annual audit fees paid to the
external audit firm for performing audit services to capture these firm-specific and related en-
vironmental forces. Accordingly, our firm-specific proxy for the demand for monitoring of the
financial reporting process is firm-size-deflated total annual audit fees.
External to the firm, we consider the impact of the requirements of the Sarbanes-Oxley Act
(SOX), and the factors that led to the legislation, on the demand for monitoring of the financial
reporting process. SOX addresses widespread concerns of regulators and investors about the
financial reporting process, including the role of the audit committee. Specifically, SOX requires
that all members of the audit committee be independent and that the company’s annual report
disclose whether a member of the audit committee is a financial expert. These provisions,
along with overall investor pressure to improve corporate governance, are likely to create an
increased demand in many firms for audit committee members to monitor the financial reporting
process more diligently. Accordingly, our second proxy, an indicator variable for the post-SOX
time period, is designed to capture factors relating to the enhanced monitoring environment,
greater board accountability and increased credential requirements directed at audit committee
members that are not expected to be fully reflected in the audit fee variable. This variable
allows us to capture a potentially important external shift in the demand for monitoring of the
financial reporting process that is triggered by the provisions of SOX and concurrent higher
levels of investor scrutiny.
We expect that the factors that lead to greater demand for monitoring of the financial
reporting process require an increased commitment of time and effort by audit committee
members. We hypothesize that, holding director quality constant, this effect leads to higher
compensation for these directors. We control for director quality because audit committee
compensation is likely related to both the demand for monitoring of the financial reporting

2
process and the quality of the audit committee. Including an audit committee quality measure
— specifically, the financial expertise of the audit committee chair — allows us to investigate
both effects.
To investigate our research questions, we collect compensation data for outside directors
from proxy statements for the sample of ExecuComp firms between 2000 and 2004. We also
collect data on the financial expertise of audit committee chairs during these years. Our analyses
consider two main time periods: the pre-SOX period including 2000 and 2001, and the post-
SOX period from 2002 through the end of 2004. Our descriptive analyses document that total
compensation for audit committees increased significantly in the post-SOX period, with notable
increases in the cash retainer and meeting fee components. We also find that a significantly
larger percentage of firms have audit committee chairs with financial expertise, and especially
accounting expertise, in the post-SOX period.
We conduct two primary regression analyses. Our first set of regressions examines the de-
terminants of the level of audit committee compensation, while our second set of regressions
explains the difference between compensation of audit committee members and compensation
committee members on the same board. In each regression, we include audit fees, as well as
the post-SOX indicator, to capture the demand for monitoring of the financial reporting pro-
cess. While our prediction is that audit committee compensation is positively related to audit
fees because the two variables are responding similarly to underlying economic factors, we note
that it is also possible that audit fees are endogenous in the compensation regression. Conse-
quently, before we perform our regression analyses, we instrument for audit fees in a two-stage
least squares regression and conduct a Hausman test to determine whether audit fees are an
endogenous regressor. The Hausman test fails to reject that audit fees are exogenous for all
specifications. Thus, the use of ordinary least squares regressions to test our hypotheses will
yield consistent coefficient estimates. In the levels regressions, we find that total compensation
(excluding meeting fees) and cash retainers paid to audit committee members are positively
correlated with annual audit fees, our proxy for the demand for monitoring of the financial
reporting process. These compensation measures are also positively associated with our mea-
sure of audit committee chair expertise. Further, our empirical evidence indicates that the

3
level of compensation for audit committees has increased substantially in the post-SOX period
compared to the pre-SOX period.
Our regressions examining the differences in compensation between audit committees and
compensation committees are motivated by the idea that audit committees are more likely to be
affected by the demand for monitoring of the financial reporting process, including the implica-
tions of SOX, than compensation committees. By using compensation committees as a control
group, we control for systematic shocks to the market for outside directors and firm-specific
factors. The regression analyses using the difference in compensation support the predictions
that firms with a higher demand for monitoring of the financial reporting process are likely to
pay a higher level of total compensation to audit committees relative to compensation commit-
tees. Further, these analyses document statistically significant increases in the differences in
total compensation and in the cash retainer component between the two committees from the
pre- to the post-SOX period. Additional analyses indicate that the significant relations between
the audit committee pay premium and the demand for monitoring of the financial reporting
process exist only in the post-SOX period.
In studying pay for audit committee members, we control for firm-wide factors that affect the
overall level of director compensation by comparing pay for audit committee members to pay for
compensation committee members. Our regression analyses suggest a pay premium of $1,248
in total compensation earned by audit committee members relative to compensation committee
members in the post-SOX period, in contrast to almost identical pay of the two committees in
the pre-SOX period. We note that this finding is surprisingly small in economic magnitude given
the importance that regulators, politicians, and the media have placed on audit committees in
the post-SOX period. However, we argue that the mere presence of within-firm director pay
heterogeneity in the post-SOX period is of interest. Prior studies of director pay — see, for
example, Farrell et al. (2008) — have noted that firms design outside director compensation for
a group of directors, rather than tailoring compensation packages to the specific characteristics
or outside opportunities of individual directors. Variation in annual director pay at a given firm

4
typically comes through service on different committees or as committee chair or lead director.2
This approach to pay-setting seems to be quite different from that used for employees; in many
firms, there is substantial across-employee pay heterogeneity even within narrowly defined job
categories (see Baker, Gibbs and Holmstrom (1994)). We also find that following SOX, the
premiums paid to audit committee members relative to compensation committee members are
related to the firm-specific proxy for the demand for monitoring of the financial reporting
process and director-specific expertise in financial reporting. These results suggest that firms
are showing a willingness to deviate from the historically prevalent one-size-fits-all approach
to director pay, and to adjust director compensation packages to the specific characteristics of
individual directors. These findings may be particularly notable in light of recent accounting
scandals that have raised questions about the effectiveness of audit committees. Given the role
played by the audit committee in overseeing the firm’s financial reporting process, the incentives
provided by compensation arrangements for these directors seem to be taking on an increased
importance.
The remainder of the paper is organized as follows: In Section 2 we review prior studies
on compensation for outside directors, and develop hypotheses. We discuss the sample and
research methodology and provide descriptive statistics in Section 3. We discuss our empirical
approach and present the main empirical results in Section 4. Section 5 concludes the paper.

2 Related Research and Hypothesis Development

2.1 Related Research

Our research relates to two strands of literature: research on outside directors, and research on
audit committees.
The vast majority of research on outside directors has focused on the determinants of board

2
These within-firm sources of pay variation have typically been ignored in prior research. For example, Farrell
et al. (2008) and Linn and Park (2005) analyze pay for a representative director at each firm, and Yermack (2004)
notes that he ignores committee fees and meeting fees in order to keep the data collection and analysis tractable.

5
characteristics such as composition or size and on how these board characteristics affect firm
performance or observable actions of the board such as CEO turnovers, the takeover market
and executive compensation (see Hermalin and Weisbach (2003) for a review). Another line of
research on outside directors, motivated by Fama and Jensen’s (1983) conjecture that reputa-
tion and the market for directors are the primary incentive mechanisms for outside directors,
focuses on directors’ accumulation of seats on additional boards and directors’ turnover around
circumstances such as financial distress. Recently, with the trend toward more equity-based
compensation for outside directors, researchers have begun to examine compensation for out-
side directors. Notably, Yermack (2004) studies incentives for outside directors by following
a sample of directors for five years after election and tracking director compensation, changes
in equity ownership by directors, other board seats obtained and departures from the board.
In contrast to Fama and Jensen’s (1983) hypothesis, he finds that incentives from compensa-
tion and ownership account for more than half of total incentives for outside directors. This
indicates the importance of understanding compensation arrangements for outside directors.
Research on audit committees parallels research on boards of directors, and focuses on the
determinants of audit committee characteristics and how these characteristics are related to
financial reporting quality. Following the passage of SOX, a growing number of papers have
examined another feature of audit committees — the inclusion of a director with financial
expertise. For example, Defond, Hann and Hu (2005) examine the market reaction to the
appointment of financial experts on audit committees. However, few papers study the com-
pensation and incentives of audit committee members. One exception is Srinivasan (2005),
who investigates whether audit committee members are held accountable for financial report-
ing failure by looking at director turnover and the loss of board positions in other companies
when their companies experience accounting restatements. In general, however, the incentives
provided specifically to audit committee members have received little attention in the literature
on directors. This is likely because, as noted above, differences in within-firm director pay were
small and relatively uncommon until recently.
Recently, Linck, Netter and Yang (2008) extend the literature on outside directors by study-
ing the effects of SOX on various dimensions of corporate boards, including director workload,

6
structure, risk, compensation and turnover. Our paper is similar to Linck et al. (2008) in that
we explore the impact of regulatory rules on director compensation. However, given that the
primary focus of SOX is on strengthening firms’ financial reporting processes, the effects appear
to weigh most heavily on audit committees. Thus, we are able to investigate the broader issue
by examining a more targeted group of outside directors. More importantly, our paper also
addresses a more general question of the relation between compensation for audit committees
and demand for monitoring of the financial reporting process.

