Section 304 (âSOX 304â) of the Sarbanes-Oxley Act of 2002 (âSOXâ). SOX ... To do so, we hand collect from the pr
Clawback Provisions Ilona Babenkoa Benjamin Bennettb John M. Bizjakc Jeffrey L. Colesd,* First Draft: July 2010 Current Draft: June 5, 2012 Abstract ____________________________________________________________________________ We collect and analyze a comprehensive sample of company-adopted clawback provisions, reported by S&P 1,500 firms over 2000-2011, that potentially enable firms to recoup employee pay under certain conditions. Reported usage climbs over the decade from less than 1% in 2000 to almost 50% in 2011 (70% for S&P 500 firms). We document the form of adopted provisions including – who is covered, what events trigger the clawback, what can be recovered, the period over which the provision applies, complexity of the policy, and who oversees implementation of the policy. Firms are more likely to report adoption of a clawback provision when: there is prior executive misbehavior at the firm; earnings management is more feasible and harder to detect; rent extraction by executives is easier or more damaging; external monitoring is greater and the board is more independent; and executives have compensation-related reasons to misrepresent firm performance. Conditional on adoption, the policy extends to more employees and covers more components of compensation when the firm is larger and when harmful employee activities can be more damaging to the firm. Adoption of a clawback is associated subsequently with higher executive pay and proportionally more equity-based executive pay. While we find that clawbacks are rarely triggered by the firm, we find evidence of higher executive turnover and reduced CEO tenure following adoption of a clawback. The stock market reaction to the public report of a clawback policy is modestly positive. Overall, our analysis identifies the economic determinants of usage and form of clawback policies and the behavioral implications of those policies. Our results suggest that the presence of these provisions, even when not implemented, may provide the board with an additional mechanism to align executive incentives.
____________________________________________________________________________ __ JEL Classifications: G32; G34; J33, M41, M52, M55. Keywords: Clawback, recoupment, recover, executive compensation, employee pay, accounting restatement, fraud, corporate governance. a
W.P. Carey School of Business, Arizona State University, Tempe, AZ., 85287, USA;
[email protected]. W.P. Carey School of Business, Arizona State University, Tempe, AZ., 85287, USA;
[email protected] c Neeley School of Business, Texas Christian University, Fort Worth, TX, 76129, USA;
[email protected] d W.P. Carey School of Business, Arizona State University, Tempe, AZ., 85287, USA;
[email protected] * Corresponding author. b
The authors thank Arthur Allen, Carr Bettis, Stu Gillan, and Swaminathan Kalpathy for helpful comments and Carr Bettis and IncentiveLab for generously providing assistants in data collection. Additional financial support was provided by the Lowden Chair in Finance at TCU (Bizjak). The paper has benefited from seminars at the Arizona State University, University of Nebraska, and Texas Tech University. We also thank Linda Pratt, Colin Gallison, Amelia Pape, Ben Bodkin, and Michael Nguyen for valuable research assistance.
Clawback Provisions
Clawback provisions, in one form or another, have been in use for hundreds of years. For example, non-compete agreements that include financial penalties for noncompliance have been employed in the US since the early 1800s and perhaps even prior (Fisk (2001)). Partly as a response to regulatory changes and to perceived failures in corporate governance, companies have expanded the use and sophistication of these policies. Currently, as our data reveal, these provisions focus on the recovery of compensation paid to executives and employees related to cases of fraud, earnings manipulation, accounting restatements, or other actions undertaken by executives or employees perceived to be misconduct or harmful to the firm. The first regulatory action in the U.S. pertaining to the use of clawback provisions is Section 304 (“SOX 304”) of the Sarbanes-Oxley Act of 2002 (“SOX”). SOX 304 authorizes the Securities and Exchange Commission (SEC) to enforce the recovery from the CEO and the CFO of a public company their “bonus or other incentive-based or equity-based compensation” or “any profits received from the sale of securities” when there was a restated financial statement “due to the material noncompliance of the issuer, as a result of misconduct, with any financial reporting requirement under the securities laws.”1 More recently, the American Recovery and Reinvestment Act of 2009 imposed additional repayment rules for financial institutions receiving funds under the federal bailout program. The restrictions generally applied to the five highestpaid senior executive officers plus up to the next 20 highest-paid employees and required repayment of “any bonus, retention award or incentive compensation” that was based on “statements of earnings, revenues, gains, or other criteria that are later found to be materially 1
Sarbanes-Oxley Act of 2002 section 304.
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inaccurate.”2 Third, the Dodd-Frank Wall Street Reform and Consumer Protection Act (“DoddFrank”) of 2010, in Section 954 on “Erroneously Awarded Compensation,” when fully implemented will require companies to adopt a policy that will recapture any excess incentive compensation that was paid based on erroneous financial statements. Dodd-Frank requires the SEC to issue rules directing the national securities exchanges and associations to prohibit the listing of any company that fails to comply with the new recapture or clawback policy contained in Dodd-Frank.3 The logic for usage of clawback provisions is simple. First, a clawback can impose an ex post cost on an executive who commits fraud or earnings management or otherwise behaves inappropriately. Second, if a recoupment provision is based on a measure of firm performance, that provision can provide a supplement to or an additional source of wealth-performance sensitivity (WPS or “delta”) to executive incentives arising from other sources, such as accumulated stock and option holdings (net of dispositions). Third, in numerous instances the consequences of managerial decisions are far-removed in time from the initial decisions themselves. In the context of such a timing mismatch, a clawback provision can address the corresponding horizon problem, thereby inducing better managerial decisions in the first place. Finally, a clawback provision that is triggered by extreme outcomes would reduce or alter the risk taking incentives of managers. By way of illustration, such a provision, if it were contingent on low realizations of a state variable correlated with firm performance, would have the effect of
2 Emergency Economic Stabilization Act (EESA) 2008 Section 111(b)(2)(B). 3
The clawback affects current or former executive officers that received incentive-based pay during the three-year period prior to the date the issuer was required to prepare a restatement and requires the recovery of compensation paid in excess of what would have been paid under the restatement. It also states that all incentive compensation based on erroneous financial statements will be subject to recapture, including stock options if applicable. The ultimate form of the rules to be issued by the SEC, as well as the date by which the SEC must issue its rules, remain uncertain.
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making a manager’s wealth- or pay-performance relation more concave over the lower part of the domain of performance realizations, thereby inducing more risk-averse decision making. Of course, the applicability of the above reasons for the presence and structure of a clawback provision varies across firms. Thus, one cost of requiring a very specific form, such as a one-size-fits-all recoupment policy which most of the regulations impose, is that it may be a poor contractual solution for some firms. Firms that vary in product market, cost structure, asset base, governance structures, and regulatory regimes, for example, can have different optimal contractual solutions to incentive problems. A rigid, procrustean mandate that firms all adopt a recoupment policy within narrow bounds would impose costs on at least some firms. In contrast, if the recent regulatory statutes are a response to real or perceived deficiencies in contracting, then perhaps all firms should have some sort of recoupment policy. To the extent that the assertion of overregulation is inaccurate, firms may have responded individually to the need for these provisions, having implemented one independent of any regulatory or political impetus. Furthermore, under the current regulatory structure, it is possible that firms have sufficient flexibility to choose a version that is not too far from optimal. Recoupment policies may perform the intended purpose of solving or nearly solving agency problems and aligning incentives. In this paper, we provide a comprehensive description of the adoption, usage, characteristics, and implications of clawback provisions adopted and implemented over the last 12 years. To do so, we hand collect from the proxy (DEF 14A), 10-K, and 8-K statements of S&P 1,500 firms from 2000 through 2011 all information reported on the presence and form of recoupment policies. Our data enable three primary classes of empirical contributions.
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First, we provide the empirical facts on clawback adoption and form. The frequency of firms reporting a clawback provision has risen substantially over the last decade. For example, among S&P 1,500 firms, reported usage climbs from less than 1% in 2000 to over 48% by 2011. By 2011 almost 70% of S&P 500 firms had adopted a clawback policy. Clawback provisions present a wide spectrum of contractual possibilities.
We document the form of adopted
provisions, including: who is covered; what events and behaviors trigger the clawback; which components of compensation can be recovered; the length of time after the event that the provision applies; and who oversees implementation of the policy. For example, when details of the policy are revealed about who is covered, the CEO is covered in 66% of provisions, and all named executive officers (NEOs) 62% of the time.
Triggering events include earnings
restatements (70%), fraud (32%), misconduct and negligence of fiduciary duty (48%), “misrepresentation” (18%), and violation of non-compete agreements (15%). While clawback policies rarely, if ever, cover the board of directors, it is the board that is primarily involved in overseeing and implementing the policy. Executive bonuses, equity grants, and option grants either in whole or part, often all are fair game, and there is evidence of expiration or a “statute of limitations” only in a modest number of cases.4 Second, we identify the economic determinants of adoption and contractual form of adopted provisions. We find that firms are more likely to report adoption of a clawback provision when: (a) there is evidence of prior executive misbehavior at the firm (prior class action lawsuit); (b) fraud, misrepresentation, and earnings management are more feasible and harder to detect (e.g., higher R&D expenditures, more volatile prior stock returns, the firm is more diversified); (c) rent extraction by executives is easier or more damaging (higher cash flow, 4
The level of information reported in SEC filings varies widely by time period and firm. For example, not all filings reveal who is covered by the clawback policy. We discuss this issue below and other issues regarding how these policies are reported and the information contained in filings.
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more assets); (d) the board is more independent; and (e) executives have compensation-related reasons to misrepresent firm performance (executives have higher equity-based pay, face performance-vesting (p-v) provisions on equity-based pay, or have golden parachutes). Clawback usage appears to be unrelated to institutional ownership, prior executive pay level, capital structure, or state law pertaining to contract enforceability of such a provision. In terms of form of the recoupment policy, conditional on adoption the policy extends to more employees when the firm is larger and covers more components of compensation when the firm is larger and R&D expenditures and cash flows are greater. In addition, more events or behaviors trigger the policy when the policy has broader employee coverage. Policy complexity increases in firm size, EBITDA scaled by total assets, and whether there was a class action suit prior, and is negatively related to Tobin’s Q. Third, we assess the implications of clawback provisions. We find evidence that the adoption of a clawback is associated with changes in pay levels and pay structure. The pay to top five executives increases by approximately $518,000 which suggests executives need to be compensated for the increased cost and risk these provisions impose. In addition, adoption of a clawback is followed by a higher proportion of equity based pay and longer compensation horizon. Firms with a greater proportion of equity based pay are more likely to suffer from managerial actions such as earnings manipulation (Burns and Kedia (2006)) that clawbacks policies can mitigate. That clawback usage corresponds with the conveyance to managers of incentives to increase stock price (delta) and firm risk (vega) suggests that firms are concerned with both the benefits and potential adverse effects associated with equity based pay.
