Why do Restatements Decrease in a Clawback Environment? An Investigation into Financial Reporting Executives' Decision-Making during the Restatement Process

Abstract

Prior archival studies find that firms that voluntarily adopted clawback policies have experienced a reduction in restatements. I experimentally examine this outcome by investigating the influence of two key factors (i.e., executive compensation structure and auditor quality) on financial reporting executives' (hereafter, “executives”) decision-making regarding a proposed restatement that will lead to a clawback of their incentives. I find that executives (i.e., CFOs, controllers, and treasurers) facing a lower quality auditor are less likely to agree with amending prior financial statements when a higher proportion of their pay is incentive-based. However, this tendency is reduced when executives face a higher quality auditor, indicating that higher quality auditors can act as effective monitors. My results identify an ex post unintended consequence of clawback regulation that could at least partially offset the benefits of the ex ante deterrent effects of clawbacks, and that could contribute to findings of less frequent restatements when clawback policies are in place. I discuss potential implications regarding the role of executives during restatement decisions and auditors' risk assessments in a clawback environment. Data Availability: Data are available from the author upon request.

The Influence of Auditor Quality and Executive Compensation Structure on Financial Reporting Executives' Restatement Decisions in a Clawback Environment

“…Specifically, deHaan, Hodge, and Shevlin (2013) find that restatements decreased for companies that voluntarily adopted a clawback policy compared to companies that did not adopt such a policy. Yet, prior to Pyzoha (2015), no study had previously examined executive behavior during the restatement process when their incentive compensation was at risk of being clawed back.…”

“…T his article summarizes a recently published study titled ''Why do Restatements Decrease in a Clawback Environment? An Investigation into Financial Reporting Executives' Decision-Making during the Restatement Process'' (Pyzoha 2015). We discuss the study's motivation, hypotheses, research method, and results.…”

“…Prior research finds one benefit of voluntarily adopting a clawback is a decrease in restatements. A recent study by Pyzoha (2015) uses an experiment to further investigate restatements in a clawback environment by studying executives' restatement decisions based on auditor quality and executive compensation structure. Results show there may be an unintended consequence of clawbacks that partially offsets the aforementioned benefit.…”

Thematic Symposium: Accounting Ethics and Regulation: SOX 15 Years Later

“…The SOX provisions were reinforced by the Dodd-Frank Act, 2010. Surprisingly, Pyzoha (2015) presented empirical evidence that suggests that clawbacks may have the opposite effect to that intended. By effectively imposing a financial penalty on executives for financial restatement, the likelihood of financial restatements is inhibited.…”

Do Voluntary Clawback Adoptions Curb Overinvestment?

“…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.…”