2.2 Hypothesis Development

Our primary objective is to examine cross-sectional variation in compensation for audit commit-
tees. In particular, we are interested in how compensation arrangements of audit committees
vary with the demand for monitoring of the financial reporting process in general and relative
to the compensation of members of other board committees. In this section, we discuss the
channels through which the demand might affect the level of audit committee compensation,
and develop hypotheses about this relation. We also discuss the effects of audit committee
director quality on audit committee compensation.
We expect that the demand for monitoring of the financial reporting process is high when
a firm has complex business operations and is subject to great risk of financial misstatement.
This setting requires outside directors who understand financial accounting issues in order to
effectively monitor the financial reporting process. One might expect that these firms have
a high demand for qualified directors and that the overall supply of such directors may be
relatively limited. We expect these forces to lead to higher compensation for directors serving
on audit committees of firms with a high demand for monitoring of the financial reporting
process.
In addition to being financially literate, the outside directors serving on audit committees of
firms with a high demand for monitoring of the financial reporting process are likely to spend
more time and effort learning, communicating, and understanding firms’ financial reporting
processes. Managerial productivity theory (Rosen (1992)) predicts a higher reservation wage

7
for directors serving on audit committees in this case.
Another channel through which a high demand for monitoring of the financial reporting
process might affect audit committee compensation is the increased risk of misstatement that is
likely to be present in such firms. Previous research (Srinivasan (2005)) has suggested that audit
committee members suffer reputation penalties as a result of financial reporting failure. Agency
theory predicts that a risk-averse agent requires a higher risk premium when risk exposure is
greater. These arguments all suggest that there will be a positive relation between compensation
paid to audit committees and the demand for monitoring of the financial reporting process.
The effects described above are likely to be exacerbated by recent financial reporting failures
and the concurrent passage of SOX. As mentioned in the introduction, SOX and the events
leading to its passage have raised the demand for monitoring of the financial reporting process
for all public companies: (1) SOX focuses on financial reporting and audit committees, requiring
that all members of the audit committee be independent, and that the company’s annual report
disclose whether a member of the audit committee is a financial expert. These requirements are
likely to lead to a decrease in supply and an increase in demand for qualified directors serving
on audit committees. (2) SOX and recent investor pressure have increased the workload of
audit committees substantially. Linck et al. (2008) find that audit committees meet more than
twice as often post-SOX as they did pre-SOX, and that the average number of directorships
held by a director on the audit committee decreased significantly. (3) SOX and the financial
reporting failures leading to SOX have also increased the risk exposure of audit committees.
Again, Linck et al. (2008) document that average Director and Officer insurance premiums
increased by more than 150%, and the proportion of firms that experienced audit committee
turnover has increased significantly in the post-SOX period compared to the pre-SOX period.
We therefore expect that compensation for audit committees increases in the post-SOX period.
Finally, it seems reasonable to expect audit committee compensation to be related to both
the demand for monitoring of the financial reporting process and the quality or expertise of
audit committees. If this is true, one might argue that the positive relation we hypothesize
between audit committee compensation and the demand for monitoring of the financial report-
ing process could also reflect a relation between compensation and audit committee quality.

8
Thus, we include a measure of audit committee financial expertise in addition to the demand
for monitoring of the financial reporting proxies in order to separately examine these effects in
our regressions. If the relation is actually driven by committee financial expertise, we expect
this effect to be captured by the expertise variable. We hypothesize that both audit committee
financial expertise and the overall demand for monitoring of the financial reporting process will
be positively related to audit committee compensation.

3 Sample, Research Methodology and Descriptive Statistics

3.1 Sample and Data

We identify the sample of outside directors using ExecuComp firms covering the period from
2000 to 2004.3 Following previous studies on outside directors (Adams (2003) and Yermack
(2004)), we exclude utilities (2-digit SIC 49) and financial institutions (1-digit SIC 6) from the
sample because these firms tend to have different corporate governance structures than firms
in non-regulated industries (Macey and O’Hara (2003)).
We then collect data on fees paid to members of audit and compensation committees of
the board from corporate proxy statements. Specifically, we collect data on the annual cash
retainer and equity retainer, the number of stock option grants, the number of stock grants,
and the meeting fees paid to directors serving as chair of the audit committee, members of
the audit committee, chair of the compensation committee, and members of the compensation
committee, respectively.4 Following Yermack (2004), we assume that when directors can choose

3
2000 is the first year that audit fee data is publicly available for US public companies.
4
Stock option awards include options and SARs; stock awards include common stock, restricted stock, de-
ferred stock units and phantom stock units; meeting fees include attending both board and committee meetings,
but special committee meeting fees are excluded. The following committees are defined as audit committee:
audit committee, audit and legal committee, audit review committee, audit and ethics committee, audit and
affiliated transactions committee, audit and compliance committee, audit and public policy committee. The
following committees are defined as compensation committee: compensation committee, executive salary com-
mittee, compensation and stock option committee, compensation policy committee, organization and compen-

9
between cash retainer and equity retainer, they choose the maximum amount of cash pay
permitted.5 For equity compensation awarded upon election as directors, we assume that the
awards are made equally through the terms of the directorship. However, we exclude one-
time/special/discretionary equity-based awards made on an irregular schedule, such as the one-
time equity award when a director joins the board. We also do not consider insurance plans,
retirement plans and charity matching contributions in the compensation packages. We value
stock grants by multiplying the number of shares by the closing stock price. For the value of
stock option awards, if the proxy statement discloses the number of stock options awarded, we
use the Black-Scholes method to compute the value of option awards assuming that firms issue
at-the-money options at the end of the fiscal year and with a seven-year maturity. Volatility
and dividend yields for each firm-year are obtained from the ExecuComp database. If the
proxy statement only discloses the dollar value of options, then we use the dollar value. In
addition, we obtain information on CEO characteristics (i.e., tenure, equity ownership and role
on board), other board-related data (e.g., director independence and audit committee chair
flag) from IRRC (the corporate governance database maintained by the Investor Responsibility
Research Center), and collect number of committee meetings during the year, audit fee data,
and the background information of audit committee chairs from proxy statements.
To be included in the sample, financial and stock return data must be available from Com-
pustat and CRSP, and data on the parameters of the Black-Scholes option pricing model must
be available from ExecuComp. This screening procedure leaves us with an initial sample of
5,465 firm-year observations. We conduct our basic regressions of the key relations with con-
trols for various firm-specific characteristics on this broader sample. For our analyses that also
control for audit committee financial expertise and those variables suggested by bargaining the-
ory to explain compensation for audit committees, we also require that certain CEO and board

sation committee, compensation and leadership committee, compensation, benefits and stock option committee,
compensation and incentive committee, etc.
5
The retainer paid for special committees formed for special reasons is excluded. We also note that results
are not sensitive to instead assuming that directors choose the maximum amount of equity pay permitted.

10
member data be available from IRRC. This reduces the sample to 3,295 firm-year observations,
an average of roughly 660 firms per year over the five-year sample period.6

3.2 Research Methodology

3.2.1 Variable Measurement

In this section, we describe the measurement of audit and compensation committee compensa-
tion (our dependent variables), and our proxies for the demand for monitoring of the financial
reporting process and audit committee quality.

Committee Compensation Measures Annual compensation for audit and compensation

committees is composed of five components: cash retainer, equity retainer, stock grants, option
grants and meeting fees. In our empirical analysis, we focus on total compensation, along with
the cash component of total compensation, cash retainer. Total compensation in the regression
analyses is measured as the sum of these components with the exception of meeting fees.7 Since
the compensation variables are highly right skewed, we use a logarithmic transformation. We
collect compensation information for both the audit and compensation committee chairs and
the other members of these committees. In many instances, committee chairs receive additional
compensation recognizing the typically substantial additional effort chairs exert in preparation
for meetings. In our main analyses, we focus on the chairs of audit committees (and chairs of

6
We note that the use of the ExecuComp and IRRC databases results in a sample of firms that are, on average,
larger in size (market value and sales) than the average Compustat firm. We note that our sample firms, with a
mean (median) market value of $7,600 (1,313) million and a mean (median) sales of $5,000 (1,156) million, are
considerably larger than the CRSP/Compustat firms, whose mean (median) market value and sales are $2,475
(98) million and $1,923 (99) million, respectively. The use of this sample, however, allows for comparability
with the large number of related studies that draw from the ExecuComp and IRRC databases. Nonetheless, our
results must be interpreted in the context of our relatively large sample firms.
7
We exclude meeting fees from the compensation variables to avoid a mechanical relation with one of our key
control variables, the number of audit committee meetings. We discuss this and other issues relating to the audit
meetings variable in section 4.

11
compensation committees, in the difference regressions). Results based on committee members
are similar.

Demand for Monitoring of the Financial Reporting Process Proxies We use two
proxies to capture the demand for monitoring of a firm’s financial reporting process. Our
first proxy is the amount of audit fees charged by the outside auditors for performing the
firm’s annual audit services (AuditFee). Our second proxy, PostSOX, captures the demand for
monitoring of the financial reporting process relating to a regulatory shift in the overall demand
for monitoring of the financial reporting process — the passage of the Sarbanes-Oxley Act. We
elaborate on these proxies below.
As discussed earlier, our main hypothesis is that audit committee compensation is positively
related to the demand for monitoring of the firm’s financial reporting process. One way to
examine this hypothesis would be to identify factors that affect the demand for monitoring
and regress compensation on those factors. While some of these factors are observable —
for example, size and industry — others, such as the risk of financial misstatement and the
complexity of the firm’s organizational structure, are more difficult for researchers to capture.
As a result, a regression of audit committee compensation on the observable firm-specific factors
that determine the demand for monitoring is likely to omit some relevant factors.
To incorporate unobservable factors that influence the demand for monitoring, we consider
the relation between audit committee compensation and the audit fees paid to auditors. We
argue that both are likely to be positively related to factors that increase the demand for
monitoring. For example, our earlier arguments suggest that firms with high risk of misstate-
ment or complex organizational structures will likely ask for more effort from audit committee
members, and thus pay higher compensation. Similarly, we note that the extent of work and
billings by the audit firm is expected to be linked with many firm-specific forces that give rise
to the demand for monitoring of the financial reporting process, including the complexity of
the business and the firm’s organizational structure, the strength of internal control systems,

12
financial reporting quality and litigation risk.8 These factors influence the overall transparency
and riskiness of the financial reporting process, which impacts the scope and complexity of the
annual audit activities, and the risk premium required by auditors. A regression of audit com-
mittee compensation on audit fees is therefore predicted to yield a positive coefficient, as audit
fees proxy for firm-specific variation in the demand for monitoring of the financial reporting
process.
Such a regression may suffer from simultaneity bias if auditor effort and audit committee
effort are substitutes or complements in the firm’s objective function. For example, auditor
effort might make audit committee effort more valuable; in this case, the firm’s optimal choice
of audit committee effort would be an increasing function of auditor effort. This would suggest
a direct causal link between audit committee compensation and audit fees. Econometrically,
this scenario would require modeling audit committee pay and audit fees as a system of simul-
taneous equations. As Wooldridge (2002) points out, however, a system of equations need not
be simultaneous, even when two choice variables are regressed on similar economic factors.9 It
is possible that ordinary least squares (OLS) is appropriate when both audit fees and audit
committee compensation are positively related to factors that increase the demand for moni-
toring. Accordingly, as we discuss in more detail later, we perform a Hausman test to assess
whether the endogeneity of audit fees in our setting poses a threat to the OLS estimates.
In determining annual audit fees from corporate proxy statements, we include only fees
directly related to auditing services (including internal control analyses) and exclude fees related
to supplemental and tax work. We scale audit fees by the square root of total asset value of

8
See, for example, prior work by O’Keefe, Simunic and Stein (1994), Bell, Landsman and Shackelford (2001)
and Danielsen, Van Ness and Warr (2007).
9
See chapter 9 of Wooldridge (2002) for a discussion of structural models and systems of simultaneous equa-
tions. Wooldridge (2002) cites Biddle and Hamermesh (1990) as an example of a study that considers the
responses of two choice variables to the same factors. Biddle and Hamermesh (1990) conduct an OLS regression
of one choice variable (minutes per week spent sleeping) on another (minutes per week working). They note that
their results suggest that the time spent sleeping is changed by the indirect effects of the economic factors on
decisions about work time.

