Insider Sales and the Effectiveness of Clawback Adoptions in Mitigating Fraud Risk

Posted: 9 Feb 2015 Last revised: 1 Jan 2016

See all articles by Simon Fung

Simon Fung

Deakin University

K. K. Raman

The University of Texas at San Antonio

Lili Sun

University of North Texas - Department of Accounting

Li Xu

Washington State University, Vancouver

Date Written: February 8, 2015

Abstract

In recent years, firms (and lawmakers) have sought to mitigate the dysfunctional effects of incentive-based executive compensation by adopting clawbacks. However, extant clawbacks (whether firm-initiated or as mandated by the 2010 Dodd-Frank Act) do not go far enough in that they seem to allow executives to retain trading profits linked to sales of their own companies’ shares at a time of inflated earnings (Fried and Shilon 2011). In this paper, we examine the moderating effect of insider sales on the relation between firm-initiated clawback-adoptions and fraud risk. Our results indicate that clawback-adopting firms experience a decrease in fraud risk following adoption relative to non-adopters during the same time period. However, this decrease in fraud risk for the clawback-adopting firms is materially weakened in the presence of insider trading. At this time (July 2014), the SEC is still working on rules for implementing clawbacks (one of nearly half of the rules yet to be completed under Dodd-Frank). Our findings suggest that clawback rules (as and when issued by the SEC) need to address insider sales for clawbacks to be fully effective in mitigating the risk of fraudulent financial reporting.

Keywords: Clawback adoptions, equity incentives, insider sales, fraud risk

Suggested Citation

Fung, Simon and Raman, K. K. and Sun, Lili and Xu, Li, Insider Sales and the Effectiveness of Clawback Adoptions in Mitigating Fraud Risk (February 8, 2015). Journal of Accounting and Public Policy (July-August 2015), 34(3):417-436. Available at SSRN: https://ssrn.com/abstract=2562077

Simon Fung

Deakin University ( email )

221 Burwood Highway
Burwood, Victoria
Australia

K. K. Raman (Contact Author)

The University of Texas at San Antonio ( email )

One UTSA Circle
San Antonio, TX 78249
United States
210-458-8749 (Phone)

Lili Sun

University of North Texas - Department of Accounting ( email )

1155 Union Circle #305219
Denton, TX 76203-5017
United States
940-565-3077 (Phone)

Li Xu

Washington State University, Vancouver ( email )

14204 NE Salmon Creek Avenue
Vancouver, WA WA 98686-9600
United States

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