Clawback Provisions: How Sharp Are the Claws? An Analysis of the Deterrence Effectiveness of Voluntary Clawback Provisions

This paper investigates the effectiveness of voluntary clawback provisions as a deterrent for earnings management behavior. The Dodd-Frank (DF) Bill signed into law July 21, 2010 mandates that the SEC adopt a rule requiring all U.S.-listed companies to implement clawback provisions that recapture excess compensation received by executives on the basis of a faulty financial statement filing with the SEC that later must be restated. Implicitly, the DF regulation assumes that clawbacks will successfully constrain financial misreporting and that a “one-size-fits-all” approach is best. In contrast with prior research that has investigated factors associated with a firm’s decision to adopt a clawback provision and/or various capital market consequences associated with clawback adoptions, I develop a stringency metric for analyzing clawback structures. I analyze the financial reporting consequences associated with clawback structure and mediating effects of antecedent corporate governance quality. Preliminary results indicate that, for both weak-governance and strong-governance firms adopting clawback provisions, increased clawback stringency is generally associated with lower levels of earnings management. However, the deterrent effect of clawback stringency is often attenuated for the strong-governance firms. None of the identified adopting firms had duality of the CEO and Chairman positions, thus, confirming that clawback adoptions may be conceptualized as a component of strong governance. This observation, coupled with the documented success of the clawbacks in deterring earnings management, provides support for the need for regulation.