13
the firm based on the findings of Simunic (1980) and Kinney, Palmrose and Scholz (2004) that
the square root function best captures the relation between audit fees and assets. Size deflation
allows us to ensure that our findings are not driven solely by the well established association
between compensation and size (see, for example, Rosen (1992) and Murphy (1985)).10
In selecting total assets as a size deflator, we are careful not to purge our demand for
monitoring proxy of its key attributes. Audit fees can be viewed as the product of quantity
(Q) and price (P) of audit labor hours, where Q captures the number of audit hours in the
engagement and P reflects the audit firm’s price per unit of auditing. The price component is
further impacted by both the mix of labor units (i.e., class of labor) and billing rates for each
class of labor chosen by the audit firm. We can thus expand the basic audit fees equation to
be:
Total Audit Fees =

n
X
{z for class of labor }i × |Billing rate per hour
|Hours of labor units {z
for class of labor i
}
i=1
Quantity Price

where i = audit class of labor (e.g., staff, senior, partner).

We argue that both the quantity and price components of audit fees chosen by the audit
firm are impacted by firm size, complexity and risk. The empirical findings of O’Keefe et al.
(1994) largely support these relations. Thus, deflating audit fees by firm size preserves the key
elements of interest — firm complexity and risk — through both the price and quantity in our
proxy for the demand for monitoring of the financial reporting process.
Our sample period includes the years 2000 to 2004. This sample period allows us to develop
an additional proxy for the demand for monitoring of financial reporting arising from an im-

10
Because size may also capture the complexity of the firm’s financial reporting system, one might argue that
the undeflated audit fee variable is an appropriate demand proxy. While our primary model includes a size
variable (i.e., market value) in the regressions, we address this issue by also conducting our analyses using the
logarithm of undeflated audit fees as the demand proxy. All regression results using the undeflated audit fees
measure are qualitatively similar to those in Tables 5 through 7.

14
portant external regulatory event — the passage of the Sarbanes-Oxley Act. While audit fees
in the post-SOX period can capture some aspects of increased demand for financial monitoring
due to SOX — for example, requirements relating to internal control disclosures and testing
— it is possible that factors relating to the enhanced monitoring environment, greater board
accountability, and increased credential requirements directed at audit committee members are
not fully reflected in the audit fee variable. Following SOX and the events leading to its pas-
sage, audit committee members are also likely to spend more time communicating with outside
auditors, as well as additional time and effort communicating and monitoring internal auditors
and financial executives of the company. SOX was signed into law on July 31, 2002; thus we
define our PostSOX indicator variable to equal zero for years 2000 and 2001, and to equal one
for years 2002 through 2004.11

Audit Committee Expertise in Monitoring of the Financial Reporting Process We

develop a measure, AC Expertise, that captures the extent of audit committee expertise based
on information about the audit committee chair’s background described in corporate proxy
statements. In classifying the background of audit committee chairs, we are guided in part
by both the proposed and final definitions of financial expertise of audit committee members
under the Sarbanes-Oxley Act. Initial SOX proposals defined a financial expert as a director
with prior or current experience as a public accountant, auditor, principal or chief financial
officer, controller or chief accounting officer. Final regulations expanded this definition to in-
clude a broader set of experience, including supervision or oversight of employees with financial
reporting duties. This broader category would include corporate presidents and chief executive
officers. We also consider the findings of Defond et al. (2005), which highlight the distinction be-
tween accounting and non-accounting financial experts. Using a sample of 702 announcements
of audit committee director appointments over the period 1993 to 2002, Defond et al. (2005)

11
The use of annual data determines how we partition the sample period. We find qualitatively similar results
for all of our regression analyses (1) when we exclude year 2002 observations in the empirical tests to address
the concern that the year 2002 is a transition year, and (2) when we define the post-SOX period as years 2003
and 2004.

15
document a significant positive market reaction to announcements of appointing of account-
ing financial experts, while the market reaction to similar announcements of non-accounting
financial experts is not significant.
Using biographies included in corporate proxy statements, we categorize the employment
experience and background of audit committee chairs as follows:

• Non-financial director (Non Financial Expert) — audit committee chairs with no direct
financial training or experience. This category includes directors with responsibility to
oversee the financial reporting process but who do not have direct experience in a financial
position themselves. AC Expertise takes a value of 1 for these directors.

• Finance financial expert (Expert Finance) — audit committee chairs with financial train-
ing and experience, including chief financial officers, vice-presidents of finance, and finance
professors. AC Expertise takes a value of 2 for these directors.

• General accounting financial expert (Expert Accounting General) — audit committee chairs
with accounting training and experience, including certified public accountants (CPAs),
chief accounting officers, controllers, accounting professors and those who served on ac-
counting standard or other oversight boards. Accounting experts with employment ex-
perience with a Big 5(4) accounting firm are excluded; these directors are separately
considered in the next category. AC Expertise takes a value of 3 for these directors.

• Accounting expert with Big 5(4) employment experience (Expert Accounting Big 5) —
audit committee chairs with employment experience at a Big 5(4) accounting firm.12
This category is designed to capture a higher quality accounting expert, as Big 5(4)
accountants are more likely to have direct experience with the financial reporting process
of public firms. AC Expertise takes a value of 4 for these directors.

12
Big 5(4) refers to the five (four) largest global professional accounting firms that perform a substantial
majority of audits of publicly traded firms. The number of global firms was reduced from five to four during our
sample period due to the collapse of Arthur Andersen in 2002 following Enron.

16
 Our classification highlights firms that have explicitly chosen an audit committee chair with
financial reporting expertise. We note that our classifications of both finance and accounting
experts are narrower than those of both the proposed and final SOX regulations. We have
attempted to identify firms that have chosen directors with greater ability to specifically monitor
the financial reporting process vs. those with more broad finance skills and training.

3.2.2 Regression Specifications

Our first set of analyses explores factors associated with the level of audit committee com-
pensation. Since our tests use panel data, we include firm fixed effects in our regressions and
estimate robust standard errors to mitigate potential problems with the panel data. We include
AuditFee and PostSOX to capture the demand for monitoring of the financial reporting process.
Similar to Linck et al. (2008), we select control variables mainly based on agency theory
and bargaining theory. While agency problems are generally defined as the conflict between
shareholders and managers, agency problems could also exist between shareholders and outside
directors. Agency theory suggests that compensation should provide incentives to align the
interests of the parties. Thus, it predicts relations between compensation and effort, firm
performance, job complexity, and leverage.
We use the number of times the audit committee of the board of directors met during the
year (AuditMeet) disclosed in the firm’s proxy statement to reflect the effort and workload of
audit committees. One might argue that the number of audit committee meetings is also an
indicator of the overall demand for monitoring of the firm’s financial reporting process. Firms
with greater demand for monitoring of the financial reporting process are those that are willing
to incur the increased costs of a more active audit committee. Menon and Williams (1994)
document that the number of annual audit committee meetings is positively associated with
firm size, suggesting a connection between monitoring complexity and the need for greater audit
committee involvement. The number of audit committee meetings is also often used as a proxy
for audit committee diligence.13

13
See Vera-Munoz (2005) and DeZoort, Hermanson, Archambeault and Reed (2002) for insightful discussions

17
 We use industry-median-adjusted stock returns and industry-median-adjusted ROA (Return
on Assets) to control for the potential impact of firm performance on compensation. We control
for firm size (measured as the logarithm of market value of equity), R&D (measured as R&D
expenditures deflated by total assets), and market-to-book ratio (measured as book value of
assets minus book value of equity plus market value of equity divided by book value of assets).
We define leverage as short term and long term debt scaled by total assets, and we capture cash
constraints and the tax advantages of options by including a zero dividend dummy and a net
operating loss carryforward dummy (Yermack (2004)).14 Finally, in regressions without firm
fixed effects, we include a control for an increased demand for monitoring that is driven by the
strength of the firm’s internal controls over the financial reporting process. MatlWeak takes a
value of 1 for all sample firm-years if the firm disclosed the existence of a material weakness in
internal control under SOX.15
Alternatively, bargaining theory suggests that director compensation is determined by the
negotiation process between the board and the CEO (see Hermalin and Weisbach (1998) for
theory, and see Ryan and Wiggins (2004) for empirical evidence). Following that literature, we
use the percentage of independent directors on the board and the ownership of outside directors
to measure the board’s negotiation power. To capture the CEO’s bargaining power, we use CEO
tenure, ownership, and a dummy variable equal to one if the CEO chairs the board.
Our second set of regression analyses examines audit committee compensation relative to
compensation committee members. One potential challenge in conducting multivariate analy-
ses is the possibility of correlated omitted variables. Because some data are unobservable or
unavailable, we cannot include all firm-specific variables in the regression model. It is possible

and reviews of the related literature on audit committee effectiveness, including diligence.
14
The zero dividend dummy is equal to one if a firm pays a dividend (Compustat data26). The net operating
loss carryforward dummy is equal to one if a firm has a net operating loss carryforward (Compustat data52).
15
We thank Doyle, Ge and McVay for sharing their dataset of firms disclosing material internal control weakness
under Sections 302 and 404 of SOX. Doyle, Ge and McVay (2007) use SEC electronic filings of annual 10-Ks
and subscription data from Compliance Week to identify material weakness disclosures by firms over the period
August 2002 through the end of our sample period.

