Voluntary Clawback Adoption and the Use of Financial Measures in CFO Bonus Plans

Abstract

Firms trade off CFOs' fiduciary duties against their decision-making duties when designing CFO bonus plans. Decreasing bonus incentives tied to financial measures benefits CFOs' fiduciary responsibilities at the expense of motivating their decision-making duties. As prior research indicates that clawbacks increase personal misreporting costs through the loss of previously awarded compensation, we examine whether clawbacks allow firms to increase incentives in CFO bonus contracts. Based on a sample of U.S. firms between 2007 and 2013, we find that clawbacks are associated with greater CFO bonus incentives. We also find the increase in incentives to be more pronounced for CFOs relative to other executives. Our results are moderated by firms' susceptibility to misreporting. The relation between clawbacks and incentives is weaker when firms experienced internal control deficiencies, have larger abnormal accruals, when CFOs are more vulnerable to pressure from CEOs, and when audit committees have less financial expertise and prestige.

Determinants and consequences of clawback provisions in management compensation contracts: a structured literature review on empirical evidence

“…Clawbacks as ex post settings are very costly, and the board of directors will include them in management contracts only if it is absolutely necessary (Liu et al 2020). Based on the above information, asymmetrical gains and losses are a main characteristic of manager contracts, as executives benefit from increased firm values but do not lose rewards due to poor financial performance or financial restatements (Kroos et al 2018;Mburu and Tang 2018a).…”

“…In cases with clawbacks, boards of directors have the right to reclaim part of executives' compensation upon the occurrence of pre-defined triggering events, such as restatements or fraudulent reporting (Erkens et al 2018). Thus, the implementation of clawbacks provides adequate ex-ante incentives for management to prevent misstatements as well as ex post sanctions for an executive's misbehavior (Kroos et al 2018). Due to their discipline function and ability to strengthen firms' reputation, the implementation of firm-initiated clawbacks has increased since the 2008/09 financial crisis (Babenko et al 2019).…”

“…In contrast, Natarajan and Zheng (2019) found that mandatory SOX clawbacks lead to decreased CEO in-the-money option value. Moreover, clawbacks are linked with decreased asymmetric sensitivity between CEO/CFO cash compensation and firm performance (Liu et al 2019), better sensitivity of unvested (long-term) compensation (Remesal 2018), and higher CFO bonus incentives tied to financial measures (Kroos et al 2018). With regard to different compensation items, according to Mburu and Tang (2018a), decreased vega and bonus payments can be found after clawback adoption.…”

Can CFOs Resist Undue Pressure from CEOs toManage Earnings?

“…This is because, unlike CEOs, they cannot credibly claim unawareness or lack of understanding of accounting matters. Accordingly, prior studies have shown that CFOs are more likely to face significant labour market costs in the presence of earnings management, including job turnovers (Hennes et al, 2008;Karpoff et al, 2008;Leone and Liu, 2010), loss of previously awarded compensation through clawback provisions (Kroos et al, 2018) and significant reduction in compensation levels (Hoitash et al, 2012). Additionally, as Feng et al (2011) shows, CFOs of manipulating firms are more likely to face severe legal penalties, including future employment restrictions, fines, disgorgement of illegal gains, and even criminal charges while they gain similar level of financial incentives as their counterparts in other firms.…”

Ex Post Settling Up in Cash Compensation: New Evidence

“…Section 954 of the Dodd‐Frank Wall Street Reform and Consumer Protection Act introduces rules requiring firms to further adopt and enforce clawback provisions in 2010. Prior research examines the effect of clawbacks on financial reporting quality, such as earnings management, and on the way executives are compensated (e.g., DeHaan et al ; Natarajan and Zheng 2019; Kroos et al ).…”