Not all clawbacks are the same: Consequences of strong versus weak clawback provisions

Abstract

We develop a Clawback Strength Index and show that while some firms adopt unambiguous and strong clawback provisions, others adopt weak ones. We find that strong clawback adopters experience improvements in financial reporting quality, fewer CEO turnovers, and lower CEO pay. We advance two possible explanations: First, clawback strength may be primarily responsible for the improvements in reporting quality. Second, strong clawbacks may yield benefits because they are part of a broader reform package. While our findings on reporting quality and CEO turnover are consistent with both explanations, our results on CEO pay support only the broader reform explanation.

The unintended consequences of voluntary adoption of clawback provisions on managerial ability

“…For example, I use log asset (Ln_Asset) to control for firm size because firms that are larger in size are more likely to adopt clawback according to Dehaan et al (2013). Prior research also suggests that governance characteristics may partly determine clawback adoption; Erkens et al (2018) finds that the percentage of institutional ownership is associated with clawback strength. Therefore, I include institutional investors (Inst_Inv) as a covariate in the analysis.…”

“…For example, strong clawbacks are comprehensive in coverage and include compensation coverage and clawback time period. Strong clawback provisions are likely to incentivise managers to enhance the financial report quality while weak clawback does not necessarily cause a change in managerial incentives to work for the best interests of shareholders (Erkens et al, 2018). Able managers can self-select the incentives-based compensations that suit their abilities (Gan and Park, 2016).…”

“…Definitions of variables are in the Appendix. controllable risk that is not attributed to CEO decisions (Erkens et al, 2018). It is not expected, however, that CEOs will be able to reduce the overall firm risk post clawback triggered by misconduct due to the increased level of noncontrollable risk.…”

“…Second, clawback may be part of a constellation of corporate climate that stresses over doing whatever it takes to achieve the firm's goals. This latter explanation was referred to as the broader reform package by Erkens et al (2018).…”

“…This latter evidence suggests a dysfunctionality in the equitybased compensation even in the presence of clawback and calls for further investigation on whether clawback provisions are indeed effective in causing a change in managerial behaviour. Second, recent research (Erkens et al, 2018) suggests that not all clawback provisions are the same. Strong clawback is more effective in making a change in managerial behaviour.…”