18
that these unobservable factors might contaminate the statistical relationship. To address this
concern, we run difference regressions that analyze the compensation variables for audit com-
mittees relative to compensation committees. Thus, we are able to use outside directors serving
on compensation committees as a control group to control for unobservable firm-specific factors
that may be associated with board member compensation across firms.
It is possible that other factors occurring around the time of the SOX legislation, includ-
ing general macroeconomic conditions, pressure from more active institutional investors, and
changes in the public’s view of corporate governance, may have contributed to the passage of
SOX. However, given that the primary focus of SOX is on firms’ financial reporting processes,
directors on the audit committee are likely to be affected more by SOX. As such, another
appealing feature of the difference specification is the use of outside directors serving on the
compensation committee as a control group to control for these factors.16

3.3 Descriptive Statistics

Table 1 presents summary statistics relating to the compensation of audit committee members.17
Panel A presents the level of compensation and the key components of the compensation pack-
ages for outside directors serving as chair of the audit committee and other members of the
audit committee. We observe that the equity component (equity retainer, options and equity

16
While SOX focuses mainly on the financial reporting process, it is possible that other SOX requirements
(e.g., independence of compensation committee members) could impact the level of compensation committee pay
in some firms. We would expect any such effect to be less substantial than the effect on audit committees and
not linked with the demand for monitoring of the financial reporting process. However, if SOX requirements
do increase compensation committee pay, any pay differential for audit committee members would be reduced,
making it harder for us to document a link between the audit committee pay differential and the demand for
monitoring. We note that the recent expanded Compensation Discussion and Analysis disclosures in corporate
proxy statements required by the SEC, which would likely have a greater impact on the risk and required effort of
compensation committee members, were implemented subsequent to our 2000 - 2004 sample period (specifically,
these disclosures were required in proxy statements filed after December 15, 2006).
17
All compensation, audit fees, and price-level variables are in real (vs. nominal) terms, adjusted using the
GDP price deflator index with 2004 as the base year.

19
grants) of total compensation is, on average, greater than the cash component (cash retainer
and meeting fees). We also note that the average and median compensation (in total and by
component) is slightly greater for the audit committee chair than for other members of the
audit committee. For example, the average (median) total compensation is $140,912 ($97,000)
for the audit committee chair and $135,451 ($91,459) for other members.
Panel B shows the time series variation in compensation and its components from 2000 to
2004 for the chair of the audit committee. The average (median) total compensation for the
audit committee chair is $138,474 ($104,651) in the post-SOX period, compared to $145,308
($82,515) in the pre-SOX period. Despite the decline in average total compensation, the com-
ponents of total compensation generally increase over time. We note significant increases (at
better than the 1% level) from the pre-SOX to the post-SOX period in the levels of each of the
components of total compensation, with the exception of the value of options, which experi-
enced a decline in value from the pre-SOX to the post-SOX period. This reduction in the value
of options granted to committee members is due primarily to the significant drop in the value
of stock options granted in 2002. The component with the largest percentage increase is the
cash retainer: the average total cash retainer is $32,394 in the post-SOX period, compared to
$24,143 in the pre-SOX period.
Table 2 provides summary compensation statistics for compensation committees. Panel
A presents the level of total compensation excluding meeting fees and the level of total cash
retainer for outside directors serving as chair of the compensation committee and other members
of the compensation committee. When we compare these statistics for compensation committees
with those for audit committees in Table 1, we note that outside directors on audit committees
are in general paid more than outside directors on compensation committees. For example,
mean (median) total compensation for the chair of the compensation committee is $133,311
($87,946), compared to $140,912 ($97,000) for the audit committee chair.
Panel B shows the time series variation in compensation variables from 2000 to 2004 for
the chair of the compensation committee and the difference between audit and compensa-
tion committee chairs. We define the difference variables as compensation variables for audit
committees less compensation variables for compensation committees. When we compare the

20
inflation-adjusted levels of compensation for audit committees and compensation committees,
we note that while the level of compensation for compensation committees is comparable to
that for audit committees in the pre-SOX period, the level of compensation for audit commit-
tees exceeds that of compensation committees in the post-SOX period. The mean (median)
difference in total compensation excluding meeting fees between the two committees is $13 ($0)
in the pre-SOX period, and $1,910 ($0) in the post-SOX period. The increase in the differ-
ence from the pre-SOX period to the post-SOX period is statistically significant at better than
the 1% level. We note that while the $1,910 premium is small in magnitude, the presence of
within-firm director pay heterogeneity in the post-SOX period appears to represent a shift in
director pay patterns. We also note that the pay premium in those firms that do deviate from
the historically prevalent uniform pay to directors is larger than the mean of $1,910, given that
the median of the pay premium is zero.
Table 3 displays the summary statistics (Panel A) and the time-series trend (Panel B) of
audit fees, board/committee meetings, and audit committee chair expertise. Panel A notes
that the average (median) number of audit committee meetings is 6.6 (6.0) per year, which
exceeds that of the compensation committee (4.3 (4.0)). Consistent with Linck et al. (2008),
we find overall increases in the number of annual committee meetings over the sample period
(2000 - 2004). Panel B shows that the average number of total committee meetings is 16.88 in
the post-SOX period, significantly higher than the 11.38 meetings in the pre-SOX period. The
number of audit committee meetings shows a similar impressive increase: the average number
of audit committee meetings is 7.71 in the post-SOX period, compared to 4.52 in the pre-SOX
period.18 These differences are statistically significant at better than the 1% level. While we
also observe a significant increase in the number of compensation committee meetings from the
pre-SOX to the post-SOX period, the magnitude of the increase is much smaller (average of 3.8
meetings pre-SOX vs. 4.6 in the post-SOX period) than that of the audit committee. Another
notable trend is in audit fees: Audit fees have increased significantly from an average of $1.164

18
The increase in the number of audit committee meetings per year is likely due, in part, to the new required
communication between auditors and audit committees.

21
million in the pre-SOX period to $2.289 million in the post-SOX period, and the ratio of audit
fees to the square root of total assets has increased significantly from 0.61 in the pre-SOX period
to 1.17 in the post-SOX period (see Ghosh and Pawlewicz (2008) and Griffin and Lont (2008)
for similar findings on changes in audit fees around SOX).
Table 3 also reports significant increases in the number of audit committee chairs that have
both finance and accounting expertise, with the largest increase in Expert Accounting Big5,
the category of audit committee chairs with employment experience at a Big 5(4) accounting
firm. While the vast majority of sample firms continue to have audit committee chairs without
financial expertise, the percentage of firms with non-financial chairs has declined significantly
from 83% in the pre-SOX period to 73% in the post-SOX period. The percentage of firms with
finance financial experts increased from 11% in the pre-SOX period to 15% in the post-SOX
period. The percentage of firms with accounting experts (both general and Big 5(4)) doubled
from 6% to 12% from the pre-SOX period to the post-SOX period with the largest increase in
the Big 5 expert category (increased from 3% to 7%). The increases in the percentage of experts
in each category result in the aggregate expertise variable, AC Expertise, increasing from 1.27 in
the pre-SOX period to 1.45 in the post-SOX period. These increases are statistically significant
at better than the 1% level, suggesting that more boards have chosen to increase the level of
financial expertise of their audit committees by appointing directors with finance and, especially,
accounting experience after the passage of SOX.
Table 4 lists summary statistics for the control variables capturing the determinants of
directors’ compensation suggested by contracting theory and the bargaining model. With regard
to the determinants related to contracting theory, we first note that our sample firms perform
better than their industry peers, with an average industry-adjusted accounting return of 6%
and industry-adjusted stock return of 17%.19 On average, our sample firms spend 4% of their
total assets on research and development. The mean (median) market value is $7.60 ($1.31)
billion, and the mean (median) market-to-book is 2.06 (1.59). In addition, the average firm

19
Industry adjustments are computed using CRSP/Compustat firms as a comparison group, defining industry
based on two-digit industry codes.

22
leverage is 0.19, 46% of the sample firms issue dividends, and 36% of the sample firms have a
net operating loss carryforward. Finally, 16% of our sample firms disclosed material weaknesses
in internal controls after the passage of SOX.
Turning to the variables suggested by the bargaining model literature, we find that the mean
percentage of independent directors on the board is 68%, and these outside directors hold on
average 3.8% of the equity of the firm. Table 4 also notes that the average tenure of a CEO in
the sample is 8 years, 66% of CEOs also chair the board, and these CEOs’ average ownership
is 1.93%.

4 Empirical Results

4.1 Hausman Test for Endogeneity

As discussed earlier, we include audit fees in the audit committee compensation regression as
a proxy for the demand for monitoring of the financial reporting process. Audit fees and audit
committee compensation are predicted to respond to the same set of economic factors. We
note, however, that OLS is inappropriate if audit fees are endogenous in the audit committee
compensation regression. In this case, audit fees would be correlated with the residual from
the regression, resulting in inconsistent estimates of the regression coefficients. To address this
possibility, we run a Hausman test to determine whether audit fees are endogenous in our
compensation regressions.
The Hausman test provides a formal test for the endogeneity of a regressor by comparing
the OLS estimate with a two stage least squares (2SLS) estimate. As Wooldridge (2002) notes,
if the potentially endogenous variable is uncorrelated with the residual from the regression, then
OLS and 2SLS estimates should differ only by sampling error. Consequently, the first step in
running a Hausman test is to identify one or more exogenous instruments that will allow us to
run 2SLS. An instrumental variable needs to satisfy two requirements: the instrument should
be partially correlated (after the other exogenous variables in the regression have been netted
out) with the potentially endogenous variable, and the instrument should be uncorrelated with
the regression residual (Wooldridge (2002), Greene (2000)). While the first requirement can be

