Is Compensating Audit Committee Members with Stock Options Associated with the Likelihood of Internal Control Weaknesses?

We examine whether firms with a stock option plan for their audit committee members are more likely to have internal control weaknesses. Using a sample of 486 US firms, we find that firms with a stock option plan for their audit committee members are significantly more likely to report an internal control weakness than firms without such a stock option compensation plan. Our results support a UK government report which indicates that compensating outside directors with stock options may diminish the effectiveness of these directors. Our findings suggest that stock option compensation plans may adversely affect the functioning of a firm's audit committee.