Does the design of CEO equity-based compensation contracts mitigate agency costs? Evidence from the U.K.

Abstract

Using a sample of 185 U.K. firms over the time-period 2013 to 2017, we investigate if the degree of granted CEO equity-based compensation is positively associated with audit fees. Further, we investigate whether the design of CEO equity-based compensation contracts is associated with variations in audit fees. We find audit fees to significantly increase when higher degrees of equity-based compensation are granted for CEOs, consistent with the notion that auditors perceive highly incentivised CEOs as more prone to act opportunistically. Further, our findings suggest that the design of CEO equity-based compensation contracts is associated with variations in audit fees, where firms with market-based performance targets present higher audit fees, as compared to accounting- or combination-based targets. Conversely, firms applying accounting-based targets present lower audit fees. Our findings highlight the importance of an adequate design of CEO equity-based compensation contracts, to mitigate agency costs to the greatest extent.