23
tested statistically, the second requirement needs to be satisfied on theoretical grounds.
The endogeneity concern in our setting stems from the possibility that audit fees are cor-
related with the residual from the audit committee compensation regression. In considering
potential instruments, we note that many firm-level variables are correlated with audit fees,
but they are also likely to be correlated with audit committee compensation. For example, we
would expect a company with M&A or restructuring transactions to pay both higher audit fees
and higher audit committee compensation as a result of these transactions. Consequently, we
will have to go beyond the traditional audit fee model to identify an instrument.
As our instrument, we use an indicator variable for whether the firm has a December fiscal
year end.20 As prior work on audit fees has found (see, for example, Francis (1984) and Craswell
and Francis (1999)), audit fees are lower, all else equal, for firms with “off-peak” fiscal year ends.
Francis (1984) hypothesizes that the higher peak fees relate to the auditor production function;
higher audit fees for these firms appear to reflect the increased auditor workload during the
busy season. A majority of U.S. firms (63% in our sample) have December fiscal year ends,
so we use December fiscal year end to capture auditors’ peak period. We do not expect a
corresponding response to calendar year-end busy season in audit committee compensation.
Unlike auditors, directors tend to serve on relatively few firms’ boards (for example, Yang and
Krishnan (2005) find that audit committee members average 1.3 outside directorships in their
sample of randomly chosen Compustat firms). Thus, while auditors’ busy season is determined
by the fiscal year ends of auditees, which tend to be concentrated in December, any additional
effort required by audit committee members will be related to the firm’s own fiscal year end.
In the first stage of 2SLS, we regress audit fees on all of the explanatory variables from
the second stage (i.e., the explanatory variables other than audit fees in our tabulated regres-
sions) and the December fiscal year end instrument.21 The December fiscal-year indicator is

20
Variation in fiscal year ends has been used as an identification technique by other researchers, most notably
Oyer (1995). He uses variation in fiscal year ends to identify incentive effects of nonlinear incentive contracts.
21
As noted in Larcker and Rusticus (2008) (footnote 8), if we are only interested in one equation in a potentially
simultaneous system, we do not need to estimate both equations with exogenous instruments. The simultaneous

24
significantly positive with a t-statistic of 10.04 in this regression, indicating that the instru-
ment is partially correlated with the potentially endogenous variable, as required for a valid
instrument.22 The R2 in the first stage regression is 0.20. In the second stage, we include the
predicted value of AuditFee in the compensation regression and compute the 2SLS estimates.
We then conduct a Hausman test that compares the OLS and 2SLS estimates of AuditFee to
test the null hypothesis that this variable is exogenous. The Hausman test fails to reject the null
hypothesis that audit fees are exogenous in both the levels and difference regressions and for
both total compensation and cash retainer. For example, in the levels (difference) regression
of total compensation that controls for audit committee expertise, the test statistic is 0.113
(0.037), corresponding to a p-value of 0.74 (0.85), which indicates that the audit fee variable
is uncorrelated with the residual from the audit committee compensation regression.23 Similar
results hold for the Hausman tests on AuditFee in our other specifications. These results from
Hausman tests indicate that OLS will generate consistent estimates in the audit committee
compensation regression. As such, we use OLS in the analysis that follows (see Wooldridge
(2002) and Wooldridge (2004)).

4.2 Levels Regression Results

We proceed by estimating an OLS regression for the compensation variables of interest. Columns
(1) – (3) of Table 5 present our first set of regression analyses, which examine the relation be-
tween the level of total compensation and proxies for the demand for monitoring of the financial
reporting process. Given that there is a mechanical relation between meeting fees and Audit-

equation estimator is identical to an independent application of the 2SLS procedure to each equation. See also
Wooldridge (2002), p. 192.
22
Because fiscal year ends may be similar for firms in a given industry, we also run 2SLS with industry fixed
effects. The t-statistic on December fiscal year end is 7.73 when indicators for two-digit industry are included in
the first stage.
23
We conduct the Hausman test on a levels regression with industry fixed effects rather than firm fixed effects,
since the December fiscal year end indicator would be subsumed by firm fixed effects.

25
Meet, we use the level of total compensation excluding meeting fees in all regression analyses.24
We predict that firms with a higher demand for monitoring of the financial reporting process
are likely to pay higher compensation to audit committees. In Column (1), we consider the
demand for monitoring of the financial reporting process proxies and also include firm level
control variables suggested by contracting theory.25 We find a significantly positive relation be-
tween the level of total compensation and our firm-specific proxy for the demand for monitoring
of the financial reporting process, AuditFee. We also document a significantly positive relation
between the level of total compensation for audit committees and the post-SOX indicator vari-
able, PostSOX, which proxies for an external shift in the overall demand for monitoring of the
financial reporting process.
In addition to evaluating the statistical significance of our results, we can use the coefficients
from the regression to calculate economic effects. Using the estimates in Column (1), we
compute that the predicted total compensation of the audit committee chair is $78,523 for a
firm in the 10th percentile of AuditFee (0.28), and $83,756 for a firm in the 90th percentile of
AuditFee (1.89), where all other explanatory variables take their median values.26 Again using
the estimates in Column (1) to illustrate the economic effects, the predicted total compensation
of the audit committee chair of a median firm (i.e., holding all other explanatory variables at
their medians) is $71,084 in the pre-SOX period, and $79,907 in the post-SOX period. While
one might argue that these numbers are small in economic magnitude compared to the total
wealth of these directors, Adams and Ferreira (2008) present evidence that directors are more
likely to attend board meetings when board meeting fees are higher, suggesting that corporate

24
We obtain qualitatively similar results when we include meeting fees in the level of total compensation as
the dependent variable.
25
Given that we estimate the OLS regression by including firm fixed effects, the MatlWeak dummy is subsumed
by firm fixed effects. In an alternative specification using industry fixed effects, we find the results on MatlWeak
are similar to those from the difference regressions presented later.
26
Because we calculate these values with all other explanatory variables at their median values, these numbers
appear low in comparison to the descriptive statistics presented earlier. Similar calculations using the means of
other variables produce values more similar to the means of our descriptive statistics.

26
directors appear to perform for even very small financial rewards. As such, our results are
consistent with the prediction that firms respond to the increased demand for monitoring of
the financial reporting process from both firm-specific and external forces by providing more
financial rewards.
We also note a significantly positive coefficient on AuditMeet in Column (1), consistent
with the notion that audit committees are paid for their time and effort. While AuditMeet
is not our main variable of interest, its economic effects on audit committee compensation are
similar to those of AuditFee. Using the estimates in Column (1), we compute that the predicted
total compensation of the audit committee chair is $77,313 for a firm in the 10th percentile
of AuditMeet (3), and $84,425 for a firm in the 90th percentile of AuditMeet (11), where all
other explanatory variables take their median values. Recall that the relation between audit
committee total compensation and AuditMeet is not simply a mechanical effect, since meeting
fees paid to committee members are excluded from the computation of total compensation.27
We observed earlier that AuditMeet could be viewed as an alternative proxy for the demand
for monitoring of the financial reporting system. The number of audit committee meetings
captures the firm’s response to a need for additional monitoring by the audit committee. We
note, however, that this conclusion should be interpreted cautiously due to potential concerns
about the endogeneity of the number of audit meetings. To assess these concerns, we also
consider a version of our model of the audit committee compensation/demand for monitoring

27
We also consider the more subtle mechanical effect that some firms may not have explicit meeting fees, but
instead may pay a cash retainer based on the expected number of audit meetings. Approximately 20% of our
sample firm-years do not have a separate disclosure of meeting fees, suggesting that these firms either do not
provide additional compensation for meeting attendance or the meeting fees are implicit in the cash retainer.
In the latter case, our measure of total compensation excluding explicit meeting fees may still include implicit
meeting fees, confounding our goal of measuring total compensation without meeting fees. Since firms that
do not pay or separately disclose meeting fees do so uniformly for all board members, our primary difference
regressions effectively control for this concern. The issue, however, may be present in our levels regression. As a
sensitivity test, we conduct our levels regression analyses after excluding the observations for which meeting fees
are not separately reported in proxy statements. We find that our results are robust to the exclusion of these
firm-years.

27
of financial reporting relation that excludes AuditMeet. We find that the coefficients are similar
and the statistical significance of both AuditFee and PostSOX remains unchanged when we
exclude AuditMeet from our models in our primary analyses. This suggests that the inclusion
of AuditMeet does not have a material adverse econometric impact on the interpretation and
significance of the coefficients of our key demand proxies. Finally, with regard to other control
variables, we find that larger firms (high LogMV) and firms with higher investment opportunities
(high M/B) and leverage award their audit committees higher total compensation.28
As discussed before, it seems reasonable to expect both the demand for monitoring of the
financial reporting process and the quality of audit committees to be related to compensation
arrangements of audit committees. To separately examine these effects, we additionally include
a measure of audit committee quality, AC Expertise, in Column (2). The results show that
AC Expertise is significantly and positively related to the level of total compensation. At the
same time, the coefficients on the key proxies for the demand for monitoring of financial report-
ing remain significantly positive. These results support the notion that both audit committee
quality and the overall demand for monitoring of the financial reporting process are positively
related to the level of audit committee compensation.
We also include control variables suggested by the bargaining model in Column (3). Consis-
tent with prior research (Ryan and Wiggins (2004)), our results indicate that directors serving
on outsider dominated boards (high BdInd%) receive more compensation. This result is consis-
tent with the notion that director compensation varies systematically with barriers to effective
monitoring. We note that the inclusion of these control variables does not alter the results
of the proxies for the demand for monitoring of financial reporting and the quality of audit
committees.
We continue our analysis by examining the level of total cash retainer. Columns (4) – (6)
report our results. In all three columns, we find a positive and statistically significant relation

28
As a robustness check, we have replaced LogMV with MV, MV-Squared, and MV-Cubed. We obtain qual-
itatively as those reported in the paper, suggesting that our results are not affected by the functional form of
MV.

