When Do Executive Clawback Provisions Have Real Claws in Action? Evidence from Conservative Accounting

• In Event: Pension Plans, Derivatives, & Clawback Provisions

Abstract

We examine whether executive compensation clawback provisions (“clawbacks”) affect conservative accounting and how compensation contracts interplay with debt covenants and corporate governance in determining the degree of conservative accounting. Although shareholders and debtholders may demand less conservatism after adopting clawbacks, which directly restrain managerial opportunism, we predict that firms with clawbacks in place will recognize bad news timelier than good news due to the increase in the ex-post penalty on managers for misstated financial reporting. Consistent with this prediction, we find that firms with clawbacks use more conservative accounting in general. In addition, the positive association between clawbacks and conservatism is less pronounced in firms with a greater number of debt covenants (stronger governance) than in firms with fewer covenants (weaker governance). Overall, our findings provide new evidence on (1) the role of compensation contracting in conservative accounting and (2) the substitution effect between compensation contracts and debt contracts (corporate governance) determining in conservative accounting.

Authors

• Ahrum Choi, Seoul National University

• Sung-Han (Sam) Lee, Iowa State University

• Peter Oh, University of Southern California

• Patrick Woong Ryu, University of Georgia