Does Voluntary Adoption of a Clawback Provision Improve Financial Reporting Quality?

Abstract

We examine whether financial reporting quality improves after firms voluntarily adopt a compensation clawback provision. Clawback provisions allow companies to recoup excess incentive pay in the event of an accounting restatement, and are intended to ex ante deter managers from publishing misstated accounting information and to ex post penalize managers who do so. For the period 2007-2009, our difference-in-differences analysis reveals significant improvements in both actual and perceived financial reporting quality following clawback adoption, relative to a propensity-matched set of control firms. We also find an increase in compensation for CEOs who are subject to new clawback provisions, as well as an increase in the sensitivity of cash compensation to accounting performance. In cross-sectional tests, our findings indicate that “robust” clawback provisions, those that apply to restatements caused by either intentional or unintentional errors, have an incrementally larger impact on financial reporting quality and compensation than do clawback provisions that apply only to restatements involving fraud.

Keywords: compensation clawback provisions, financial reporting quality, executive compensation

JEL Classification: K22, M41, M48, M52