We also
find that the adoption of a clawback is associated with an upgrade in the credit rating of the company. To the extent that clawbacks reduce risk taking incentives and the agency costs
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between stock holders and bondholders they can reduce the riskiness of debt and lower the cost of debt capital. Contrary to some prior studies, we do not find that clawback adoption lowers the incidence of financial restatements (Chan, Chen, Chen, and Yu (2012)) or reduces shareholder litigation or discretionary accruals. On average, the market reaction to report of a clawback policy prior to Dodd-Frank is on the order of 0.5 percent. We find some evidence that the announcement-period return is larger when stock return volatility is higher and the firm is larger. Finally, we examine the extent of enforcement of these provisions by identifying how firms respond to financial restatements or shareholder suits after they have adopted a clawback policy. We find little evidence that firms themselves implement a clawback to recover pay following these events. Perhaps one reason that enforcement of these policies is infrequent is because the majority of these policies have only been recently adopted. While enforcement of these provisions is rare, we do find that both executive turnover is higher and CEO tenure is shorter subsequent to the adoption of a clawback policy. The presence of a clawback policy likely provides a tool for the board to discipline a CEO for underperformance or other reasons. Consequently, while at this point in time clawbacks seem to be rarely triggered by the firm, the evidence suggests that they likely still provide a valuable disciplinary role. The paper proceeds as follows. Section I describes the related literature. Section II describes the data used in the study and characterizes usage along with the form of recoupment policies in large US companies. Section III develops hypotheses on the economic determinants of clawback usage and form and on the implications of clawbacks for executive behavior, firm outcomes, and value. Section IV empirically identifies the economic determinants of clawback policy adoption, while Section V examines the determinants of the characteristics of the clawback provisions. Section VI estimates the behavioral implications of clawback provisions
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and Section VII assesses the wealth effects of the adoption of these provisions. Section VIII explores the few instances in which the SEC has exercised its clawback powers under SOX or firms themselves have triggered recoupment actions. Section IX examines the determinants of the complexity of clawback policies. Section X concludes.
I. Related Literature In this section, we place our study in the context of the related literature. At inception of our data collection process, which we started in 2008, we were aware of no other study of clawback provisions. A number of working papers on clawback policies and related topics have since appeared. Since there are considerable differences between or work and the related literature in sample characteristics, analysis, and findings, we provide more details in Appendix B, where we place our work in the context of the other research in this area. Below we briefly describe the concurrent research. Levine and Smith (2010) provide a theoretical analysis of the incentive properties of mechanisms that can retract previously awarded cash bonuses but do not provide any empirical analysis of these policies. Chen, Greene, and Owers (2012) develop a model to examine the same question and empirically examine the stock market reaction to adoption for 505 announcements among Fortune 1000 firms over 2004-2011. Focusing exclusively on clawbacks that only deal with financial restatements they find that the average market reaction is significantly positive. Moreover, Chen, Green, and Owers (2012, abstract) report that their empirical results are consistent with “the empirical predictions that (i) the benefits of a clawback provision are decreasing in managerial risk aversion, firm risk, and the quality of a manager’s private information; (ii) a voluntary clawback will tend to reduce managerial misreporting; and
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(iii) a voluntary clawback will tend to be followed by an increase in the sensitivity of pay to accounting performance.” Gao, Iskander-Datta, and Jin (2011) also perform an event study on 486 adoptions over 2005-2009 using the Corporate Library data on clawbacks and find a significant positive market reaction. Brown, Davis-Friday, and Guler (2011), in a sample from the Corporate Library database of 252 clawbacks over 2005-2009, find that adopting firms are larger, have less influential CEOs, and have higher M&A bonuses and goodwill impairments. Chan, Chen, Chen, and Yu (2012), based on 343 firms that had a clawback provision in place in 2009, using the Corporate Library data, find that after adoption such firms suffer fewer accounting restatements and have a higher earnings response coefficient than non-adopters. Fried and Shilon (2011) provide information on usage rates for firms in 2010 in the S&P 500. In comparison to these studies, as will be seen below, our data are more comprehensive and contain much more detail, which enables us to study a number of issues not addressed in the other papers. Our data enable a wide spectrum of in-depth empirical experiments that isolate the determinants of usage of clawbacks, form of the policy, and the implications of these provisions for behavior and value. Finally, our results in some instances differ from prior studies, which suggests that both the types of firms analyzed and the time period have important implications for understanding these provisions.
II. Sample Collection and Characteristics In order to frame the development of our hypotheses, we first describe collection of the sample and characteristics of observed clawback provisions. This information, particularly on the variation in contractual forms, facilitates development of our hypotheses in section III.
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We obtain data on clawback policies using global keyword searches of proxy statements, 10-Ks, and 8-Ks filed with the SEC and housed on their Electronic Data Gathering, Analysis, and Retrieval (EDGAR) database.
We use the search engine in Morningstar
Document Research. The keyword searches cover the calendar years 2000 through 2011. Because firms vary in how they describe a clawback in these filings, we use a number of different keyword strings to capture the presence of these contracts. For example, the term “clawback” is one common term used to refer to these policies, but firms also refer to these provisions as “recoupment” or “recovery” policies. In order to be as thorough as possible, we use several different Boolean strings to capture the presence of a clawback. 5 We manually inspected every filing to insure that the keyword was referring to a compensation clawback policy.6,7 Having verified that the firm had a clawback provision in place, we extract as much information as possible about characteristics of the policy. While we perform a global search of all firms with SEC filings on EDGAR, we focus our analysis on the S&P 1,500. We also examine a random sample of 50 proxies and 10-Ks that we identify in our dataset as not having a clawback in 2008 in order to verify we were not missing any keywords firms used to identify these provisions. Table 1 provides information on the number of clawbacks adopted at S&P 1,500 firms between 2000 and 2011. As the table illustrates, clawbacks are very rare up until around 2005. Starting in 2006 we see a sharp increase in these provisions, perhaps because of the change in 5
Specifically the search terms we used were clawback!; claw! w/4 back!; compensat! w/6 recover!; compensat! w/6 recoup!; recoup! w/6 provision!; recoup! w/6 polic!; recoup! w/6 award!; recover! w/6 award!. 6 The term clawback (and other search strings) can refer to more than a provision that allows for the recoupment of compensation. For example, clawbacks are used in private equity funds that allow the limited partners to recover any “excess” distributions by the general partner. These provisions also show up in lending and franchise agreements but are not related to compensation or the issues we address in this paper. 7 Another reason why manual inspection of the filings is important is that firms will mention they are considering the adoption of a clawback but have yet to adopt. In addition, in a number of filings the clawback is part of a shareholder proposal to push the firm to adopt the policy but the clawback has not been adopted by the firm.
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Regulation S-K, which states that a clawback is a material element of executive compensation and should be disclosed. By 2011 close to 70% (342) of the firms in the S&P 500 report a clawback provision and about half (723) of firms in the S&P 1,500 have a clawback provision in place. Clawback provisions are now quite common. Potentially one reason for the increased adoption of clawbacks in the more recent time period is the Dodd-Frank Act which, when adopted, will mandate that firms adopt a clawback policy. In our sample of 2,115 firm-year observations with a clawback provision, the most frequent data source is corporate proxy statements (81%), followed by 8-Ks (12%) and 10-Ks (7%). To set ideas and provide concreteness, we provide two examples below. In each case, we reproduce here everything that we could find in the relevant disclosure pertaining to the recoupment policy. The first example, IXIA, is relatively simple discussion, and the second, McKesson Corporation, is more involved.
IXIA (XXIA) 4/27/2010 Proxy (Page 20) To reinforce our commitment to ethical conduct and discourage excessive risk taking, Ixia’s 2010 Executive Officer Bonus Plan includes a “clawback” provision which states that the Compensation Committee has the absolute right not to pay, to delay the payment of or to recover all or a portion of any bonus awarded to an officer under such plan if the Company’s 2010 financial statements are restated. … Ixia’s long-term incentive performance-based NSOs include a “clawback” provision which states that if the Company restates its financial statements for any reason for 2010 and/or 2011, then all unearned and/or unvested options will be automatically cancelled and forfeited for no value.
McKesson Corporation – MCK 6/21/2010 Proxy (Page 54) Compensation Recoupment Policy The Board is dedicated to maintaining and enhancing a culture that is focused on integrity and accountability, and that discourages conduct detrimental to the Company’s sustainable growth. To that end, on January 20, 2010 the Board approved 10
an updated Compensation Recoupment Policy (the “Recoupment Policy”) that both expands on and clarifies the previous “clawback” policies embedded in the Company’s various incentive plans and programs. The updated Recoupment Policy applies to any Company employee who receives a cash or equity incentive award after January 20, 2010. Under the Recoupment Policy, and consistent with the Company’s core values, the Board determined that it may be appropriate to recover annual or long-term incentive compensation provided to certain employees in the event that these individuals engage in conduct that is detrimental to the Company. Specifically, the Company may recoup incentive compensation from any employee if: (i) he or she engages in intentional misconduct pertaining to any financial reporting requirement under the Federal securities laws resulting in the Company being required to prepare and file an accounting restatement with the SEC as a result of such misconduct, other than a restatement due to changes in accounting policy; (ii) there is a material negative revision of a financial or operating measure on the basis of which incentive compensation was awarded or paid to the employee; or (iii) he or she engages in any fraud, theft, misappropriation, embezzlement or dishonesty to the material detriment of the Company’s financial results as filed with the SEC. If triggered, then to the fullest extent permitted by law, the Company may require the employee to reimburse the Company for all or a portion of any incentive compensation received in cash within the last 12 months, and remit to the Company any profits realized from the sale of the Company’s common stock within the last 12 months. As described in the Company’s standard incentive plan award documentation, the Compensation Committee may also seek to recoup any economic gain from any employee who engages in conduct that is not in good faith, and which disrupts, damages, impairs or interferes with the business, reputation or employees of the Company. The 2010 clawback policy of McKesson illustrates the potential for considerable complexity in these policies. The McKesson example is also interesting because it illustrates that a clawback policy may well be associated with the adoption of a new compensation plan. It is also worth noting that this is a modification of a clawback policy that was adopted earlier by the firm. Once we confirm that a firm has a clawback policy, we gather all information about the structure of the clawback that is available in the filing. When available, we gather information on: (i) the date the provision was formally adopted; (ii) the stated reason for adoption; (iii) who 11
is covered by the clawback; (iv) the event(s) that can trigger the clawback; (v) the elements of compensation that potentially can be recovered by the clawback; (vi) whether the clawback allows for additional penalties besides the recovery of compensation; (vii) who oversees or has the authority to implement the policy; and (viii) the date at which coverage by the policy begins and the period of time the policy stays active. Tables 2-6 report our findings on the nature and characteristics of these agreements.8 We note immediately that, conditional on a filing that establishes the presence of a clawback provision, the amount of information provided can vary considerably across firms and policy dimensions.
Some firms provide almost no information about the clawback
provision other than acknowledging they have adopted the policy, while other firms provide a significant amount of detail.9 This is illustrated in Table 2, which tabulates the reasons for adoption. Numerous filings specify other reasons for adoption (742, 35%) or give no reason at all (160, 8%). When a specific reason for adoption is given, the provision can be part of a compensation plan (749, 35%) or part of a specific employment agreement (83, 4%). Some impetus arises from Sarbanes Oxley (145, 7%). While SEC rulemaking in response to DoddFrank will soon mandate a clawback for all registered firms, few firms mention that as the primary motivation (62, 3%). Because some firms state more than one reason for adoption, the percentages sum to more than 100%. As we will see below, while firms implement some of the general features of clawbacks that are part of SOX, American Recovery and Reinvestment Act (TARP related), and Dodd 8
As is also illustrated in the McKesson example firms often report the presence and information about a clawback in more than one filing. If so, we gather information from the multiple sources about the specific characteristics of the clawback policy. 9 An interesting question is whether firms that provide minimal disclosure differ in any significant dimensions from firms that provide a richer description of the policy. A logit analysis comparing firms that provide minimal disclosure (no information besides adoption) with those that provide more complete disclosure indicates that the groups differ significantly only in analyst coverage. This suggests that selection bias does not contaminate our analysis of the determinants of clawback characteristics (section V).
