How Does a Firm's Information Environment Influence CEO Compensation?

ABSTRACT This paper investigates the relationship between firms’ information environment and chief executive officer (CEO) compensation. This study measures firms’ information environment by their internal and external information quality. The internal information quality is proxied by four variables: discretionary accrual, income smoothing ratio, internal control weakness, and restatements. The external information quality is measured by four other variables: analysts following, analysts forecast accuracy, stock liquidity, and bid‐ask spread. We provide three primary results. First, a firm's overall internal and external information quality significantly increases the CEO's total compensation. Second, a higher quality of internal financial information leads to an increase in the CEO bonus. Finally, a greater quality of the external information environment results in a rise in the CEO's equity compensation. Our additional test provides novel evidence that the dual role of compensation and audit committees increases CEO equity compensation. Our study contributes significantly to the literature on the determinants of CEO compensation and the impact of the board of directors on a firm's information quality and management compensation. Our study's findings highlight that overlapping audit and compensation committees can effectively oversee executive compensation practices and monitor the external market environment.