M&A Decisions and US Firms’ Voluntary Adoption of Clawback Provisions in Executive Compensation Contracts

Abstract

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.

Do Voluntary Clawback Adoptions Curb Overinvestment?

“…Clawback provisions are viewed as a mechanism for improving financial reporting quality (Boyd, Santos, & Shen, 2012;Brown et al, 2015;Cashman et al, 2016). Prior research examines factors related to the adoption of clawback provisions within managerial compensation contracts.…”

“…Prior research examines factors related to the adoption of clawback provisions within managerial compensation contracts. Firms with more independent governance (Addy, Chu, & Yoder, 2014), of larger size (Cashman et al, 2016;Chan et al, 2012), with more previous restatements (Babenko et al, 2015;Gao, Iskandar-Datta, & Jia, 2012), and with more frequent merger and acquisition activity (Brown et al, 2015) are more likely to voluntarily adopt clawback provisions.…”

“…All independent variables are lagged by one year. Larger firms and more profitable firms are more likely to adopt clawback mechanisms (Brown et al, 2015;Cashman et al, 2016;Dehaan et al, 2013). We include firm size (SIZE), the market value of equity (MVE), net income (INCOME) and revenue (REVENUE) to control for firm size and profitability.…”

“…All continuous variables are winsorized at 1 percent and 99 percent. the economic determinants of voluntary clawback adoption (e.g., Addy et al, 2014;Brown et al, 2015;Dehaan et al, 2013;Gao et al, 2012).…”

“…No other published study has reported that a benefit of clawback provisions is mitigating ex post overinvestment. Prior studies investigated the impact of firms' voluntary adoption of clawback provisions on their financial reporting quality and the market's reaction to these voluntary adoptions (e.g., Brown, Davis-Friday, Guler, & Marquardt, 2015;Cashman, Harrison, & Panasian, 2016;Chan et al, 2012;Dehaan et al, 2013;Iskandar-Datta & Jia, 2013;Pyzoha, 2015). However, little is known about whether clawback provisions affect executives' investment behavior.…”