28
between the level of total cash retainer for audit committees and the two proxies for the demand
for monitoring of the financial reporting process, AuditFee and PostSOX. We also note that the
coefficients in Columns (4) – (6) are higher and more significant than those in Columns (1)
– (3). Using the estimates in Column (4) to present economic effects, we compute (1) the
predicted cash retainer of the audit committee chair is $24,698 for a firm in the 10th percentile
of AuditFee (0.29), and $27,761 for a firm in the 90th percentile of AuditFee (1.91), where all
other explanatory variables take their median values; and (2) the predicted cash retainer for
the audit committee chair of a median firm (i.e., holding all other explanatory variables at their
medians) is $22,033 in the pre-SOX period, and $25,496 in the post-SOX period.
Similar to the total compensation analyses, we find that AC Expertise is significantly and
positively related to the level of cash retainer. Regarding other explanatory variables, we
continue to observe significantly positive coefficients on AuditMeet and firm size (LogMV). We
note the following differences in control variables from those reported earlier: (1) The coefficient
on industry-adjusted market returns is now negative and significant, suggesting that the weak
positive correlation between total compensation and market returns is driven by the equity
compensation component. (2) The coefficient on M/B is now negative and loses significance,
in contrast to the positive and significant coefficients reported earlier, supporting the view that
growth firms are more likely to use equity-based compensation relative to cash compensation.
(3) The zero dividend dummy and the leverage variable are positively associated with the
level of total cash retainer, supporting predictions from financial contracting theory (John
and John (1993)) that firms award more equity compensation when they face a scarcity of
cash (DivDum equal to 0), and when the conflict between creditors and shareholders is not
severe (low Leverage). (4) The CEO/Chair dummy is now negative and significant. These
results suggest that the demand for monitoring of the financial reporting process also plays an
important role in determining the cash retainer component of audit committee pay.

29
4.3 Difference Regression Results

In our next set of regressions, we employ a unique feature of our dataset to control for correlated
omitted variables. Since we have compensation data for both audit committees and compen-
sation committees, we are able to use compensation committees to control for unobservable
firm-specific variables. Thus, we conduct a difference regression in which the dependent vari-
ables now capture the differences between audit committee compensation and compensation
committee compensation. In our base case, we include both the proxies for demand for moni-
toring of the financial reporting system and control variables suggested by contracting theory
(Column (1)). Similar to Table 5, we also estimate the difference model with AC Expertise
(Column (2)) and other firm-specific controls suggested by the bargaining model (Column (3)).
Columns (1) – (3) of Table 6 present the results when the difference in the level of total
compensation excluding meeting fees is the dependent variable. In all models, we find that the
difference in the level of total compensation is positively related to AuditFee, the firm-specific
proxy for the demand for monitoring of the financial reporting process, and has increased
significantly in the post-SOX period compared to the pre-SOX period. These results support the
prediction that firms with a higher demand for monitoring of the financial reporting process are
likely to pay a higher level of total compensation to audit committees relative to compensation
committees.
Similar to the level regressions, we use the coefficients from the regression to calculate
economic effects. Using the estimates in Column (1), we compute that the predicted difference
in total compensation between audit committee chairs and compensation committee chairs
is $1,089 for a firm in the 10th percentile of AuditFee (0.28), and $1,675 for a firm in the
90th percentile of AuditFee (1.89), where all other explanatory variables take their median
values. Again using the estimates in Column (1) to illustrate the economic effects, the predicted
difference in total compensation between audit committee chairs and compensation committee
chairs of a median firm (i.e., holding all other explanatory variables at their medians) is close
to 0 in the pre-SOX period, and $1,248 in the post-SOX period.
We also include our measure of audit committee quality, AC Expertise, in the difference

30
regressions. Because it is not clear ex ante how audit committee quality will affect the dif-
ferences in compensation across committees, including this variable allows us to address two
plausible scenarios. First, we note that the definition of audit committee quality is driven by
recent regulatory calls for financial experts on the audit committee. Although recent regulation
has specified that compensation committee chairs be independent, there is not a comparable
measure of compensation committee chair quality. As a result, the quality issue appears to be
specific to audit committees, so a higher quality audit committee may be associated with a dif-
ferential compensation level between the two committees. Second, one might argue that firms
with higher quality audit committees are more likely to also have higher quality compensation
committees. In this case, the audit committee quality variable will not be related to differential
audit committee compensation.
Column (2) presents the results when we include AC Expertise in the difference regression
model. The results show that AC Expertise is significantly and positively related to the differ-
ence in the level of total compensation, while the coefficients on the proxies for the demand
for monitoring of financial reporting remain significantly positive. These results are consistent
with the expectation that firms with high quality audit committees pay a higher level of to-
tal compensation to audit committees relative to compensation committees. When we include
other control variables in Column (3), our inferences regarding the proxies for the demand for
monitoring of financial reporting and audit committee quality are unchanged.
The results for the difference in the level of cash retainer are presented in Columns (4) – (6).
We find similar results as those presented in the total compensation regressions of Columns (1) –
(3), while we note that the coefficients on AuditFee, PostSOX, and AC Expertise in Columns
(4) – (6) are of higher magnitudes and significance levels. We also observe that the coefficients
on AuditMeet continue to be positive and significant in both the total compensation (Columns
(1) – (3)) and cash retainer models (Columns (4) to (6)), consistent with the notion that audit
committee pay captures the time and effort of committee members.
The results in Table 6 indicate that audit committee compensation is significantly differ-
ent from compensation committee compensation in the post-SOX period. In our final set of
regressions, we investigate whether these post-SOX changes in the audit committee pay dif-

31
ferential can be explained, in part, by AuditFee and AC Expertise. In other words, do firms
with a greater firm-specific demand for monitoring of financial reporting and with a higher
director-specific expertise in financial reporting offer a larger audit committee pay premium in
the post-SOX period? We conduct separate regressions for the pre-SOX and post-SOX periods
and report these results in Table 7. We find positive and significant coefficients on AuditFee
and AC Expertise only in the post-SOX period for total compensation and cash retainer. The
pre- and post-SOX coefficients are significantly different from each other in both regressions.
The results in Table 7 suggest that the significant relations between the audit and compen-
sation committee pay premium and AuditFee, and between the pay premium and AC Expertise
reported in Table 6, are attributable to board compensation decisions in the post-SOX pe-
riod. While the insignificant coefficient on audit fees in the pre-SOX period in the difference
regressions likely reflects the historical lack of within-firm pay variation for directors, these re-
sults provide evidence of firms’ increased willingness to offer differential compensation to board
members following SOX and the events leading up to its passage. Further, this post-SOX pay
differential is related to variation in firm-specific demand for monitoring and director-specific
expertise in financial reporting.

5 Conclusion

In this paper, we have examined how cross-sectional variation in the demand for monitoring
of the financial reporting process is associated with compensation for audit committees. Au-
dit committees have become an important part of firms’ financial reporting process; thus it is
important to investigate the internal governance mechanisms for audit committees. We add to
the literature on audit committees by exploring the determinants of audit committee compen-
sation. We also contribute to research on board compensation by documenting an increasing
trend toward differences in annual pay among board members within a firm.
We focus our analyses on the demand for monitoring of the financial reporting process.
Specifically, we predict a positive association between audit committee compensation and the
demand for monitoring of the financial reporting process. In conducting the empirical analyses,

32
we control for director quality because audit committee compensation is likely related to both
the demand for monitoring of financial reporting and the quality of the audit committee.
We examine audit committee compensation, both in absolute terms and relative to com-
pensation committee compensation. We find that total compensation and cash retainers are
positively correlated with proxies for the demand for monitoring of the financial reporting pro-
cess and measures of audit committee quality. Our empirical evidence is consistent with the
notion that the demand for monitoring of the financial reporting process is an important de-
terminant of the compensation paid to audit committees. In addition, our findings that pay
is increasingly different for audit and compensation committee members suggest a new-found
willingness on the part of boards and firms to acknowledge the differential contributions and
outside opportunities of board members.
We view our study as a first step toward understanding the compensation arrangements
for audit committees. One important area for future research is to examine how compensation
incentives interact with reputation incentives to impact the effectiveness of the audit committees
in monitoring financial reporting.

33
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36
 Table 1: Summary Statistics: Audit Committee Compensation
Panel A: Compensation Statistics for Audit Committees
N Q1 Mean Median Q3 Std
Audit Committee Chair
Total Compensation (incl. meeting fees) 5465 57176.40 140912.20 97000.00 156488.13 290335.08
Total Compensation (no meeting fees) 5465 51000.00 134544.21 89360.02 149774.98 290384.75
Cash Retainer 5465 16500.00 29449.76 26666.60 39762.80 19847.70
Equity Retainer 5465 0.00 6346.22 0.00 0.00 17355.51
Options 5465 0.00 90104.43 37272.22 97451.42 292176.91
Equity Grants 5465 0.00 8643.79 0.00 0.00 23309.42
Meeting Fees 5465 0.00 6367.99 4746.72 9295.20 7221.82
Audit Committee Member
Total Compensation (incl. meeting fees) 5465 54000.00 135451.46 91459.27 150241.28 289279.54
Total Compensation (no meeting fees) 5465 48028.55 129728.28 84377.57 144084.60 289393.44
Cash Retainer 5465 15492.00 26249.10 24787.20 35000.00 17385.20
Equity Retainer 5465 0.00 5845.21 0.00 0.00 16216.99
Options 5465 0.00 88990.18 36901.63 96700.35 291236.71
Equity Grants 5465 0.00 8643.79 0.00 0.00 23309.42
Meeting Fees 5465 0.00 5723.18 4315.20 8454.40 6229.34
Total compensation includes cash retainer, equity retainer, options, equity grants. Meeting fees are
included in the first total compensation measure but not the second. Options include stock options and
SARs. Equity grants include common stock, restricted stock, deferred stock units and phantom stock
units. Meeting fees include fees for attending both board and committee meetings; special committee fees
are excluded. All compensation data is price-level adjusted using the GDP price deflator index with 2004
as the base year.