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Frank, the nature of these policies deviates significantly not only from the current regulations but also differs across firms. This heterogeneity is to be expected if firms that adopt these policies differ in firm, industry, market characteristics, and regulatory environment. Table 3 lists eleven events firms identify as triggers of the 2,115 reported clawback provisions. The most common actions that trigger the use of a clawback are accounting restatements (1,473, 70%). This is not surprising given that SOX targets restatements as a primary trigger for the implementation of clawbacks, as do the American Recovery and Reinvestment Act (hereafter ARRA) and Dodd-Frank. Unlike the regulatory rules, violation of the employee’s fiduciary duties to shareholders and other parties is another event that frequently triggers the clawback (1,006, 48%). A traditional trigger, violation of non-compete agreements, is also frequently specified (320, 15%). Again because some firms state more than one reason for adoption, the percentages sum to more than 100%. It is important to understand the specific reason for both the adoption of these provisions and the events that trigger the clawback. Some of the contemporaneous research on clawback adoption often focuses on clawback policies that are triggered by one specific event such as accounting restatements (e.g., Chen, Green, and Owers (2012)). As our data suggest, however, firms rarely adopt these policies for one particular reason or limit the triggering event to one particular activity. Table 4, Panel A identifies who is covered by the provisions. When information is provided about the characteristics of the provision the CEO is explicitly identified as covered (66% of all provisions) and very often the remaining named executive officers (NEOs) are mentioned as covered as well (62%).10 The filing identifies no employee in 18% of cases. 10
This number is likely to underestimate the number of provisions that cover executives such as the CEO or NEOs since the numbers here only account for filings that explicitly state who is covered. As an example as to why this
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Otherwise, non-NEO executives (12%) or employee groups besides executive officers (9%) are covered under some policies, but non-employee board members are rarely explicitly covered by the clawback (1%). Panel B of Table 4 indicates that the clawbacks primarily target the individual(s) that are responsible for the events that trigger the clawback, but some policies extend beyond the parties directly responsible. The data illustrate that the coverage for these plans varies from SOX which only covers the CEO and CFO, ARRA which covers senior executives (defined as the 20 highest paid executives), and Dodd-Frank which covers all current and former executive officers. Clawback policies are often tied to specific components of compensation or are part of a specific compensation plan. For example, in recent years clawback policies have been attached to newly adopted compensation plans that are offered for shareholder vote. In these cases the clawback is often associated with a specific component of compensation (e.g., a new stock option plan). Table 5 delineates the propensity of policies to identify specific components of compensation that can be recovered. For example, as Panel A indicates, equity based awards of stock or stock-like instruments (e.g., phantom stock) are named as recoverable in 44% of clawback policies. The amount to be recovered is the amount arising from the act triggering the provision for 16% of all clawbacks, out of the 44% of clawbacks that specifically cover stock awards. Frequently the firm can recover up to the full amount of the stock award (25%), even if that amount exceeds what was obtained through the triggering action by the executive. This number is of interest because Dodd-Frank, when implemented, would require recovery of the entire award even the amount beyond the portion of the award associated with the clawback number is low, often times the filings refers to the clawback as being part of a bonus or equity award program. In this case, any employee that receives a bonus or equity award under the program would be covered by the clawback. For this example the filing would not explicitly identify which executives where covered by the clawback but to the extent the CEO or other NEOs received a bonus or equity award they would be covered by the clawback provision.
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event. In contrast, SOX allows only for the recovery of the part of compensation and profits realized as a result of the misconduct. In 50% of all cases, and 56% of cases naming stock awards as recoverable, the filing does not specify how much of the stock award is recoverable. In a few cases (3%), only the unvested portion of the stock grant is recoverable. The frequencies are similar for stock option awards and stock-option-like instruments (e.g., stockappreciation rights) and for short-term (annual or more frequent) cash bonuses. Firms also specify longer-term cash bonuses as fair game, but at a somewhat lower overall rate of 14%. Overall, clawback policies have a significant emphasis on incentive based pay comprised of performance-contingent bonuses and equity pay. This is consistent with the notion that a primary reason for adopting a recoupment policy is concern over accounting manipulation by executives to increase bonus payments or increase the likelihood of clearing the performance hurdles defined in performance-based vesting provisions (see Bettis, Bizjak, Coles, and Kalpathy (2010a, 2012)). As we also note above, there is substantial variation in the amount of each component that can be recovered. Our initial notion is that the amount recoverable would be the excess pay derived from the triggering action, which is the remedy under SOX and for other SEC enforcement actions.
Along these lines, some provisions only allow recoupment of the
different components of pay associated with the trigger event. Other policies are more onerous and allow recovery of the entire payment or grant, even if the value exceeds what was obtained by the employee through the event that triggered the recovery, as with Dodd-Frank. Likewise, as Panel B of Table 5 indicates, some policies explicitly extend beyond pay recovery to include employee dismissal (2%), legal action (5%), and reduction of future compensation (3%). Decoupling penalties from damages often increases the severity of the punishment and can
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provide optimal incentives for deterrence. An example of this in a different context is treble damages that can be recovered in antitrust actions and some insider trading cases.11 Panel A of Table 6 characterizes who firms identify as overseeing and implementing the clawback policy. When disclosed, the primary enforcer of the clawback provision is the compensation committee of the board (45%). The entire board is named in 25% of the filings, while human resource committee (1%) and independent directors (1%) rarely oversee clawback policies. Panel B tabulates the frequency with which the description of the clawback explicitly states that the overseer has the discretion to determine whether a triggering event has occurred, trigger recoupment, and determine the amount to be repaid. Finally, Panel C of Table 6 tabulates the data on when the clawback starts and the applicable horizon of the clawback. In many cases the description of the provision is silent. Given the focus in Dodd-Frank on a three-year period, the 5% usage rate for a three-year expiration seems low. As Panel C indicates, however, the vast majority of filings do not reveal the “statute of limitations.” One of the interesting findings in our data collection is that firms often do not provide much detail about the nature and structure of a clawback. Perhaps firms provide more detail to employees and executives but choose not to provide detail outside the firm because of concerns over what competitors might learn about managerial contracts and incentives. It is also possible that firms purposely remain ambiguous about the details of these policies for other reasons. For example, ambiguity on the exact nature of the policy could make executives more cautious because of increased uncertainty about activities and events that would trigger the clawback and about unknown remedies. 11
One of the common remedies in antitrust cases is recover of up to three time damages. The Insider Trading Sanctions Act or 1984 allows for disgorgement of illegal profits plus penalties up to three times illegal profits. See Baumol and Ordover (1985) for discussion of the benefits of separating damages from penalties.
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Additional data used in the analyses in this and subsequent sections come from a variety of different sources. Stock price and financial data come from CRSP and COMPUSTAT. We gather data on litigation from the Securities Class Action Clearinghouse (SCAC) database maintained by Stanford University. The SCAC database contains information on federal class action securities fraud lawsuits. 12
We obtain data on earnings restatements from Audit
Analytics. Compensation data come from Execucomp and data on corporate governance come from Risk Metrics. Data on institutional holdings come from Thomson- Reuters, and data on analyst coverage come from I/B/E/S. Because a significant number of different variables are used to analyze clawbacks and test the following proposed hypotheses, in Appendix A we include a detailed description of how each variable is constructed along with its source.
III. Development of Hypotheses Below we lay out various hypotheses on why firms adopt clawback policies along with what explains the different provisions incorporated into these policies. We then discuss what effects we expect these policies to have on behavior and the organization. A. Why do firms adopt clawback provisions? What firm characteristics would imply that a clawback provision would be a suitable component of organizational form? One obvious candidate would be prior signs of trouble, as manifested in behaviors and outcomes such provisions are meant to penalize and discourage. We anticipate that firms who have experienced prior accounting restatements or shareholder litigation are more likely to adopt a clawback to discourage future managerial behaviors that could lead to these events. Formally, we propose:
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More detailed information on this database can be found at http://securities.stanford.edu/.
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Hypothesis 1 (Prior Malfeasance): The propensity of a firm to adopt a clawback provision is positively related to the prior incidence of accounting restatement or the firm being a defendant in an SEC action or shareholder lawsuit. To the extent that such malfeasance or other triggering actions are harder to detect in real time, because of performance volatility or lack of transparency, adoption of a clawback should be more likely. Furthermore, because of difficulty in differentiating ex ante among appropriate and inappropriate managerial decisions in certain types of firms, we expect clawbacks to be used in more complex firms, such as those engaged in R&D or with multiple business segments. Consistent with Coles, Daniel, and Naveen (2006), we use firm size, leverage, whether the firm operates in multiple business segments, and investment intensity as measures of complexity.
Hypothesis 2 (Detectability): Firms with higher prior stock-return volatility, higher R&D intensity, larger scale, more leverage, higher investment, and multiple business segments are more likely to employ a clawback provision. We also expect that recoupment policies should be used by firms that are likely to be damaged more by the managerial malfeasance. We measure potential damage by what is available to misappropriate directly, that is, firm size and scaled cash flow.
Hypothesis 3 (Expropriability): Firms with higher cash flow and larger firms are more likely to use a recoupment provision. To the extent that a clawback can discourage risky behaviors by executives and mitigate the conflict between equity- and bond-holders, the adoption of a clawback policy could lower the costs of debt financing. To extend this argument, the adoption of a clawback is more likely
18
in firms with higher leverage and lower credit ratings (note that this prediction reinforces that for leverage in Hypothesis 2).
Hypothesis 4 (Financing Costs): Firms with greater leverage and lower credit rating have a higher propensity to adopt a clawback. Alternatively, if the cost of debt financing is high prior to the adoption of a clawback then these firms could use less debt. To the extent that a clawback lowers the cost of debt financing this would then allow the firm to raise additional debt in the future at a lower rate subsequent to adopting a clawback. We explore this issue in more detail later in the paper. While the use of equity-based pay aligns managerial and shareholder interests, prior research has documented negative secondary effects of these incentive schemes. For example, Burns and Kedia (2006) find that executives are more likely to manage earnings when they receive higher levels of equity-based pay. Efendi, Srivastava, and Swanson (2007) find that firms where the CEO has significant holdings of in-the-money options are more likely to restate earnings. The presence of a clawback should discourage these types of behaviors while at the same time enabling the company to utilize substantial pay-for-performance sensitivity to incentivize managers. Performance-vesting provisions are now commonly attached to the cash and equitybased components of executive pay (Bettis, Bizjak, Coles, and Kalpathy (2010a, 2012)). For example, contingent-vesting awards require that one or more performance hurdles be achieved for the grant to vest. Failure to meet the performance conditions results in the forfeiture of the awards. Because many of the vesting conditions on p-v awards are accounting based, managers have incentive to manipulate accounting numbers to trigger vesting. In order to maintain the improved managerial incentives tied to p-v provisions but at the same time mitigate the 19
incentives these provisions provide to manipulate the performance target, we expect clawbacks to be adopted more frequently when cash and equity awards contain an explicit p-v condition.13 In addition, because golden parachutes provide for deferred payments to executives and given that fraudulent behavior may not be discovered until after the departure we anticipate a clawback policy to be more likely when the firm has a golden parachute. Finally, for a clawback to cut there must be some compensation to recapture. Moreover, for pay to be “excessive,” there must be significant pay or the potential for significant pay in the first place and some likelihood that pay will be inappropriately high. We propose the following hypothesis with regard to the relation between clawback adoption and executive pay.
Hypothesis 5 (Compensation): Firms with higher levels of pay to executives, higher ratios of incentive pay to total pay, p-v provisions attached to equity and cash pay, and golden parachutes are more likely to use a recoupment provision.
