Impact of internal control material weaknesses on executive compensation: evidence from Iran

Abstract

After several financial scandals of large companies and the approval of the Sarbanes-Oxley Act, management performance and responsibilities were formalised by launching and maintaining an effective internal control system. Different criteria and financial tools were applied for management performance measurements. These criteria are often used for rewarding and compensating managers. This study investigates non-financial criteria as a rewarding measure for Iranian executive compensation. Managers know that a lack of an effective internal control system can increase the difficulty of accomplishing the company mission, maintaining profitability, and minimising unexpected events. Therefore, the present paper aims at explaining the relationship between internal control material weaknesses and managers' compensation in the years 2004-2010 in an Iranian context. We examined a sample of 97 firms (679 firm-year observations) with combined regression and a pooled model. Results revealed an inverse relationship between the executive compensation and internal control material weaknesses. It can be concluded that the executive compensation is decreased by increasing the company's internal control weakness.