Executive compensation is a frequent topic in the media today. From an auditor’s perspective, executive compensation is an important consideration when it is time to develop the audit plan and audit strategy. If earnings and revenue are tied to compensation, then there is a risk of manipulation.

Search the internet for information on labor costs in the retail catalog industry (for example, labor costs as a percentage of sales).

Executive compensation ballooned in the 1990s with notable compensation abuses. The most popular form of executive compensation in the 1990s was company stock (or options to purchase stock). Designers of these compensation plans argue that by compensating officers with stock, the officers would take actions in the best interest of the shareholders. Critics claim that executive compensation is often too high in proportion to average salaries at companies, and that the compensation levels motivate officers to take selfish actions.

In your initial discussion post, provide your opinions on the following:

  • In your opinion, what are the costs and benefits associated with compensating executives with stock or the option to purchase stock?
  • What do you believe are the most effective audit procedures to use to identify executive compensation abuse or fraud? Support your opinions and recommended audit procedures with at least one scholarly source in addition to your textbook.

In your responses to your peers, state whether you agree or disagree with the costs and benefits provided. What other costs or benefits do you think are associated with this type of compensation? What additional audit procedures do you think are most effective in detecting abuse or fraud related to executive compensation? Support your reply post with at least one scholarly source other than your textbook.

The increase in the use of stock awards and stock options as part of executive compensation since the 1990s has resulted in staggering differences in salaries for executives versus employees. The U.S. Bureau of Labor Statistics (2017) reported average weekly pay of $749.49 for (non-farm) production and nonsupervisory employees, resulting in an average annual salary of $38,973. This amount pales in comparison to executive salaries at many publicly traded companies. For example, The TJX Companies, Inc. (2017), the parent company of clothing retailer TJ Maxx, reported total compensation of $18,536,866, including $9,000.025 in company stock awards, for its CEO Ernie Herrman. As a result, Mr. Herrman was paid 476 times more than his employees in 2017. In my opinion, no CEO is worth this much more than his/her employees.

Compensating executives with company stock or stock options (the opportunity to purchase stock at below market value) may help to attract and keep executives. With an explicit performance-based method of compensation (the more a company earns, the more the executive earns), companies will create more dedicated executives. In addition, vesting provisions require the executive to remain employed for a certain amount of time, increasing employee retention. The costs to the company include the lost opportunities to sell stock at market value. However, companies should always remember that compensation through stocks and stock options creates an incentive to commit fraud. Securities and Exchange Commission (2015, 2016a, 2016b) press releases are full of accounting fraud committed by executives who decided to improve their own financial situations at the expense of their companies’ reputations and ability to remain in business.

The most effective audit procedures to identify executive compensation abuse or fraud would include understanding how the compensation packages are created and testing transactions created by the executives to determine whether the transactions increased the appearance of company earnings (earnings often being the metric by which stock awards and stock options are granted). Public Company Accounting Oversight Board (PCAOB) (2010) requires auditors to perform procedures to obtain an understanding of the company’s financial relationships and transactions with its executive officers.

The procedures “should include, but not be limited to (1) reading the employment and compensation contracts between the company and its executive officers and (2) reading the proxy statements and other relevant company filings with the Securities and Exchange Commission and other regulatory agencies that relate to the company’s financial relationships and transactions with its executive officers” (para. .10A). In addition, auditors should interview members of the compensation committee as well as review the company’s policies and procedures regarding executive compensation and expense reimbursement. These audit procedures will assist the auditor with understanding the both the motivations and opportunities to commit fraud resulting in increase compensation. The auditor should then consider designing specific tests of transactions and journal voucher entries created by executives that would increase company earnings.