Governance is likely to be an element in whether a firm has a recoupment provision. The direction of any effect, however, is ambiguous. Managerial incentive alignment through external and internal monitoring may be substitutes for the incentives provided by the potential for recoupment, in which case monitoring and the presence of a clawback would be negatively related. On the other hand, perhaps external and internal monitoring, either because they cause the presence of a clawback provision or because the need for incentive alignment requires the joint usage of the full array of governance mechanisms, would be positively associated with the 13
In comparison, a clawback often focuses on specific acts and often must be actively and deliberately enforced to recapture compensation paid prior. A conditional p-v provision is more like a non-specific, passive recoupment policy that determines whether cash or stock or option grant is paid out. In one case the cows are out of the barn and the rancher seeks to round them up, and in the other the decision is whether to let the cows out in the first place. To the extent that p-v and clawback provisions are substitute devices, it is possible that the presence of a pv provision will reduce the likelihood the firm adopts a clawback provision.
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propensity to have a recoupment provision.
Since the effect of governance on clawback
adoption is ambiguous we do not propose a formal hypothesis but include governance characteristics in our analysis below. B. What determines the characteristics of a clawback provision? As discussed in Section II, there is significant variation in the characteristics of adopted recoupment policies.
Characteristics of the firms and the markets in which they operate
potentially determine characteristics of the provisions. Moreover, some features of provisions may complement each other and, thus, are likely to be found together. If restatements can trigger an attempt to recover compensation, we would expect that the CFO and others who are involved in assembling the financial reports would be covered. If violation of a non-compete requirement is a trigger, or if there are other triggering actions that are feasibly within the discretion of non-NEO employees, then we would expect the clawback to extend deeper into the employee pool and to encompass a broader set of employee actions. Related to this argument, in a more complex firm there is likely to be opportunity and scope for inappropriate behavior from a larger number of employees. Moreover, in firms with more portable, intangible assets, such as intellectual property (pharmaceuticals, software, banking), an employee who departs for a firm in the same industry will damage the firm more, so the clawback should include a non-compete clause and cover more employees. Overall clawback provisions in complex firms and firms with intangible assets should cover a broader set of behaviors and more employees. Further, if state law implies that recoupment provisions are relatively enforceable, then the recoupment policy will encompass more triggering events and extend deeper into the firm. The effects of performance volatility are unclear. If volatility makes malfeasance harder to
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observe in the short term, then a provision would specify more depth and breadth. On the other hand, if the potential use of the clawback in a risky firm increases the risk borne by employees, then the clawback would specify less depth so as to expose risk-averse employees to less risk.
Hypothesis 6 (Depth of Employee Coverage): The policy will go deeper into the employee pool the more complex the organization, the broader the coverage of employee actions, the more intangible the assets, and the higher the non-compete enforceability index. Hypothesis 7 (Breadth of Actions Covered): The policy will cover more employee actions the more complex the organization, the deeper the coverage of the employee pool, the more intangible the assets, and the higher the noncompete enforceability index. When a clawback provision is more likely to cover stock and option grants as well as cash pay? Similarly, when will a provision extend beyond short-term (annual) pay to include cash, stock, and options conveyed over a longer horizon? We propose the obvious hypothesis that the largest components of pay will be targeted. If non-cash awards or long-term awards represent a higher proportion of executive pay, then it is more likely that the clawback provision will be applicable to those components of pay.
Hypothesis 8 (Horizon and Liquidity): The clawback is more likely to cover the larger components of pay.
C. What are the implications for outcomes and value of clawback provisions? The threat of a clawback provision, even if it is not actually triggered, should discourage the behaviors specified by the policy. If a clawback deters risk taking behavior, firm risk should fall after adoption of a recoupment policy. If a clawback reduces risk and otherwise reduces the agency cost of equity, then after adoption the debt rating should increase and a debt issue becomes more likely. 22
Hypothesis 9 (Effective Deterrence): The likelihood of class-action lawsuit and earnings restatement, and the extent of earnings management all decline after adoption of a clawback provision. Hypothesis 10 (Risk Deterrence): Firm risk falls, debt rating increases, and an issue of debt is more likely after adoption of a recoupment policy. The presence of a clawback provision increases compensation-related risk for employees covered by the policy. In order to compensate employees for the increased risk introduced by a clawback provision, we expect that compensation will increase after the adoption of a clawback. The use of equity based pay and performance vesting conditions in managerial compensation can improve both the incentives to increase stock price and risk taking (Bettis et al. (2010a, 2012)). One concern with the high levels of equity compensation, however, is increased incentive for managers to manipulate earnings or misreport accounting numbers (Burns and Kedia (2006)). In addition, the presence of a p-v provision can induce the incentive to manage earnings or produce fraudulent accounting numbers in order to trigger vesting. Introduction of a clawback policy enhances the ability of firms to increase the proportion of equity based pay and also to incorporate p-v provisions in compensation while mitigating the incentives for adverse behavior. Consequently, we would expect adoption of a clawback to enhance a firm’s ability to increase the use of equity based pay and p-v provisions.
Hypothesis 11 (Effects on Executive Compensation): Total compensation, equity-based pay, and the usage of p-v provisions will be higher after adoption than before. The alternative hypothesis is also plausible. It is possible that the reason that firms adopt a clawback policy is about the potential for earnings management and fraudulent misreporting of financial statements. To the extent that clawbacks reflect these concerns, firms may reduce the 23
use of equity based pay and p-v provisions since they potentially encourage the types of behavior clawbacks are meant to mitigate. In such a case, firms may substitute fixed compensation not tied to performance and may consider designing compensation not tied to financial targets.
IV. The Determinants of Adoption For context for the analysis of the determinants of usage, Table 7 presents summary statistics and univariate comparisons on firm characteristics in firm-years with a reported clawback as compared to no report of a clawback. While we present summary statistics we focus the analysis and discussion on the multivariate logit specifications presented in Tables 8. On the logit specifications, the dependent variable equals one in any year a firm reports a clawback policy in place and zero otherwise. All specifications include industry (Fama-French 17 industries) and year fixed effects. All t-statistics are adjusted for clustering at the firm level. The independent variables are constructed to test Hypotheses 1 through 5. A. Logit analysis of reported adoption The specifications for adoption control for prior performance to account for the possibility that firms that perform well are more likely to use the full array of contractual devices to align managerial incentives with shareholder interests. Also included as controls are Tobin’s Q and a state enforceability index. The legal environment in which the firm operates affects the benefits versus costs of adopting a clawback.
Different states have different
standards for recourse if managers behave fraudulently.
Per the enforceability index of
Garmaise (2011) and Kedia and Rajgopal (2009), historically non-compete clauses and nondisclosure agreements have been more easily enforced in some states (e.g., Florida) than in others (e.g., North Dakota, California).
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Numerous banks and other financial institutions were mandated by American Recovery and Reinvestment Act of 2009 (i.e., TARP firms) to adopt clawback policies. For the years these firms fall under ARRA we drop them from the analysis. The logit specifications in Table 8 vary according to the themes represented in hypotheses 1 – 5, which include: prior malfeasance, detectability; enforceability; financing costs; and compensation. We also estimate a specification with governance characteristics. The table associates each right-hand side variable with the hypotheses that inclusion of that variable is meant to test. The first specification in Table 8 (Panel A) is a parsimonious base case and the final specification in Table 8 (Panel C) includes the entire collection of independent variables. Prior Malfeasance. Focusing on specification 1 in Panel A of Table 8, the adoption of a clawback is more common among firms that have experienced a prior class action lawsuit but does not appear to be related to prior earnings restatements. While not included in the table, we also estimate specification 1 including a measure of usage of discretionary accruals, and the coefficient is not statistically significant. These findings provide some support for Hypotheses 1, which argues that a clawback is related to prior malfeasance. Detectability and Expropriability. The results from Table 8, Panel A, specifications 2 and 3, provide support for the notion that the detectability of inappropriate managerial actions affects whether the firm employs a clawback provision (Hypothesis 2). Model 2 indicates that clawback adoption is more likely when the firm is more complex, as measured by size and number of business segments, and when the firm has higher stock return volatility. While not significant at the 10% level in model 2, the estimated coefficients on R&D in all specifications are positive and significant in some, which is also consistent with Hypothesis 2. In contrast, leverage and scaled investment are not significant in any specifications.
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Turning to model 3, the coefficients on both scaled cash flow and firm size are positive and statistically significant.
These findings support the notion that firms with more to
expropriate are more likely to have a clawback policy (Hypothesis 3). Financing Costs. Specification 4 of Panel A includes leverage and an indicator variable that equals one if the firm has an investment grade credit rating. The coefficient on the indicator variable for debt rating is positive and significant, while the coefficient on the amount of debt is positive but not significant. These findings indicate that firms with investment grade debt are more likely to adopt a clawback. This is contrary to Hypothesis 4, which conjectures that firms with low credit ratings adopt a clawback to raise their credit rating. One potential explanation is that firms with better credit ratings adopt a clawback in order to maintain the rating. Compensation. The presence of a golden parachute and the proportion of executive pay in equity-based instruments are positively associated with the reported presence of a clawback policy (Table 8, Panel B, model 1). These findings are consistent with Hypothesis 5. The analysis also provides evidence that the presence of p-v provisions in equity based pay is associated with clawbacks. The coefficient on the p-v equity dummy is significant in models 2 and 3. Some performance vesting provisions could potentially be manipulated by management in order to trigger vesting (Bettis, Bizjak, Coles, and Kalpathy (2010)). The presence of a clawback would provide a deterrent to such behavior. Governance, Enforceability and Other Aspects of Adoption. Relative to conventional wisdom on what constitutes “good” governance, the results on governance are mixed. Focusing on Panel C of Table 8, in specification 1 the sign on board independence is positive and significant. On the other hand, the estimated coefficient on board size is significantly positive.
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Also, analyst coverage and the level of institutional ownership do not appear to be associated with the adoption of a clawback. Control Variables.
All specifications include the enforceability index of Garmaise
(2011). In no specification is the estimated coefficient significant, which suggests that state laws which determine the enforceability of these contracts do not affect adoption. The estimated coefficient on prior firm stock performance is positive and in some cases statistically significant. While we do not offer this as a hypothesis, one potential reason firms adopt a clawback would be to reduce risk taking incentives.
