Curbing Earnings Management: Experimental Evidence on How Clawbacks Provisions and Board Monitoring Affect Managers’ Use of Discretion.

• In Event: Behavioral Financial and I/S Research

Abstract

Concerns about earnings management and financial reporting quality have lead regulators to propose rules that clawback incentive-based compensation from managers when there is a financial restatement. Earnings management (EM) could, in theory, be curbed by internal governance mechanisms (e.g., strong boards) or by external governance mechanisms (e.g., clawbacks and other rules). We experimentally examine the impact of mandated clawbacks on managers’ EM behavior, conditional on firms’ board type (strong versus weak) We posit that aggregate earnings management will not be affected by mandated clawbacks. When boards are weak, we predict that mandated clawbacks simply shift EM from accrual-based methods to real-activities manipulation. When boards are strong, we predict that clawbacks will have little impact on EM. Our results are consistent with these predictions and suggest that clawbacks, at best, do little to deter EM (when boards are strong) and, at worst, may have counter-productive effects (when boards are weak).

Authors

• Shankar Venkataraman, Georgia Institute of Technology

• Jeffrey Hales, Georgia Institute of Technology

• BALAJI KOKA, RICE UNIVERSITY