Clawback enforcement heterogeneity and the horizon of executive pay: empirical evidence

• Date: 01 August 2024
• Pages: 773-802
• DOI: https://doi.org/10.1108/IJAIM-04-2023-0099
• Published date: 01 August 2024
• Subject Matter: Accounting & finance,Accounting/accountancy,Accounting methods/systems
• Author: Alvaro Remesal

Clawback enforcement

heterogeneity and the horizon of

executive pay: empirical evidence

Alvaro Remesal

Department of Finance and Accounting, CUNEF Universidad, Madrid, Spain

Abstract

Purpose –Clawback provisionsentitle shareholders to recover previously awardedincentive compensation

after the discovery of accountingmanipulation or misconduct. The author evaluatesthe impact of clawback

enforcementheterogeneity on the horizon of executive compensation.

Design/methodology/approach –The author provides empirical tests to evaluate the impactof clawback

adoption decisions. The author deals with the endogeneity of clawback adoption decisions through an

instrumental variables strategythat exploits the transmission of governance choices within f‌irms’networks.

Findings –While the author f‌inds that clawback adoptionreduces the frequency of accounting manipulation,

this reduction is accompanied by heterogeneous effects on the horizon of executive pay across f‌irms. Clawback

adopters with high director independence, high leverage, high managerial termination payments and low

executive ownership tilt theircompensation toward the short-term.

Practical implications –The results, robust to alternative specif‌ications, suggest that clawbacks allow

strong-enforcement f‌irms to tilt compens ation toward the short -term, offsetting som e of the direct

manipulation disincentives generated by the clawback. The stock market reacts positively to the adoption

in f‌irms with weak enforceme nt, suggesting that c lawbacks signif‌icantly reduce the managers’rent-

extraction capacity .

Originality/value –Using a novel empirical and identif‌ication approach, the results suggest that

clawbacks allow strong-enforcementf‌irms to tilt compensation toward the short-term, offsettingsome of the

direct manipulationdisincentives generated bythe clawback.

Keywords Clawback, Executives, Governance, Compensation, Accounting Manipulation

Paper type Research paper

1. Introduction

Clawback provisions enableshareholders to recover compensation from managers after the

discovery of accounting manipulation or misconduct. A majority of U.S. public f‌irms report

the adoption of clawback provisions following several regulatory reforms and recommendations

from proxy advisory f‌irms that mandate or encourage the adoption of clawbacks (Institutional

Shareholders Services, 2017;Skadden, Arps, Slate, Meagher and Flom LLP, 2017). In particular,

such popularity can be largely explained by the anticipated implementation of the 2010 Dodd-

Frank regulations. U.S.-listed companies should have adopted a Dodd-Frank-compliant clawback

policy by December 1, 2023.

This paper assesses and provides novel evidence on the empirical relationship between

clawback adoption and the time horizon of executive pay. We hypothesize that clawback

adoption should have a heterogeneous impacton compensation schemes, depending on the

JEL classif‌ication –D86, G34, J33, K41

Empirical

evidence

773

Received21 April 2023

Revised15 April 2024

Accepted16 June 2024

InternationalJournal of

Accounting& Information

Management

Vol.32 No. 5, 2024

pp. 773-802

© Emerald Publishing Limited

1834-7649

DOI 10.1108/IJAIM-04-2023-0099

The current issue and full text archive of this journal is available on Emerald Insight at:

https://www.emerald.com/insight/1834-7649.htm

enforcement structures available to f‌irms. Clawback enforcement is infrequent relative to

the frequency of f‌inancial restatements (Fried, 2016). This means that relevant frictions

must appear when shareholdersattempt to recover executive pay.

The literature has shown that f‌irms design clawback policies with heterogeneous degrees of

severity (Chen and Vann, 2014;Erkens et al., 2018;Liu et al., 2018;Velte, 2020;Asante-Appiah

and Sharma, 2022). This heterogeneity likely responds to and generates differential

expectations of clawback enforcement, and its costs, ac ross f‌irms. For instance, powerful

managers can resist an earnings restatement (Pyzoha, 2015), litigate against shareholders

(Fried, 2016) or embark into real earnings manipulation (Chan et al., 2015). Thus, f‌irms with

better enforcement structures should expect relatively low costs from enforcing their clawback

provisions or impose high costs over managers in the form of litigation or reputation costs.

The likelihood of clawback enforcement also depends on the incentives that managers

have to manipulate accounting information after the adoption of a clawback. These

incentives should partly arise from the relative steepness of their short-term compensation

(Bergstresser and Philippon, 2006;Kediaand Philippon, 2009;Edmans et al.,2014;Edmans

et al., 2017;Bennett et al., 2017).Firms that expect a strong clawback enforcement should be

relatively less afraid of tiltingtheir compensation structures toward the short-term once the

clawback has been adopted. Thatis, strong enforcement guarantees that compensation can

be largely recovered at low cost. Hence, as our main hypothesis, we conjecture that f‌irms

with strong clawback enforcement structures should tilt their compensation toward the

short-term, relative to f‌irms with weak enforcement, because of their low costs of

enforcement and thehigh potential penalties to be borne by managers.

We hypothesize that clawbackadoption induces changes in the time horizon of executive

pay, thereby having an impact on the managers’accounting manipulation incentives. That

is, the increase in short-term compensation in strong enforcement f‌irms may offset some of

the direct manipulation disincentives brought about by the clawback adoption decision.

Indeed, shareholders may perceive manipulation as less costly due to the reduction in the

size of erroneously awarded pay in case of manipulation (Goldman and Slezak, 2006;

Remesal, 2024).Thus, we also hypothesize a relatively homogeneous reduction inaccounting

manipulationacross clawback adopters,regardless of theirenforcement structures.

As identif‌ication strategy to test our hypothesis, we exploit the clawback adoption

decisions within institutional investor networks as an instrumental variable. Our design is

motivated by the existenceof common governance shocks or spillover effects that propagate

across the institutional ownershipnetwork (Kempf et al, 2017;Liu et al., 2020a;Blanco et al.,

2024). By pursuing an instrumental variables identif‌ication, we provide an alternative

identif‌ication tool that is different from propensity-score matching, which is the most

popular approachin the empirical literature on clawback provisions [1].

Institutions hold an increasing and sizable fraction of global equities and pose a

signif‌icant inf‌luence over f‌irms’decisions (McCahery et al., 2016;Ben-Rephael et al., 2017;

Schmidt and Fahlenbrach, 2017;Heath et al.,2021). Our identif‌ication arguments capture

that clawback adoption within ownership networks is due to compliance motives with

respect to new regulations and proxy advisors’recommendations that inf‌luence the

investors’decisionsacross their portfolios (Crane et al., 2019;McCahery et al.,2016).

The validity of the instrumental variables strategy rests on two main aspects. First, the

process of generalized clawback adoption across U.S. f‌irms responds mostly to the

anticipation of binding clawback regulations –a regulation-compliance motive –within a

general change in the corporate governance environment after the 2007–2009 Global

Financial Crisis. The adoption timing at the individual f‌irm level may be associated with

other unobservable determinantsof corporate policies. However, the timing of adoption by a

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