Consistent with this notion, we find that the estimated
coefficient on Tobin’s Q is negative and statistically significant in the various specifications in Table 8. If managerial risk-taking is particularly important in realizing the value of growth opportunities, then firms with high Tobin’s Q are likely to want to avoid adopting a clawback. When we include a measure of compensation convexity, NEO vega, in some specifications the coefficient estimate is negative and statistically significant. The results on vega, excluded for brevity, are consistent with the results on Tobin’s Q and suggest that firms where risk taking is important, those with high vega and high Tobin’s Q, do not adopt a clawback. Summary. Note that our specifications include numerous variables and test hypotheses 1 – 5 using multiple proxies. Some of those proxies are likely to be highly correlated and, thus, the estimated coefficients in some instances are unstable or estimated imprecisely. In this light, overall, the results indicate that firms are more likely to report adoption of a clawback provision when: there has been prior shareholder litigation; earnings management is more feasible and harder to detect (e.g., volatile prior stock returns, more business segments, higher R&D); rent extraction is easier or more damaging (higher cash flow, more assets); executives have compensation-related reasons to misrepresent firm performance (executives have golden
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parachutes, higher equity-based pay, or face p-v provisions on equity-based pay); and the board is more independent. Clawbacks are also more likely to be adopted when credit ratings are high. Clawback usage is unrelated to institutional ownership, executive pay level, capital structure, or state law pertaining to contract enforceability. B. Additional analysis and robustness checks Both for purposes of checking robustness and to provide additional evidence on the reasons behind clawback adoptions, we estimate several additional empirical specifications and tests. We perform the analysis for the time period 2005 – 2011 since clawbacks prior to 2005 are rare. The results are very similar to those in Table 8. We also perform the analysis for the set of firms that adopt clawbacks between 2000 and 2008. Following the financial crisis in 2008, clawback policies began attracting more attention from both the press and regulators. In particular, these provisions were directly addressed by the Dodd-Frank bill, which will mandate adoption. Consequently, some recent clawback adoptions are likely to be due to anticipation of the mandated requirement to adopt these provisions. We suspect that “early adopters” are more likely to implement a clawback to improve the contracting environment rather than as a response to recent regulation. Nonetheless, even firms that adopt a clawback as a response to Dodd-Frank would structure the plan so as to improve the firm’s organizational design while also meeting the regulatory requirements. The overall results for the set of firms we characterize as early adopters generally are similar to the findings for the full sample, but there are some differences in the coefficients that pertain to the primary hypotheses we test. Relative to Panel A of Table 8, for the sample of firms that adopted clawbacks between 2000 through 2008, the coefficients on R&D intensity are positive and now significant, while the coefficients on prior stock return volatility become
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insignificant. Among early adopters, support for Hypothesis 2 (detectability) comes from R&D intensity rather than prior volatility. Relative to Panel B, the coefficients on the performancevesting equity variable (PV Equity) become insignificant. This is likely to arise from data on p-v provisions being available only for the 2006-2008 portion of the early adopters subsample. The indicator for a golden parachute becomes insignificant in model 3.
For the regressions
analogous to those in Panel C, in model 1 CEO ownership becomes insignificant. In model 2, the coefficients on volatility and cash flow become insignificant, while the coefficients on p-v equity, fraction of equity-based pay, the p-v cash indicator, and the number of analysts all become significant at p = 0.05.14
V. The Determinants of Clawback Characteristics Table 9, Panels A, B, and C, contain the results of our analysis of the determinants of the characteristics of the clawback provision, conditional on adoption in the first place. Hypotheses 6 and 7 pertain to depth of employee coverage and breadth of actions covered, respectively, and Hypothesis 8 relates to liquidity (cash pay) and horizon (equity pay). In Panel A, the dependent variable for depth equals one if the clawback covers other employees besides NEOs and zero if it covers only NEOs. Likewise, in Panel B the dependent variable for breadth equals one if the clawback covers additional actions beyond fraud or restatements and equals zero if it covers fraud or restatements only. The dependent variable in the liquidity specifications equals one if it allows for recoupment of equity awards and equals zero if the clawback can recoup only short term or long term cash bonuses. Finally, for the horizon specifications the dependent variable 14
We also estimate the specifications in Table 8 for a smaller sample of early adopters based on years 2003-2008. The intent is to enable comparability with the significant number of other studies that examine a similar time period (see Appendix B). The results of the analysis are similar to those based on our sample of early adopters (2000-2008).
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equals one if it can be used to recover any component of pay and equals zero if the clawback can only recover short term cash bonuses. For right-hand-side variables used to test the hypotheses, Table 9 specifies the corresponding hypothesis and predicted sign. All the specifications include year and industry fixed effects and all t-statistics are based on standard errors clustered at the firm level. A. Logit analysis of clawback provision form Depth and Breadth. As Panel A of Table 9 indicates, for depth of employee coverage, support for the effect of complexity (Hypothesis 6) arises from the significantly positive coefficients on firm size. We also find that firms with less tangible assets, as proxied by high R&D expenditures, design policies with more employee coverage (the positive coefficient on R&D). The Tobin’s Q results, however, run contrary to Hypothesis 6, where we postulated that firms with more intangible assets are likely to have clawbacks that cover more employees. Perhaps executives at firms with more intangible assets have more control over investment decisions and risk taking. If true, these types of firms may not need to target lower level employees with clawbacks and thereby avoid imposing additional compensation risk on these individuals. The coefficient on breadth of actions covered is positive which indicates that the deeper the clawback extends into the firm the more types of actions that are covered, which is consistent with Hypotheses 6.
We do not find evidence that how enforceability of these
provisions varies by state has any effect on employee coverage. In terms of the extent of transgressions covered, in Panel B of Table 9 the coefficients on size and R&D are positive and significant, which is consistent with Hypothesis 7. The finding for both firm size and R&D suggests that more complex firms cover more actions that are potentially harmful to the firm. The coefficient on cash flow is also positive and significant at
30
the 10% level. This finding suggests that firms with more at stake are more likely to cover more behaviors that are harmful to the firm. Note that both specifications indicate a strong positive association between breadth and depth. Liquidity and Horizon. In Panel C of Table 9, the coefficient in the liquidity regression on cash pay is negative and significant. Keep in mind that the dependent variable is one if the clawback provision extends beyond cash pay and covers equity pay. Consequently, the negative coefficient on cash pay indicates that the greater the fraction of cash bonuses in pay the more likely the clawback focuses on cash bonuses and not equity pay. This finding is consistent with Hypothesis 8. For the horizon specification, the coefficient on long-term pay is positive which indicates that the greater is long-term pay in overall compensation the more likely the clawback is to cover long-term components of pay. This, as well, is consistent with Hypothesis 8 but the coefficient estimate on long-term pay is not statistically significant at conventional levels. The coefficients on firm size and cash flow are positive and significant in both regressions. Firms with more to lose are more likely to target equity based pay and specify longer horizons for clawbacks use. B. Additional analysis and robustness If we restrict the sample to 2000-2008, the results for the variables associated with our primary hypotheses differ in some dimensions. In Panel A, the coefficients on Q become more negative and significant and volatility becomes insignificant. For clawback breadth as the dependent variable (Panel B), all right-hand side variables become insignificant except for clawback depth, which continues to be positive and significant. For the specifications based on Panel C, cash pay becomes insignificant in explaining clawback liquidity (model 1) and,
31
consistent with Hypothesis 8, the coefficient on long-term pay is significant in explaining clawback horizon (model 2).
VI. Implications of Clawback Provisions We now turn to whether the reported adoption of a recoupment policy is associated with a subsequent (a) reduction in frequency of corporate events that can indicate managerial misconduct or (b) changes in investment, financial, and compensation policy. We employ a difference-in-difference approach to compare adopting firms versus non-adopters before and after adoption. We perform the analysis based on both the full sample and also for early adopters (i.e., clawbacks adopted between 2000 through 2008). We report the results for the full sample in Table 10, Panels A through D. In each specification the dependent variable is one if that particular event (e.g., an earnings restatement) occurred after the clawback adoption, and zero otherwise. We do not report the results for early adopters in Table 10 but discuss and compare the findings to the full sample below. Panel A of Table 10 reports empirical results that provide tests for Hypothesis 9 (Effective Deterrence). For the full sample focusing on the coefficient on the variable “recent clawback” we do not find robust evidence of a reduction in the extent of accruals management or the likelihood of a restatement. In unreported results, however, we observe a reduction in accruals management following adoption of clawbacks targeting fraud and misrepresentation. Our results on restatements stand in contrast to Chan et al. (2012) and Chen, Green, and Owers (2012) who find a lower frequency of financial restatements following the adoption of a clawback. Potential explanations include different sample size, sample period, and statistical approach. Chan et al. (2012) examine 343 clawbacks adopted by firms in the Russell 3000
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during 2005 – 2009 identified in the Corporate Library data. Chen, Green, and Owers (2012) examine clawbacks adopted by the Russell 1000 covering a period similar to ours. They provide a univariate assessment of financial restatement frequency based on the presence or absence of a clawback that targets restatements. Our findings suggest that time period, sample, and use of a multivariate design affect results on the deterrent effect of these polices. 15 In unreported results, we also confined our analysis to only fraud-related clawbacks and found similar results for restatement frequency and likelihood of shareholder suits. Discretionary accruals, however, declined significantly following the adoptions of fraud-related clawbacks. Panel B of Table 10 reports results for one aspect of investment policy, firm risk, and one implication of financial policy, whether the firm has investment-grade debt.
The first
specification in Panel B shows no statistically significant reduction in firm risk (i.e., stock return volatility). In contrast, consistent with Hypothesis 10, there is a significant increase in likelihood that the firm has bonds rated as investment grade (S&P BBB- and above for long-term debt). The results for early adopters are similar to the findings for the full sample. In results not reported we also examined if firms we more likely to have a public debt issue following clawback adoption, Hypothesis 10, but found no evidence that firms were more likely to issue new debt following clawback adoption. Panel C reports the results of our analysis of the effects of clawback adoption on executive compensation. We find that the introduction of a clawback policy is followed by an increase in total executive compensation.16 In terms of the components of pay, the second model 15
We do obtain a statistically significant reduction in earnings restatements following the adoption of a clawback policy in the univariate setting or if we do not include time effects in the multivariate specification (p = 0.004). Given that the frequency of restatements may vary over time, it appears important to control for time effects since the restatement frequency likely vary significantly over time (e.g., higher following industry booms or changes in accounting practices). 16 Based on models not reported here, the increase in total compensation is particularly strong when recovery under the clawback policy can extend beyond those employees directly responsible to other employees as well.
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in Panel C indicates that companies tend to increase equity-based compensation following a clawback adoption. 17 Given that previous literature finds that equity-based compensation, particularly in the form of stock options, is associated with greater earnings manipulation (see e.g., Burns and Kedia (2006) and Efendi, Srivastava, and Swanson (2007)), our evidence suggests that boards adopt a clawback to mitigate incentives to manipulate earnings. The third model in Panel C indicates that firms award more equity-based pay and more long-term compensation, which we define as equity-based pay plus cash bonus payments defined over a grant horizon greater than one year, after the introduction of a clawback. The results for early adopters are similar and we observe a larger increase in total compensation following a clawback adoption (by $814,000 on average). The increase in performance based pay after adoption is, however, less pronounced for early adopters. Panel D reveals an insignificant relation between p-v provision usage and the report of a clawback.18 In contrast, the coefficient on Clawback Ever is positive and significant when the dependent variable indicates usage (or not) of a p-v provision with an equity-based grant. In testing robustness, in the subsample of early adopters, there is evidence of a decrease in usage of p-v provisions for cash awards following adoption. Since most p-v awards have accounting hurdles (Bettis et al. (2012a)) boards may want to put a clawback in place prior or concurrent to a p-v award to reduce the motivation of managers to manipulate earnings in order to clear the performance vesting condition tied to the award. This effect, however, does not appear in the full sample.
17
In unreported specifications, we find a similar increase in total compensation even after controlling for the contemporaneous increase in the use of equity-based compensation. 18 We do find a significant increase in the use of performance vesting provisions on equity pay after adoptions of fraud-related clawback provisions.
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To frame further our analysis of executive pay and incentives, Panel D also includes a difference-in-difference analysis of the association between report of a clawback and CEO tenure and Named Executive Officer (NEO) turnover. We find that CEO tenure is significantly negatively related to the report of a clawback provision.
