Firm-Level Heterogeneity of Clawback Provisions

Abstract

We investigate the degree to which implementing a clawback policy, a special part of the executive's compensation contract, is an adequate governance mechanism to deter executives from misbehavior and to recover excess-pay. By focusing on the firm-level heterogeneity in the structure of clawbacks, we recognize that firms have considerable discretion in how they design their policies. We find that firms make heavily use of their discretion in adopting more or less deterrent policies and that most firms have weak clawback provisions. We analyze voluntary adopted clawbacks of all Russell 3,000 non-financial firms over 2007-2012. We conduct an extensive linguistic and a factor analysis to construct a deterrent index for 3,578 clawback observations. This index reflects the degree to which the contractual form of each clawback contains the core elements of a deterrent clawback policy. Our results, which also take into account the self-selection problem of voluntarily adopting a clawback, show that executive power, the executives' pay level, and weak corporate governance are associated with a low deterrent level. We also find that the deterrent level increases in directors' experience, corporate profitability and management ownership. Keywords: clawback provisions, excess pay, corporate governance, linguistic analysis JEL codes: G18, G30, G34, G39, K22, K29 Firm-Level Heterogeneity of Clawback Provisions AbstractWe investigate the degree to which implementing a clawback policy, a special part of the executive's compensation contract, is an adequate governance mechanism to deter executives from misbehavior and to recover excess-pay. By focusing on the firm-level heterogeneity in the structure of clawbacks, we recognize that firms have considerable discretion in how they design their policies. We find that firms make heavily use of their discretion in adopting more or less deterrent policies and that most firms have weak clawback provisions. We analyze voluntary adopted clawbacks of all Russell 3,000 non-financial firms over 2007-2012. We conduct an extensive linguistic and a factor analysis to construct a deterrent index for 3,578 clawback observations. This index reflects the degree to which the contractual form of each clawback contains the core elements of a deterrent clawback policy. Our results, which also take into account the self-selection problem of voluntarily adopting a clawback, show that executive power, the executives' pay level, and weak corporate governance are associated with a low deterrent level. We also find that the deterrent level increases in directors' experience, corporate profitability and management ownership.

Exploring the potentials of clawbacks to check earnings management practices and enhance financial reporting quality: perceptions from the UAE

“…Clawback policy adoption may bear positive results for organizations with extended agency problems, as it may decrease the incentives of the executives’ to opportunistically misreport financial information (Erkens et al , 2014; Bakke, 2018; Remesal, 2018). Executives are more likely to inflate earnings if they have higher incentive-based compensation.…”

Do Clawback Adoptions Influence Capital Investments?

“…Pyzoha (2015) experimentally finds that executives with a higher portion of incentive-based pay are less (more) likely to accept a lower (higher) quality auditor's proposed restatement. Fried and Shilon (2012), Babenko et al (2015), and Erkens, Gan, and Yurtoglu (2014) find that clawback provisions are rarely enforced even when earnings restatements occur. Kyung et al (2016) find that clawback adopters disclose lower-quality non-GAAP earnings more frequently than non-adopters do.…”