Are optimal contracting and managerial power competing or complementary views? Evidence from the compensation of statutory auditors in Italy

Research Question/Issue This study examines whether and to what extent the compensation of independent monitors at the board-level is the outcome of an optimal contract between independent parties or the result of involvement with corporate insiders. Research Findings/Insights By using a hierarchical linear regression model with a sample of 559 statutory auditors, whose main task is to monitor the acts and the decision-making process of the board of directors, this study provides evidence that the statutory auditors’ compensation is mainly based upon the effort and responsibilities that are observable by shareholders. However, our findings highlight that the additional, poorly disclosed, compensation that a statutory auditor may receive, unrelated to his/her role, is associated with his/her involvement with corporate insiders. Theoretical/Academic Implications By analysing a de facto three-tier hierarchical agency model, this study gives insights of how and to what extent the optimal contracting and managerial power perspectives provide complementary, rather than competing, explanations to compensation basis and design at the board-level. Not only do these perspectives of agency theory co-exist at an aggregate-level, but also seem to be complementary at both the firm-level and individual-level. Practitioner/Policy Implications This study offers insights to policymakers by questioning the current regulation that allows threats to the de facto independence of a formally independent corporate governance mechanism. We recommend further disclosure about the criteria and the rationales of the additional compensation perceived by statutory auditors. In addition, we suggest investors and other stakeholders, who may rely on the work of the board of statutory auditors as independent monitor, to be careful about the way statutory auditors are paid