Consistent with this result, the
probability of NEO turnover is significantly positively related to the report of a clawback policy. CEO pay is higher, per Panel C, but tenure lower. One possibility is that NEOs of firms with clawback provisions depart more readily because the board can use the specter of triggering a clawback provision to hasten departure. Another possibility is that boards disposed to adopt a clawback provision also are disposed towards disciplining NEOs through turnover. A final alternative is that NEOs do not like clawback provisions and depart for positions in other firms. A potential issue with the difference-in-difference analysis is endogeneity. In addition to the use of a wide variety of control variables and the use of lagged right-hand side variables, we address endogeneity in two additional ways. First, we estimate the specifications in Table 10 using firm fixed effects rather than just industry fixed effects. Naturally, the number of observations is considerably lower since if a firm never restates earnings over the sample period the firm fixed effect and restatement indicator cannot be identified. Using firm fixed effects and the diminished sample, the results are the same as in Table 10 for restatements, class action suits, volatility, total compensation, performance-based pay, long-term pay, pv-equity provisions, and pv-cash provisions. There are, however, some differences. Accruals decrease after a clawback (at p = 0.10) with firm-fixed effects, whereas there was no significant relation without firm-fixed effects. There is no relation between the presence of investment grade debt and clawback adoption. There is no relation between CEO tenure and clawback adoption after we include firm-fixed effects.
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Second, in specifications in Panels A and B, we use a dummy variable for whether the firm uses a compensation consultant during the year as an instrument for the report of a clawback policy. Compensation consultants are unlikely to directly influence the volatility of stock returns, the management of discretionary accruals, or the likelihood of restatement or class action suits. In the data, reported clawback use is significantly positively correlated with use of a compensation consultant. Additionally, standard tests reject the null at the 0.10 level that the compensation consultant indicator is a weak instrument.
We employ limited information
maximum likelihood (LIML). Consistent with the results in Panel A of Table 10, we find no effect on the likelihood of a restatement or class action suit and no effect on accruals usage. In contrast to Panel B, we do find that volatility significantly decreases after a reported use of a compensation consultant (as an instrument for report of a clawback policy).19 Another potential concern with the difference-in-difference approach is that standard errors can be biased because of serial correlation (Bertrand, Duflo, and Mullainathan (2004)). This problem is likely to be more severe when the dependent variable is highly serially correlated (e.g., volatility or restatement frequency) and/or the average observation period is long. To address this concern, we implement the corrective methodology proposed by Bertrand, Duflo, and Mullainathan (2004). We first regress the dependent variable on year and industry dummies and all controls as listed in Tables 10A-10D with the exception of Clawback Ever. We obtain the residuals from this model and, for treatment firms only (Clawback Ever = 1), then regress these residuals on the recent clawback dummy. We continue to find results similar to those in reported in Table 10.
19
We do not use compensation consultants as an instrument to determine if clawback policies affect levels of compensation or compensation structure since the use of a compensation consultant is likely to affect compensation levels and pay structure.
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We perform the analysis in Table 10 for clawback firms versus a smaller set of nonclawback firms matched on various characteristics (i.e., propensity score match). For each firmyear report of a clawback, we match the firm that does not report a clawback that is most similar based on a propensity score.20 In terms of the coefficient indicating a recent clawback report, the results are similar for likelihood of an earnings restatement, discretionary accruals usage, likelihood of a class action suit, stock return volatility, investment grade debt (though with p = 0.07), CEO tenure, and NEO turnover. Otherwise, the results on the clawback indicator are the same in sign but are no longer significant for the other variables, which is likely due in part to a smaller subsample of non-clawback firms.
VII. The Market Response to Clawback Policies To the extent that the benefits of adopting a clawback policy exceed the costs, and if the market does not fully anticipate adoption, then the market response to the report of the adoption should be positive. Table 11 contains the results for a variety of event studies that vary in the sample and the window used to measure the market response.
We calculate cumulative
abnormal return (CAR) using the market model, which is estimated using the CRSP equallyweighted market stock return over 252 trading days. Day 0 is the filing date of the SEC form (Proxy, 10-K, or 8-K) that reports the clawback policy. We examine abnormal returns for three windows centered on the announcement day, specifically (-1, 1), (-2, 2) and (-5, 5), and employ a z-statistic to assess the null hypothesis that the abnormal return equals zero.21 20
The propensity score match is based on lagged (relative to the year a firm reports a clawback provision) leverage, ROA, market-to-book of equity, natural logarithm of revenue, log of CEO tenure, whether CEO ownership is reported, cash flow to assets, whether prior the firm restated earnings or was sued in a class action, stock return volatility, log of total assets, log of one plus the number of covering analysts, the Garmaise (2011) enforceability index, stock return, indicator variables, and industry fixed effects (Fama-French 47). 21 We use Eventus to perform the event study. See Cowan (2007, Appendix A.2) for information on the statistical test (specifically the Patell test) we employ.
37
When considering subsamples for purposes of event study analysis, fraud-related triggers include fraud, earnings restatement, misrepresentation, and negligence of fiduciary duty. Competition-related triggers include non-compete, non-disclosure, and non-solicitation. We examine both the full sample and, among others, the subsample of non-TARP firms adopting prior to the announcement of Dodd-Frank. For the full sample of 2,095 announcements where we can calculate CARs, for all three windows, (-1, 1), (-2, 2) and (-5, 5), the mean market reaction is positive but is not statistically significant.
When we restrict our sample to firms that adopt clawbacks prior to the
announcement of the Dodd-Frank Act (March 15, 2010), we find a positive and statistically significant market reaction.
For example, CARs for clawbacks adopted prior to the
announcement of Dodd-Frank range in value from 0.32% to 0.72%. On average, it appears that the unanticipated benefits net of costs are positive, but the net declines in the later part of the sample, perhaps because later in the sample investors anticipate adoptions better. To explore market perceptions further, in Table 12 we report the results from regressing the market reaction on type of clawback provision and firm characteristics, for various samples. Though the results vary in statistical significance, we find some evidence that the CAR tends to be larger when prior stock return volatility is higher, the firm is larger, there are competition triggers, and the firm has one or more prior class action suits or earnings restatements. Furthermore, the CAR tends to be smaller when the number of analysts is larger. None of the other variables have any explanatory power. We view these results as exploratory and at this juncture attach no interpretation.
VIII. Enforcement of Clawback Provisions
38
A natural question concerns the degree to which clawback policies have been activated by a firm following a triggering event. To examine this issue we examine firms reporting clawback policies that subsequently either restated earnings or were subject to shareholder ligation. In our data set we identify 232 firms that restated earnings following the adoption of a clawback. Of these, we find no instance in which the board of directors triggered a clawback independent of a private or SEC civil action case. We do find three cases in which executives were required to return compensation because of illicit behavior or fraudulent accounting practice where the firm had a clawback in place but the recovery was part of settlement or judgment in a shareholder lawsuit or SEC case. Two of these (KLA-Tencor in 2007 and United Healthcare in 2007) involved option backdating and one involved fraudulent accounting that led to a financial restatement (Diebold, Inc. in 2010). While the adoption of these provisions has risen over time, to date there does not appear to be widespread implementation by boards. 22 We use Factiva to perform a keyword search of the major U.S. newspapers in a further attempt to identify any instances of clawbacks being implemented to recover pay independent of litigation by shareholders or the SEC. The time period we examine is 2007 – 2011. We find only one instance, Warnaco in 2006, of firms reporting that executive bonuses were recouped because the firm restated earnings.23 More recently, in 2012 UBS and Lloyds announced they would claw back part of previous bonus awards.24 Moreover, as of the date on this working paper, there is a significant possibility that a recent $2 billion trading loss will lead J. P. 22
There are instances when firms have gone after executives for compensation following earnings restatements or fraudulent activities. In 1998, Green Tree Financial forced the then CEO Lawrence Coss to return his $102 million of his 1996 bonus after the company had to restate earnings. In 2005 Nortel Networks recovered $6.8 million in bonuses because of results based on fraudulent accounting numbers. But none of these were part of a clawback provision. 23 See “Pay It Back If You Didn’t Earn It,” New York Times, June 8, 2008. 24 See “A First for UBS Bonus Clawbacks,” New York Times, February 9, 2012 and “Lloyds Banking Group to Claws Back some Bonuses,” New York Times, February 20, 2012.
39
Morgan Chase to attempt to recoup equity awards due Ms. Ina Drew, who served as Chief Investment Officer when the pertinent trades occurred, as well as compensation to traders should they have been deemed to have taken excessive risks.25 Although the frequency of attempts to recover executive compensation has been low, clawback provisions need not be triggered to be effective. The potential threat of enforcement and the presence of the policies could influence executive behaviors. This idea is similar to the theory of contestable markets where the threat of entry can force firms to behave in a competitive manner.
Moreover, the presence of the threat of triggering a clawback could
increase the recovery rate in private civil suits brought by shareholders.
IX. Clawback Provision Complexity Inspection of Tables 1-7 indicates that clawbacks differ significantly in severity. To study the issue of clawback severity further, for each firm, we construct an index of clawback complexity that, in part, is meant to indicate how onerous the provision is likely to be for employees. In terms of the characterization of clawback provisions as analyzed in Tables 1-7, we calculate the index by adding one point for each type of trigger, for each type of person covered, for each type of pay covered, if the clawback covers pay "up to the full amount, and if there is overseer discretion. Based on the full sample of firm-year observations, the index varies from zero, when the firm does not report a clawback, up to a maximum of 19. Conditional on reporting a clawback, the median and mode are 8, with the distribution approximately uniformly distributed over 1 through 14, with frequency much lower for values 15 and higher.
25
See “Trading Blunder Claims a Casualty,” Wall Street Journal, May 15, 2012, and “Pay Clawbacks Raise Knotty Issues,” Wall Street Journal, May 17, 2012.
40
We employ three Tobit specifications in Table 13 to estimate the association between firm characteristics and clawback severity. Variables that appear in all specifications and are consistently significant at the 0.05 level are the indicator for a prior class action suit (+, p < 0.05), logarithm of total assets (+, p < 0.01), cash flow (EBITDA scaled by total assets, +, p < 0.01), and Tobin’s Q (-, p < 0.02). Variables used in fewer specifications that are significant at the 0.05 level or better are the proportion of pay that is equity-based (+, p < 0.01), whether equity grants have a p-v provision (+, p < 0.01), whether there is a golden parachute in place (+, p < 0.01), and usage of a compensation consultant (+, p < 0.01). These results provide additional empirical support for hypotheses H1, H2, H3, H5, H6, and H7.
X. Conclusion In this paper, we provide a comprehensive description of the adoption, usage, characteristics, and implications of clawback provisions adopted and implemented by large U.S. companies over the last decade. To do so, we hand collect from the proxy, 10-K, and 8-K statements of S&P 1,500 firms over 2000-2011 all information reported on the presence and form of recoupment policies. The frequency of firms reporting adoption of a clawback provision has risen substantially. Among S&P 1,500 firms reported usage climbs over the decade from 1% in 2000 to almost 50% in 2011. We document the form of adopted provisions. When reported, the CEO is covered in 66% of provisions, and all named executive officers (NEOs) 62% of the time. Triggering events include earnings restatements (70%), fraud (32%), negligence of fiduciary duty (48%), “misrepresentation” (18%), and violation of non-compete agreement (15%). The compensation
41
committee of the board of directors is frequently involved (45% of cases) in overseeing and implementing the policy, executive bonuses, equity grants, and option grants often all are fair game, and there is evidence of expiration only in a modest number of cases. We identify the economic determinants of adoption and contractual form of adopted provisions. Firms are more likely to report adoption of a clawback provision when: (a) there is evidence of prior executive misbehavior at the firm (prior class action lawsuit); (b) fraud and earnings management are harder to detect (e.g., volatile prior stock returns); (c) rent extraction is easier or more damaging (higher cash flow, more assets); (d) internal monitoring (board independence) is higher; and (e) executives have compensation-related reasons to misrepresent firm performance (executives have golden parachutes, higher equity-based pay, or face performance-vesting (p-v) provisions on equity-based pay). In terms of form of the recoupment policy, conditional on adoption the policy extends to more employees and covers more components of compensation when the firm is larger. In addition, more events or behaviors trigger the policy when the policy has broader employee coverage. Policy complexity increases in firm size, cash flow, and whether there was a class action suit prior, and is negatively related to Tobin’s Q. Finally, we assess the implications of clawback provisions. Introduction of a clawback policy appears to have no effect on the likelihood of future shareholder litigation, earnings restatements or firm stock return volatility. Adoption of a clawback is associated subsequently with lower credit risk, higher executive pay and a higher proportion of equity-based pay. As a market assessment of the costs and benefits of the adoption, event window returns to the announcement of a clawback policy are statistically significant for early adopters, ranging from about 0.32% to 0.72%.
