The Impact of Clawback Provisions on Information Processing and Investment Behavior

Posted: 19 Aug 2013 Last revised: 24 Jun 2018

See all articles by Bernhard Hirsch

Bernhard Hirsch

Bundeswehr University Munich

Bernhard Erich Reichert

Virginia Commonwealth University

Matthias Sohn

Zeppelin University

Date Written: January 18, 2017

Abstract

Proposals after the last financial crisis in 2008 have called for an extension of the scope of clawback provisions in compensation contracts beyond what is commonly legally required. Under such an extendeds cope, managers would be held accountable for losses. The reason for such an extended scope is to Counter incentives for excessive risk-taking that are currently present in many bonus contracts. We argue that such a call for an extended scope of clawback provisions ignores implications from prospect theory and motivated reasoning. We propose that if an investment decision can lead to either a gain or a loss for a company, then clawback provisions have a restraining effect on risk-taking compared to bonus-only contracts. In contrast, if the outcome of a decision affects only the potential size of a company’s loss, then clawback provisions lead to additional risk-taking compared to bonus-only contracts. In addition, we argue that additional accountability in a loss position leads to a motivated reasoning process. Managers overweigh positive project success factors and underestimate risk. We further propose that this effect occurs despite a higher risk tolerance, as suggested by prospect theory. Through an experiment, we find empirical evidence that is consistent with our predictions. Our findings contribute to the debate about extending the scope of clawback provisions in management compensation contracts. We also expand the research on prospect theory by showing that motivated reasoning processes occur even when prospect theory implies a higher risk tolerance, which conceptually should negate the need for motivated reasoning.

Keywords: Incentives, Clawback Provisions, Management Compensation

Suggested Citation

Hirsch, Bernhard and Reichert, Bernhard Erich and Sohn, Matthias, The Impact of Clawback Provisions on Information Processing and Investment Behavior (January 18, 2017). Management Accounting Research (2017), 37, 1-11; AAA 2014 Management Accounting Section (MAS) Meeting Paper. Available at SSRN: https://ssrn.com/abstract=2312487 or http://dx.doi.org/10.2139/ssrn.2312487

Bernhard Hirsch

Bundeswehr University Munich ( email )

Werner-Heisenberg-Weg 39
Neubiberg, 85577
Germany

HOME PAGE: http://www.unibw.de

Bernhard Erich Reichert (Contact Author)

Virginia Commonwealth University ( email )

Richmond, VA
United States

Matthias Sohn

Zeppelin University ( email )

Am Seemooser Horn 20
Friedrichshafen, Lake Constance 88045
Germany

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