The Relation between Abnormal AuditReport Lag and Sensitivity of Executive Pay to Accounting Earnings

[Purpose]This study examines the effect of abnormal audit report lag on accounting quality and the sensitivity of executive pay to accounting earnings. [Methodology]This study is based on a sample of 4,005 firm－year observations of listed companies on Korea Stock Exchange between 2007 and 2014. We use ordinary least squares (OLS) regression to test our research hypotheses empirically. [Findings]We show that longer abnormal audit report lag is associated with less discretionary accruals and greater weight of accounting earnings in executive compensation contracts. When the audit report is released beyond the expected period of time, auditors tend to put additional efforts to ensure the earnings quality and consequently the usefulness of accounting earnings in executive compensation contracts is enhanced. However, the positive link between abnormal audit report lag and compensation weight of accounting earnings disappears for firms with boards consisting of majority of outside directors. This suggests that independent outside directors, who are responsible for monitoring managerial discretion in financial reporting, tend to reduce the incremental effect of additional audit efforts on the usefulness of accounting earnings. [Implications]This paper adds new evidence on the relation between abnormal audit report lag, accounting quality and the sensitivity of executive pay to accounting earnings.