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Overall, our analysis identifies the economic determinants of usage and form of clawback policies and the behavioral implications of those policies. Our results suggest that the presence of these provisions, even when not implemented, may provide the board with an additional mechanism tool to discipline align executive incentives. The SEC has infrequently used its authority under Section 304 of SOX to seek recovery for shareholders. Moreover, companies have rarely triggered their own clawback provisions. Possible reasons include few instances of misconduct that could trigger the provision, misconduct that falls outside of the applicable span of the provision, or simple reluctance of those with triggering discretion to penalize executives even when the provision would allow it. The most important impending developments will be the nature of the rules formulated by the SEC to enact the components of Dodd-Frank that pertain to recoupment, the mode of enforcement of those rules by the SEC, and, in the shadow of both, the mode of enforcement by companies of their clawback provisions. The form and usage of clawback provisions will evolve with application of these significant regulatory forces along with efficiency pressures from investors and markets.
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References Addy, N., X. Chu, and T. Yoder, 2009, Recovering bonuses after restated financials: adopting clawback provisions, Mississippi State University working paper. Baumol, W., and J. A. Ordover, 1985, Use of antitrust to subvert competition, Journal of Law and Economics 28, 247-703. Bertrand, M., E. Duflo, and S. Mullainathan, 2004, How much should we trust difference-indifferences estimates? Quarterly Journal of Economics, February, 249-275. Bettis, C., J. Bizjak, J. Coles, and S. Kalpathy, 2010a, Stock and option grants with performancebased vesting provisions, Review of Financial Studies 23, 3849-3888. Bettis, C., J. Bizjak, J. Coles, and S. Kalpathy, 2010b, Preliminary evidence on the size, delta, and vega of stock and option grants with performance-based vesting provisions, Supplement to Stock and Option Grants with Performance-based Vesting Provisions, Review of Financial Studies 23, 3849-3888. Bettis, C., J. Bizjak, J. Coles, and S. Kalpathy, 2010c, Evidence on whether stock and option grants with performance-based vesting provisions are associated with earnings management, accounting restatements, and shareholder litigation, supplement to stock and option grants with performance-based vesting provisions, Review of Financial Studies 23, 3849-3888. Bettis, C., J. Bizjak, J. Coles, and S. Kalpathy, 2012, Performance-based vesting provisions, part 2, Arizona State University working paper. Brown, A. B., P. Davis-Friday, and L. Guler, 2011, Economic determinants of the voluntary adoption of clawback provisions in executive compensation contracts, Baruch College working paper. Burns, N., and S. Kedia, 2006, The impact of performance-based compensation on misreporting, Journal of Financial Economics 79, 35-67. Chan, L., K. Chen, T.Y. Chen, and Y. Yu, 2012, The effects of firm-initiated clawback provisions on earnings quality and auditor behavior, forthcoming in Journal of Accounting and Economics. Chen, M., D. Greene., and J. Owers, 2012, Clawback provisions in executive compensation, Georgia State University working paper. Coles, J., N. Daniel, and L. Naveen, 2006, Managerial incentives and risk-taking, Journal of Financial Economics 79, 431-468. Cowan, A., 2007, User’s Guide to Eventus, Cowan Research, LC.
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Davis-Friday, P., A. Fried, and N. Jenkins, 2011, The value of clawback provisions, CUNY Baruch working paper. Dechow, P., Sloan, R., Sweeney, A., 1995, Detecting earnings management, Accounting Review 70, 193–225. Efendi, J., A. Srivastava, and E. Swanson, 2007, Why do corporate managers misstate financial statements? The role of option compensation and other factors, Journal of Financial Economics 85, 667-708. Fisk, C. L., 2001, Working knowledge: Trade secrets, restrictive covenants in employment, and the rise of corporate intellectual property, Hastings Law Journal. 2, 453-454. Fried, J., and N. Shilon, 2011, Excess-pay clawbacks, Harvard Law School working paper. Gao X., M. Iskandar-Datta, and Y. Jia, 2011, Piercing the corporate veil: The case for clawback provisions, Wayne State University working paper. Garmaise, M., 2011, Ties that truly bind: Noncompetition agreements, executive compensation, and firm investment, Journal of Law, Economics, and Organization 27, 376-425. Jensen, Michael, 2005, Agency costs of overvalued equity, Financial Management 34, 5-19. Jones, J., 1991, Earnings management during import relief investigations, Journal of Accounting Research 29, 193–228. Kedia, S., and S. Rajgopal, 2009, Neighborhood matters: The impact of location on broad based stock option plans, Journal of Financial Economics 92, 109-127. Levine, C. B., and M. J. Smith, 2010, The relative efficiency of clawback provisions in compensation contracts, Boston University working paper. US Congress, 2002, The Sarbanes-Oxley act of 2002, Public Law 107-204 [H.R. 3763] Washington D.C. Government Printing Office. US Congress, 2009, American recovery and reinvestment act of 2009, Public Law 111-5. [H.R.1] Washington D.C. Government Printing Office. US Congress, 2010, The Dodd-Frank Wall street reform and consumer protection act, Public Law 111-203 [H.R. 4173] Washington D.C. Government Printing Office.
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Appendix A: Data Definitions Variable Name Firm Size
Variable Definition Natural logarithm of a firm’s book assets.
Tobin’s Q
Book value of long-term debt and debt in current liabilities plus the market capitalization of the firm divided by book assets.
Cash Flow/Assets
EBITDA divided by book assets.
Leverage
Long term debt and debt in current liabilities divided by the book value of debt and market capitalization of the firm.
R&D/Assets
R&D expenditures divided by book assets.
Investment/Assets
Capital expenditures (CAPX) of the firm divided by book assets.
Number of Business Segments
Number of different business segments a firm has in a particular year.
Discretionary Accruals/Assets
We use the modification of the Jones (1991) model, per Dechow, Sloan, and Sweeney (1995), to calculate discretionary current accruals. We use the specification that includes an intercept and we scale by total assets and multiply by 100.
Number of Analysts
The number of analysts covering the firm in a previous year (I/B/E/S).
Board Size
Number of members on the board of directors in a previous year.
Board Independence
Number of board members who are classified as independent directors divided by the number of total board members.
Institutional Ownership
Shares held by institutions (SHROUT2 in Thomson Reuters Institutional Holdings Master File) divided by the total shares outstanding (SHROUT in Compustat).
Past Stock Return
Stock return of the firm during the previous year.
Past (Current) Stock Return Volatility
Volatility of daily stock returns in the previous (current) year.
Investment Grade Debt
Set to 0 if the debt of the firm is anything other than investment grade (below BBB- or not available/reported), and 1 otherwise.
Enforceability Index
Garmaise’s (2011) non-competition enforceability index. 46
CEO Tenure
Number of days since the CEO took office, 0 otherwise.
Executive Turnover
Set to 1 if any of the Named Executive Officers (NEO) leaves the firm and is replaced by someone new, 0 otherwise.
Golden Parachute
Set to 1 if the firm has a golden parachute in place (GOLDENPARACHUTE in RiskMetrics), 0 otherwise.
Past Earnings Restatement Set to 1 if the firm restated its earnings in the previous three years for any reason, other than clerical errors, 0 otherwise. Past Fraud
Set to 1 if the firm restated its earnings in the previous three years because of fraud or investigation launched by the SEC, 0 otherwise.
Past Class Action Lawsuit Set to 1 if the firm has had a class action lawsuit filed against it in the previous three years. Total Compensation
TDC1 variable of top five NEOs in Execucomp, adjusted for inflation using CPI index (2009 $million).
Equity-Based Pay
Sum of NEOs’ Black-Scholes values of stock option grants (OPTION_AWARDS_BLK_VALUE), value of restricted stock grants (RSTKGRNT), LTIP payments (LTIP), and bonuses (BONUS), divided by their total compensation (TDC1).
Cash Pay
Sum of NEOs’ bonuses (BONUS) and LTIP payments (LTIP) divided by their total compensation (TDC1) net of salary (SALARY).
Long-Term Pay
Sum of Black-Scholes values of stock option grants (OPTION_AWARDS_BLK_VALUE), value of restricted stock grants (RSTKGRNT), and LTIP payments (LTIP) made to NEOs, divided by total NEOs’ compensation (TDC1).
PV Equity
Set to 1 if the firm gives non-discretionary (i.e., performance vesting) equity-based pay, 0 otherwise.
PV Cash
Set to 1 if the firm gives non-discretionary (i.e., performance vesting) cash bonuses, 0 otherwise.
Clawback
Set to 1 if the firm has a clawback in that particular year, 0 otherwise.
Recent Clawback
Set to 1 if the firm adopted a clawback in the previous 2 years, 0 47
otherwise. Clawback Ever
Set to 1 if the firm ever adopted a clawback during the 2000-2011 time period, 0 otherwise.
Clawback Depth of Employee Coverage
Set to 0 if the clawback covers only the CEO and/or the named executive officers and 1 if it covers anyone else.
Clawback Breadth of Action Covered
Set to 0 if the clawback covers only fraud or restatements triggers, and 1 if it covers any additional triggers.
Clawback Liquidity
Set to 0 if the clawback can recoup only cash bonuses, 1 if it can recoup other (equity-based) types of compensation.
Clawback Long-Term Horizon
Set to 0 if the clawback is with respect to short term cash bonuses only, 1 if clawback can recoup longer-term else.