37
 Table 1: Summary Statistics: Audit Committee Compensation (continued)
Panel B: Time Series Compensation Statistics for Audit Committee Chair Pre-/Post-SOX
2000 2001 2002 2003 2004 Pre-SOX Post-SOX Difference
Total Compensation Mean 150278.61 141236.05 109560.99 150629.69 156107.93 145307.52 138473.83 -6833.69
(incl. meeting fees) Median 73615.09 88187.52 79260.00 111489.86 124337.60 82515.48 104650.52 22135.04a
Total Compensation Mean 146589.80 137286.51 103718.84 142394.20 146792.09 141475.38 130699.03 -10776.35
(no meeting fees) Median 70175.11 81848.57 72070.42 102887.18 111804.13 77228.09 95933.63 18705.54a
Cash Retainer Mean 24090.15 24186.47 26497.22 32754.78 38170.97 24143.10 32393.72 8250.61a
Median 22020.00 21576.00 24306.40 30596.70 35000.00 22020.00 30000.00 7980.00a

38
Equity Retainer Mean 5464.07 5776.79 5851.98 6572.32 7839.45 5635.98 6740.24 1104.25b
Median 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00
Options Mean 111511.84 101957.36 65970.46 93170.06 84578.62 106259.32 81142.25 -25117.07b
Median 27711.35 38639.65 29971.20 47743.77 40944.41 33626.40 38474.90 4848.50
Equity Grants Mean 5523.75 5365.89 5399.17 9897.05 16203.06 5436.97 10422.83 4985.86a
Median 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00a
Meeting Fees Mean 3688.81 3949.53 5842.16 8235.49 9315.83 3832.14 7774.80 3942.65a
Median 3303.00 3236.40 4755.60 7229.60 8000.00 3236.40 6340.80 3104.40a
N 878 1,072 1,193 1,178 1,144 1,950 3,515
Total compensation includes cash retainer, equity retainer, options, equity grants. Meeting fees are included in the first total
compensation measure but not the second. Options include stock options and SARs. Equity grants include common stock, restricted
stock, deferred stock units and phantom stock units. Meeting fees include fees for attending both board and committee meetings; special
committee fees are excluded. All compensation data is price-level adjusted using the GDP price deflator index with 2004 as the base
year. Pre-SOX = years 2001 and 2001. Post-SOX = years 2002 - 2004. t-tests used to test differences in the Pre- and Post-SOX mean;
Wilcoxon two-sample tests used to test differences in the Pre- and Post-SOX median. a, b, and c denote significance of coefficients at the
1%, 5%, and 10% levels, respectively.
 Table 2: Summary Statistics: Compensation Committee Compensation
Panel A: Compensation Statistics for Compensation Committees
N Q1 Mean Median Q3 Std
Compensation Committee Chair
Total Compensation (no meeting fees) 5465 50090.80 133311.32 87945.73 147640.00 290272.40
Cash Retainer 5465 16182.00 28566.38 25891.20 38500.00 19344.51
Compensation Committee Member
Total Compensation (no meeting fees) 5465 47931.43 129542.01 84401.74 143921.16 289441.09
Cash Retainer 5465 15492.00 26169.62 24772.50 35000.00 17519.67
Total compensation includes cash retainer, equity retainer, options, and equity grants, where options
include stock options and SARs, and equity grants include common stock, restricted stock, deferred stock
units and phantom stock units. All compensation data is price-level adjusted using the GDP price
deflator index with 2004 as the base year.

39
 Table 2: Summary Statistics: Compensation Committee Compensation (continued)
Panel B: Time Series Compensation Statistics Pre-/Post-SOX
2000 2001 2002 2003 2004 Pre-SOX Post-SOX Difference
Compensation Committee Chair
Total Compensation Mean 146870.51 137032.81 103249.79 140450.65 143415.24 141462.30 128789.45 -12672.85
(no meeting fees) Median 70175.11 81596.33 71808.54 102127.34 109984.97 77046.06 94723.92 17677.86a
Cash Retainer Mean 24314.02 24192.78 26202.07 31363.21 35513.94 24247.37 30962.41 6715.04a

40
Median 22020.00 21576.00 23778.00 28402.00 33166.65 22020.00 28000.00 5980.00a
Difference between Audit and Compensation Committee Chairs
Total Compensation Mean -280.71 253.70 469.04 1943.56 3376.85 13.08 1909.59 1896.51a
(no meeting fees) Median 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00a
Cash Retainer Mean -223.87 -6.30 295.15 1391.58 2657.03 -104.27 1431.31 1535.57a
Median 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00a
N 878 1,072 1,193 1,178 1,144 1,950 3,515
Total compensation includes cash retainer, equity retainer, options, and equity grants. Options include stock options and SARs.
Equity grants include common stock, restricted stock, deferred stock units and phantom stock units. All compensation data is
price-level adjusted using the GDP price deflator index with 1998 as the base year. Pre-SOX = years 2001 and 2001. Post-SOX =
years 2002 - 2004. t-tests used to test differences in the Pre- and Post-SOX mean; Wilcoxon two-sample tests used to test differences
in the Pre- and Post-SOX median. a, b, and c denote significance of coefficients at the 1%, 5%, and 10% levels, respectively.
 Table 3: Summary Statistics: Firms’ Audit Fees and Board Committee Meetings
Panel A: Summary Statistics
N Q1 Mean Median Q3 Std
Audit Fees and Board Meetings:
Audit fees (undeflated) 5465 377.58 1887.5 779.64 1859.04 3830.97
AuditFee 5465 0.43 0.97 0.72 1.22 0.89
Total board meetings 5465 9 14.92 14 19 7.98
Audit committee meetings 5465 4 6.57 6 8 3.38
Compensation committee meetings 5465 3 4.31 4 6 2.55
Audit Committee Chair Expertise:
Non Financial Expert 3473 1 0.76 1 1 0.43
Expert Finance 3473 0 0.14 0 0 0.35
Expert Accounting General 3473 0 0.04 0 0 0.21
Expert Accounting Big5 3473 0 0.06 0 0 0.23
AC Expertise 3473 1 1.4 1 1 0.81
Audit fees are in thousands of dollars and include annual fees directly related to auditing services. Audit fees
do not include audit-related fees, tax fees, and all other fees. AuditFee = audit fees/square root of total
assets. Audit fees and total assets are price-level adjusted using the GDP price deflator index with 2004 as
the base year. Non Financial Expert = 1 if the audit committee chair has no direct financial training or
experience. Expert Finance = 1 if the audit committee chair has financial training and experience.
Expert Accounting General = 1 if the audit committee chair has accounting training and experience, but
excludes those with Big 5(4) accounting firm employment experience. Expert Accounting Big5 = 1 if the
audit committee chair has employment experience at a Big 5(4) accounting firm. AC Expertise = 1 if
Non Financial Expert = 1; 2 if Expert Finance = 1; 3 if Expert Accounting General = 1; and 4 if
Expert Accounting Big5 = 1.

41
 Table 3: Summary Statistics: Firms’ Audit Fees and Board Committee Meetings (continued)
Panel B: Time Series Statistics Pre-/Post-SOX
2000 2001 2002 2003 2004 Pre-SOX Post-SOX Difference
Audit Fees and Board Meetings:
Audit fees (undeflated) Mean 1121.74 1198.81 1641.66 1968.5 3293.51 1164.11 2288.81 1124.70a
Median 509.21 530.68 685.93 835.73 1645.1 523.79 978.06 454.27a
AuditFee Mean 0.59 0.63 0.84 0.97 1.71 0.61 1.17 0.56a
Median 0.47 0.52 0.69 0.79 1.47 0.49 0.9 0.41a
Total board meetings Mean 11.06 11.64 14.18 17.2 19.37 11.38 16.88 5.51a
Median 10 10 13 16 18 10 16 6.00a
Audit committee meetings Mean 4.24 4.75 6.52 7.83 8.84 4.52 7.71 3.20a
Median 4 4 6 8 8 4 7 3.00a
Compensation committee meetings Mean 3.87 3.75 4.04 4.56 5.2 3.8 4.59 0.79a
Median 4 4 4 4 5 4 4 0.00a

42
N 878 1,072 1,193 1,178 1,144 1,950 3,515
Audit Committee Chair Expertise:
Non Financial Expert Mean 0.85 0.81 0.8 0.75 0.66 0.83 0.73 -0.10a
Median 1 1 1 1 1 1 1 0.00a
Expert Finance Mean 0.1 0.12 0.13 0.14 0.18 0.11 0.15 0.04a
Median 0 0 0 0 0 0 0 0.00a
Expert Accounting General Mean 0.03 0.03 0.03 0.05 0.07 0.03 0.05 0.02a
Median 0 0 0 0 0 0 0 0.00a
Expert Accounting Big5 Mean 0.03 0.04 0.04 0.06 0.09 0.03 0.07 0.03a
Median 0 0 0 0 0 0 0 0.00a
AC Expertise Mean 1.23 1.29 1.32 1.42 1.6 1.27 1.45 0.18a
Median 1 1 1 1 1 1 1 0.00a
N 385 657 746 826 859 1,042 2,431
See Panel A for variable definitions. Pre-SOX = years 2001 and 2001. Post-SOX = years 2002 - 2004. t-tests used to test differences
in the Pre- and Post-SOX mean; Wilcoxon two-sample tests used to test differences in the Pre- and Post-SOX median. a, b, and c
denote significance of coefficients at the 1%, 5%, and 10% levels, respectively.
 Table 4: Summary Statistics: Control Variables
N Q1 Mean Median Q3 Std
ROA Ind 5465 0.00 0.06 0.05 0.11 0.19
Return Ind 5465 -0.15 0.17 0.07 0.34 0.60
R&D 5465 0.00 0.04 0.00 0.05 0.07
MV 5465 527.00 7600.34 1312.73 4153.60 26876.59
Leverage 5465 0.01 0.19 0.17 0.29 0.18
DivDum 5465 0.00 0.46 0.00 1.00 0.50
NOLDum 5465 0.00 0.36 0.00 1.00 0.48
M/B 5465 1.21 2.06 1.59 2.32 1.59
MatlWeak 5465 0.00 0.16 0.00 0.00 0.37

IndDirOwn% 3295 0.19% 3.80% 6.84% 2.39% 9.57

CEOTen 3295 3.00 7.59 5.00 10.00 7.03
CEOOwn% 3295 0.09% 1.93% 0.28% 1.00% 5.50
CEO/Chair 3295 0.00 0.66 1.00 1.00 0.47
BdInd% 3295 57.14% 68.18% 70.00% 80.00% 15.65
ROA Ind = industry-median-adjusted return on assets. Return Ind =
industry-median-adjusted stock return. R&D = research and development
expenditures/total assets. MV = market value ($millions, price-level
adjusted using the GDP price deflator index with 2004 as the base year).
Leverage = (short term and long term debt)/total assets. DivDum = 1 if
firm pays a dividend. NOLDum = 1 if firm has a net operating loss
carryforward. M/B = market value/book value. MatlWeak = 1 if firm
disclosed material weaknesses in internal controls in response to SOX
Sections 302 and 404. IndDirOwn% = percentage ownership of
independent directors. CEOTen = CEO tenure. CEOOwn% = percentage
ownership of CEO. CEO/Chair = 1 if CEO is chairman of board. BdInd%
= percentage of independent directors on board.

