Does the Proposed Rule for Bonus Compensation for Financial Institutions Affect Financial Reporting Choices?

• In Event: Accounting Behavior and Organizations

Abstract

Abstract: Pursuant to Section 956 of the 2010 Dodd-Frank Act, a rule was proposed in 2016 that introduced a mandatory deferral of incentive-based compensation in order to better align the interests of management with that of the institution. We question whether the rule considers the effect of prospect theory, which suggests increased risk taking in the presence of losses, or the realization effect, which suggests that there is a different risk profile for paper losses versus realized losses. This study experimentally investigates executive financial reporting choices under the proposed rule and compares this behavior with that of participants with a clawback provision. Using MBA students and MTurk participants, we find that those with deferred compensation make riskier financial reporting choices than those with a clawback condition, which is consistent with both prospect theory and the paper loss realization effect. This observation of higher levels of risk-taking is not in alignment with the initial goal of discouraging inappropriate risk-taking that could lead to financial loss as set forth in the proposed rule. Even after a realized loss occurs, we find no significant reduction in risk-taking behavior. Our overall results suggest that the proposed rule may not be as effective as intended

Authors

• Laura Alford, Louisiana State University

• Dana Hollie, University of Toledo