The Unintended Consequences of Voluntary Adoption of Clawback Provisions on Managerial Ability

Abstract

I investigate the impact of voluntary adoption of clawback provisions on managerial ability. The U.S. Securities and Exchange Commission (SEC, 2003) describes the adoption of clawback through the Sarbanes-Oxley Act (SOX) Section 304 as an action to improve the “tone at the top”. In line with this description, I predict that clawback provisions will motivate managers to exert more efforts following the adoption of clawback and these efforts will be in the form of an increased managerial efficiency. Using a propensity score matching sample of firms that adopt clawback versus firms that did not adopt clawback between 2007-2013, I find a significant positive association between voluntary clawback adoption and the changes in both ranks and scores of managerial ability. Further analysis suggests that this association is driven by proactive clawback provisions targeting bonuses and reversed when clawback provisions are reactively triggered by misconduct. My study highlights the unintended consequences of clawback provisions on CEO’s behavior and contributes to the on-going debate on the importance of proactively and carefully drafting clawback policies, further signifying the importance of the SEC’s efforts (Rule 10D-1) to enforce clawback policies.

Keywords: Clawback, Managerial Ability

JEL Classification: M41, M48, M49, C50