43
 Table 5: OLS Regressions of Audit Committee Compensation
Total compensation Cash retainer
(1) (2) (3) (4) (5) (6)
AuditFee 0.040a 0.037a 0.031a 0.072a 0.069a 0.064a
(3.71) (3.15) (2.85) (5.79) (4.16) (4.05)
PostSOX 0.117a 0.121a 0.106a 0.146a 0.131a 0.128a
(7.76) (6.54) (5.61) (13.76) (9.28) (8.88)
AC Expertise 0.041b 0.037b 0.032b 0.029b
(2.47) (2.19) (2.20) (2.05)
AuditMeet 0.011a 0.014a 0.014a 0.017a 0.015a 0.014a
(3.96) (3.97) (4.19) (7.12) (4.90) (4.61)
ROA Ind -0.040 -0.247c -0.218c -0.020 -0.264b -0.235b
(0.61) (1.81) (1.65) (0.52) (2.46) (2.23)
c a b
Return Ind 0.023 0.026 0.025 -0.025 -0.029 -0.030b
(1.78) (1.26) (1.16) (3.13) (1.99) (2.09)
R&D -0.534b -0.171 -0.107 -0.028 -0.264 -0.230
(2.43) (0.52) (0.33) (0.23) (1.01) (0.91)
LogMV 0.471a 0.463a 0.455a 0.112a 0.141a 0.149a
(22.52) (15.30) (14.72) (8.23) (5.88) (6.54)
Leverage 0.263a 0.234c 0.259b 0.021 0.087 0.093
(2.75) (1.87) (2.01) (0.36) (0.92) (0.96)
DivDum -0.014 0.041 0.032 0.130a 0.185a 0.188a
(0.36) (0.88) (0.66) (4.86) (4.55) (4.15)
NOLDum 0.061b 0.009 -0.007 0.040b 0.028 0.029
(2.42) (0.30) (0.23) (2.52) (1.35) (1.36)
M/B 0.069a 0.079a 0.082a -0.007 -0.001 -0.003
(8.19) (5.08) (5.50) (1.18) (0.08) (0.20)
IndDirOwn% 0.002 -0.001
(1.42) (0.60)
LogCEOTen 0.010 0.010
(0.71) (0.88)
CEOOwn% -0.003 -0.001
(0.74) (0.42)
CEO/Chair -0.043 -0.065a
(1.46) (3.22)
BdInd% 0.341a 0.218a
(3.42) (2.79)
Intercept 7.543a 7.406a 7.247a 9.048a 8.810a 8.643a
(51.52) (33.83) (30.94) (94.46) (50.86) (49.34)
N 5465 3473 3295 5002 3263 3100
Adjusted R2 0.81 0.82 0.83 0.81 0.82 0.82
The dependent variables are the logarithm of total compensation in Columns (1) – (3), and the logarithm
of cash retainer in Columns (4) – (6). Total compensation includes cash retainer, equity retainer, options,
and equity grants, but excludes meeting fees. AuditFee = audit fees/square root of total assets. PostSOX
= 1 for years 2002 - 2004. AuditMeet = number of yearly audit committee meetings. See Table 3 for
AC Expertise definition, and Table 4 for other control variable definitions. Regressions are estimated with
firm-level fixed-effects. t-statistics calculated using heteroskedasticity robust standard errors are in
parentheses. a, b, and c denote significance of coefficients at the 1%, 5%, and 10% levels, respectively.
 Table 6: Difference Regressions
Total compensation Cash retainer
(1) (2) (3) (4) (5) (6)
AuditFee 0.004a 0.003b 0.004 a
0.009 a
0.009 a
0.010a
(3.35) (2.34) (2.92) (3.65) (2.89) (3.17)
PostSOX 0.014a 0.013a 0.013a 0.030a 0.027a 0.027a
(5.78) (4.20) (4.01) (8.12) (5.52) (5.15)
AC Expertise 0.008a 0.008a 0.018a 0.018a
(2.95) (2.73) (4.86) (4.65)
AuditMeet 0.001a 0.001b 0.001b 0.003a 0.003a 0.002b
(4.28) (2.54) (2.28) (4.66) (2.74) (2.48)
MatlWeak 0.002 0.002 0.001 -0.006 -0.007 -0.009
(0.68) (0.64) (0.27) (1.20) (0.97) (1.28)
ROA Ind -0.007 -0.023 -0.018 -0.007 -0.029 -0.019
(1.44) (1.60) (1.25) (0.91) (1.23) (0.78)
Return Ind -0.002 -0.002 -0.001 -0.004c -0.003 -0.003
(1.47) (0.66) (0.54) (1.76) (0.73) (0.65)
R&D -0.024 -0.041 -0.028 -0.034 -0.015 0.016
(1.56) (1.33) (0.92) (1.14) (0.31) (0.32)
LogMV -0.001 0.000 0.001 -0.003b -0.002 0.000
(1.25) (0.06) (1.14) (2.22) (0.94) (0.10)
Leverage -0.003 -0.006 -0.007 -0.017c -0.028c -0.027c
(0.58) (0.63) (0.71) (1.77) (1.81) (1.75)
DivDum -0.004c -0.005 -0.004 -0.012a -0.013b -0.013b
(1.66) (1.40) (1.08) (2.94) (2.06) (2.05)
NOLDum -0.001 -0.004 -0.003 0.007c 0.005 0.006
(0.49) (1.43) (1.17) (1.89) (1.11) (1.16)
M/B 0.001 0.003 0.001 0.003c 0.005 0.003
(0.60) (0.92) (0.43) (1.90) (1.52) (0.84)
IndDirOwn% 0.000c 0.001a
(1.75) (2.77)
LogCEOTen 0.003b 0.005c
(2.29) (1.93)
CEOOwn% 0.000 0.001
(1.55) (1.60)
CEO/Chair -0.015a -0.024a
(4.99) (4.79)
BdInd% -0.013c -0.001
(1.87) (0.06)
c c
Intercept 0.001 -0.017 -0.015 0.003 -0.025 -0.032b
(0.16) (1.67) (1.63) (0.34) (1.79) (1.99)
N 5464 3472 3295 4990 3258 3097
Adjusted R2 0.02 0.03 0.04 0.05 0.05 0.06
The dependent variables are differences between audit committee compensation and compensation committee
compensation: differences in logarithm of total compensation in Columns (1) – (3), and differences in
logarithm of cash retainer in Columns (4) – (6). Total compensation includes cash retainer, equity retainer,
options, and equity grants, but excludes meeting fees. AuditFee = audit fees/square root of total assets.
PostSOX = 1 for years 2002 - 2004. AuditMeet = number of yearly audit committee meetings. See Table 3 for
AC Expertise definition, and Table 4 for other control variable definitions. t-statistics calculated using
heteroskedasticity robust standard errors are in parentheses. a, b, and c denote significance of coefficients at
the 1%, 5%, and 10% levels, respectively.
 Table 7: Difference Regressions: Pre- and Post-SOX
Total Compensation Cash Retainer
Pre-SOX Post-SOX p-value Pre-SOX Post-SOX p-value
AuditFee -0.005 0.005a 0.052 -0.003 0.010a 0.038
(0.83) (3.06) (0.48) (3.03)
AC Expertise 0.003 0.009a 0.045 0.004 0.021a 0.001
(1.65) (2.58) (1.59) (4.50)
AuditMeet 0.001 0.001a 0.375 0.001 0.003a 0.166
(0.69) (2.20) (0.39) (2.48)
MatlWeak 0.003 -0.001 0.575 -0.002 -0.012 0.447
(0.63) (0.13) (0.26) (1.35)
ROA Ind 0.009 -0.038 0.085 0.016 -0.032 0.258
(0.79) (1.53) (0.67) (0.91)
Return Ind -0.001 -0.001 0.944 -0.003 -0.002 0.992
(0.50) (0.35) (0.49) (0.35)
R&D 0.061a -0.071 0.007 0.108a -0.022 0.112
(3.05) (1.61) (3.40) (0.29)
LogMV 0.004 0.001 0.294 0.003 -0.001 0.352
(1.50) (0.51) (0.95) (0.27)
Leverage -0.005 -0.006 0.968 -0.016 -0.033 0.575
(0.35) (0.54) (0.75) (1.56)
DivDum -0.012b -0.001 0.136 -0.013 -0.013 1.000
(2.08) (0.20) (1.63) (1.57)
NOLDum -0.013b 0.000 0.054 -0.019b 0.016b 0.001
(2.09) (0.16) (2.37) (2.48)
M/B -0.003b 0.004 0.226 -0.004 0.007 0.107
(1.99) (0.70) (1.57) (1.11)
IndDirOwn% 0.000 0.000 0.849 0.000 0.001b 0.317
(0.79) (1.48) (1.22) (2.46)
LogCEOTen -0.002 0.005a 0.014 -0.002 0.008b 0.038
(0.86) (2.72) (0.78) (2.01)
CEOOwn% 0.000 0.000 0.697 0.000 0.001 0.294
(1.11) (1.25) (0.69) (1.58)
CEO/Chair -0.007c -0.018a 0.047 -0.006 -0.031a 0.004
(1.83) (4.58) (1.02) (4.68)
BdInd% -0.019b -0.011 0.549 -0.029b 0.011 0.112
(2.38) (1.13) (2.08) (0.52)
N 969 2326 894 2203
Adjusted R2 0.01 0.03 0.01 0.05
Dependent variables are differences between audit committee compensation and compensation committee
compensation. Total compensation includes cash retainer, equity retainer, options, and equity grants, but
excludes meeting fees. Pre-SOX includes observations from years 2000 - 2001. Post-SOX includes observations
from years 2002 - 2004. p-value is presented for test of difference between coefficients for Pre- and Post-SOX
regressions (one-sided test for AuditFee, AC Expertise, and AuditMeet, and two-sided for other variables).
AuditFee = audit fees/square root of total assets. AuditMeet = number of yearly audit committee meetings. See
Table 3 for AC Expertise definition, and Table 4 for other control variable definitions. t-statistics calculated using
heteroskedasticity robust standard errors are in parentheses. a, b, and c denote significance of coefficients at the
1%, 5%, and 10% levels, respectively.

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