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Corporate acquisitions are arguably one of the most important and biggest decisions CEOs have to make; yet many acquisitions do not create value for shareholders. We examine whether CEO compensation is reduced when the fair values of the acquired business units are written down (i.e., goodwill impairment losses are recognized). We find that there is a significant reduction in cash-and option-based CEO compensation as firms recognize goodwill impairment losses. In particular, we find that the decrease in CEO option-based compensation is driven by firms that are not R&D intensive, while the decrease in CEO cash compensation is driven by firms that acquired larger targets in the recent past and have CEOs with a shorter tenure. Our results suggest that compensation committees make CEOs pay a price for non-value maximizing acquisitions and discourage them from further undertaking risky investments especially by reducing the risk-inducing component of their compensation packages.

Abstract:We examine whether US firms' M&A decisions influence the likelihood of voluntary adoption of clawback provisions in executive compensation contracts and whether clawback adoption improves subsequent M&A decisions. Because prior research finds that poor M&A decisions are associated with future earnings restatements, we predict that clawback adoption is more likely after these transactions. We further conjecture that M&A decisions will improve after clawback adoption, as its presence reduces executives' willingness to manipulate post-acquisition earnings. Consistent with our expectations, we find that (1) firms with more negative M&A announcement returns are more likely to adopt clawbacks; (2) firms that acquire targets with relatively poor accounting quality are more likely to adopt clawbacks; (3) clawbacks improve investor perception of M&A quality; and (4) executives are more responsive to the market when completing M&A deals if their compensation contracts include clawbacks. These results suggest that boards take a pro-active approach and consider factors that may lead to restatements when adopting clawbacks. Our results have implications for US policymakers, as the Dodd-Frank Act of 2010 requires mandatory adoption of clawbacks. Our results also suggest that non-US firms can reduce managerial incentives to manipulate post-takeover earnings by using clawbacks.

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Eventually the Dodd-Frank Act of 2010 will require all publicly traded companies to implement clawback provisions. In the interim, some firms have chosen to implement the provisions voluntarily. Using the population of S&P 1500 firms over the period 2005-2009, we investigate the characteristics of firms that voluntarily adopt clawback provisions and those that do not. Since it is not clear whether clawback provisions are complements to or substitutes for strong corporate governance, we do not have any directional expectations regarding the relation between firms' corporate governance characteristics and their adoption of clawback provisions. However, we expect that there are firm-specific incentives, like restated financial statements and significant bonuses for mergers & acquisitions, for adopting clawback provisions. Our results indicate that the size of the firm is one of the strongest determinants of the decision to voluntarily adopt a clawback provision. Additionally, an influential CEO reduces the likelihood that a firm will adopt a clawback provision. Furthermore, even more than restatements, extraordinary M&A bonuses and goodwill impairments significantly increase the likelihood that firms adopt clawback provisions. Finally, examining the content of contractual language surrounding voluntarily adopted clawback provisions, we find that only restatements resulting from irregularities are significantly related to the likelihood of adopting fraud-based clawback provisions. The results from our analyses have implications for policymakers as they attempt to regulate the ability of executives to extract rents from shareholders through the provisions of the Dodd-Frank Act.