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Appendix B: Current Working Papers Data Richness
Main Empirical Hypotheses
Method/Dependent Variable/Results
S&P 500 firms over 2007-2008/ Corporate Library
Firm-Years (unless specified) with Clawbacks, Non-Clawbacks, and Total 170 clawbacks/326 non-clawbacks/ 496 total
Clawback (0/1), performancebased or fraudbased clawback
1) Logit (clawback) CEO influence index (-) Accruals (-) Past restatement (+) Bonus to salary ratio (+)
Chan, Chen, Chen, and Yu (2011)
Russell 3000 firms over 20002009 period/Corporate Library
2,652 clawbacks/ 12,505 nonclawbacks/ 15,157 total
Clawback (0/1)
H1: Companies with better corporate governance and less noisy environment are more likely to adopt clawbacks H1: Likelihood of financial restatement reduces after clawback adoption H2: Firm’s earnings response coefficient (ERC) is higher after clawback adoption
Brown, DavisFriday, and Guler (2011)
Mostly S&P 500 firms over 20052009/ Corporate Library
252 clawbacks/ 1,071 nonclawbacks/ 1323 total
Clawback (0/1), performancebased or fraudbased clawback
Fried and Shilon (2011)
S&P 500 in 2009/ Proxy statements
251 clawbacks/234 nonclawbacks/485 total
Clawback (0/1), board discretion to trigger (0/1), whether misconduct is required to trigger clawback (0/1)
Paper
Sample and Data Source
Addy, Chu, and Yoder (2009)
H1: Companies with better corporate governance are more likely to adopt clawbacks H2: Companies with past restatements, large size, and recent history of debt or equity issuance are more likely to adopt clawbacks N/A
1) Difference-inDifference (Financial Restatement) Clawback (-) 2) OLS (CAR around earnings announcement) Unexpected earnings* clawback (+) 1) Logit (clawback) CEO tenure(-) Board size(+) Past restatement (+) Firm size (+) Equity issuance(+) Bonus to salary ratio (+)
N/A
Appendix B (continued): Current Working Papers DavisFriday, Fried, and Jenkins (2011)
Unspecified sample of firms over 20042009/Corporate Library
Chen, Greene, and Owers (2011)
Fortune 1000 5,734 total over 20042011/Proxy Statements and 10-Ks
Gao, IskandarDatta, and Jin (2011)
S&P 1,500 firms over 20052009/Corporate Library
7,632 firmquarters total
285 clawbacks/1,119 nonclawbacks/1,404
Clawback (0/1), performancebased, noncompete or fraud-based clawback
N/A
1) OLS (CAR around earnings announcement) Unexpected earnings* clawback (-)
Clawback (0/1), who is covered, type of compensation recovered, type of trigger, date of adoption
H1: Managers with better information about firm (firm age, past restatements, long CEO tenure) and low firm risk (low leverage and ROA volatility) are more likely to adopt clawbacks H2: Likelihood of financial restatement and magnitude of discretionary accruals reduce after clawback adoption H3: Payperformance sensitivity increases after clawback adoption
1) Logit (clawback) Firm age (+) CEO tenure(+) ROA volatility (-) 2) OLS (Discretionary accruals) Clawback (-) 3) OLS ($ Value of CEO’s Bonus, Stock, and Stock Option Grants) Clawback (-)
Clawback (0/1), performancebased, noncompete or fraud-based clawback
H1: The valuation consequences to shareholders from clawback adoption are expected to be positive, and are larger for firms with past restatements and more equity-based pay. H2: Clawback policy is expected to reduce the information
1) OLS (CAR around clawback adoption) CEO Tenure (-) 2) OLS (Bid-Ask Spread or Trading Volume) Clawback (-) 3) Logit (Clawback) Past Restatement (+) Delta (-) CEO Tenure(-) Board
asymmetry in the post-adoption period. H3: The greater the tilt toward equity compensation and the more influential the CEO, the more advantageous is the inclusion of clawback policy to shareholders.
Independence (+) Firm size (+) Leverage (-)
Table 1: Year Distribution of Clawback Provisions This table documents the frequencies of adoption of clawback provisions in S&P 1,500 firms between the years 2000 – 2011. We use keyword searches of 10-Ks, 8-Ks, and corporate proxy statements (DEF14A) to identify reports of clawbacks adoption and document the frequency of usage. Year 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Clawbacks of SP500 firms 2 2 3 2 6 6 20 92 129 195 286 342 1085
Clawbacks of SP1500 firms 3 3 5 5 10 15 34 128 220 385 584 723 2115
Table 2: Reason for Adoption of Clawback Provision This table presents the stated reasons for adoption of a clawback policy. The sample consists of S&P 1,500 firms that adopted a clawback between the years 2000 – 2011. We use keyword searches of 10-Ks, 8-Ks, and corporate proxy statements (DEF14A) to identify clawbacks. The total adds to more than the 2,115 firms that report adopting a clawback because some companies report more than one reason for adoption. Reason for Adoption Compensation Plan TARP SOX Part of Employment Agreement Dodd/Frank Risk Management Market Practices Compensation Committee Recommendation Severance Agreement Separation Agreement Other Unspecified
No. 749 150 145 83 62 18 10 3 3 1 742 160
% 35.4 7.1 6.9 3.9 2.9 0.9 0.5 0.1 0.1 0.0 35.1 7.6
Table 3: Breadth of Coverage: What Triggers the Clawback This table presents the events that trigger the implementation of a clawback policy. The sample consists of S&P 1,500 firms that adopted a clawback between the years 2000 – 2011. We use keyword searches of 10-Ks, 8-Ks, and corporate proxy statements (DEF14A) to identify reports of clawbacks. The total adds to more than the 2,115 firms that report adopting a clawback because some companies report more than one triggering event. Triggers Earnings Restatement Misconduct and Negligence of Fiduciary Duty Fraud Misrepresentation Non-compete Non-solicitation Nondisclosure Early Departure Termination for Cause Embezzlement and Theft Poor Performance
No. 1,473 1,006 669 390 320 211 197 88 28 23 15
% 69.6 47.6 31.6 18.4 15.1 10.0 9.3 4.2 1.3 1.1 0.7
Table 4: Depth of Employee Coverage: Who is Covered under the Clawback Provision? This table presents data on who is covered by the clawback policy and breadth of coverage. Employee coverage includes the CEO, named executive officers (NEOs), or other employees. Breadth of coverage can include persons responsible or go beyond those directly responsible. The sample consists of S&P 1,500 firms that adopted a clawback between the years 2000 – 2011. We use keyword searches of 10-Ks, 8-Ks, and corporate proxy statements (DEF14A) to identify reports of clawbacks. In panel A, totals can add up to more than the 2,115 firms because different filings can report different groups of employees as covered by the clawback policy. Panel A: Who is Covered under the Clawback? Coverage CEO ALL NEO Non NEO Employee Group Non-Employee Board Unspecified
No. 1402 1316 249 192 30 384
% 66.3 62.2 11.8 9.1 1.4 18.2
No. 1115 177 823
% 52.7 8.4 38.9
Panel B: Does Coverage Extend beyond Who is Directly Responsible? Breadth of Application Persons Responsible Persons Responsible & Others Unknown
Table 5: Management Action This table presents data on the different components of compensation covered by the clawback policy along with additional actions that can be implemented. Panel A presents the different components of compensation that are covered by the clawback policy. The different components of compensation include cash bonuses, long-term cash awards, and equity based awards (i.e., restricted stock and stock options). Panel B provides data on whether the clawback policy allows for additional actions beyond recovery of compensation. The sample consists of S&P 1,500 firms that adopted a clawback between the years 2000 – 2011. We use keyword searches of 10Ks, 8-Ks, and corporate proxy statements (DEF14A) to identify reports of clawbacks. In Panel A, totals can add up to more than the 2,115 firms (100%) because different filings can report different components of compensation covered by the clawback policy. Panel A: Compensation Covered by Clawback Clawback Applies to the Following Compensation Cash Bonus (short term) Up to full amount Only a portion associated with clawback event Any performance or incentive based award Unknown Cash Bonus (long term) Up to full amount Only a portion associated with clawback event Any performance or incentive based award Unknown Equity Based (stock, RSU) Up to full amount Unvested portion of grant Equity award gains from clawback Unknown Equity Based (options) Up to full amount Unvested portion of grant Equity award gains from clawback Unknown
No. 405 314 348 1048 493 300 239 1083 521 69 334 1191 496 57 317 1245
% 19.1 14.8 16.5 49.6 23.3 14.2 11.3 51.2 24.6 3.3 15.8 56.3 23.5 2.7 15.0 58.9
Panel B: Can Management Take Additional Action Other Action Legal Action Reduction of Future Compensation Dismissal
No. 98 61 42
% 4.6 2.9 2.0
Table 6: Policy Implementation Panel A presents data on who oversees the clawback policy. Panel B presents data on who has the discretion to implement the policy and Panel C provides information on the statute of limitations. The sample consists of S&P 1,500 firms that adopted a clawback between the years 2000 – 2011. We use
keyword searches of 10-Ks, 8-Ks, and corporate proxy statements (DEF14A) to identify reports of clawbacks. In Panel B, totals can add up to more than the 2,115 firms because different filings can report different information on who has the discretion to implement the clawback policy. Panel A: Who Oversees the Clawback? Who oversees implementation/policy Compensation Committee Entire Board Human Resources Committee Independent Directors Audit Committee Other
No. 955 520 25 22 4 79
% 45.2 24.6 1.2 1.0 0.2 3.7
No. 1192 923 1199 916 1116 999
% 56.4 43.6 56.7 43.3 52.8 47.2
Panel B: Overseer Discretion Overseer have discretion to Determine events Trigger clawback Determine amount to repay
Yes Unknown Yes Unknown Yes Unknown
Panel C: Statute of Limitations Statute of Limitations Clawback Period
Clawback Period Starts
1 year 2 years 3 years Other Not Stated After Grant After Departure After Trigger Other Not Stated
No. 119 57 103 224 1612 76 92 160 327 1460
% 5.6 2.7 4.9 10.6 76.2 3.6 4.3 7.6 15.5 69.0
Table 7: Characteristics of S&P 1,500 Firms, Firm-Years with versus without a Clawback Provision Reported Table presents summary statistics and univariate tests of litigation, earnings restatements, and fraudulent events prior to the adoption of a clawback along with information on financial characteristics. The sample consists of S&P 1,500 firms over years 2000 – 2011. We use keyword searches of 10-Ks, 8-Ks, and corporate proxy statements (DEF14A) to identify reports of clawbacks. Appendix A contains the variable definitions. Median values are in parentheses. To test for a difference in median, a two-sample test on the equality of medians is used. Firms Reporting a Clawback (N = 2,115)
Firm Not Reporting a Clawback (N = 13,809)
p-value for Difference in Mean (Median)
4.16% (0) 13.49% (0) 3.53% (0) 10.81% (0) 0.58% (0) 1.90% (0) 0.06 (0.01)
5.26% (0) 12.79% (0) 2.65% (0) 6.79% (0) 0.62% (0) 1.68% (0) 0.15 (0.00)
0.042 (0.042) 0.389 (0.389) 0.028 (0.028) 0.000 (0.000) 0.823 (0.823) 0.493 (0.492) 0.000 (0.000)
18.39 (4.77) 1.35 (1.13) 0.023 (0) 0.167 (0.132) 0.140 (0.131) 0.423 (0.368) 0.229 (0.205) 0.041 (0.029) 9.62 (9) 0.523 (1)
7.06 (1.44) 1.72 (1.27) 0.026 (0) 0.178 (0.122) 0.139 (0.131) 0.435 (0.381) 0.215 (0.193) 0.051 (0.034) 7.69 (6) 0.327 (0)
0.000 (0.000) 0.000 (0.000) 0.042 (0.000) 0.322 (0.235) 0.622 (0.637) 0.023 (0.069) 0.004 (0.039) 0.000 (0.000) 0.000 (0.000) 0.000 (0.000)
Accounting & Litigation Events Earnings Restatement Past Earnings Restatement Class Action Lawsuit Past Class Action Lawsuit Fraud Past Fraud Discretionary Accruals/Assets Financial Characteristics Total Assets ($ Billions) Tobin’s Q R&D/Assets Past Stock Return Cash Flow/Assets Past Stock Return Volatility Leverage Investment/Assets Number of Business Segments Investment Grade Debt
Table 7 (continued): Characteristics of S&P 1,500 Firms, Firm-Years with versus without a Clawback Provision Reported Firms reporting a clawback (N = 2,115)
Firm not reporting a clawback (N = 13,809)
p-value for difference in mean (median)
0.193
N/A
N/A
0.567
N/A
N/A
0.649
N/A
N/A
0.700
N/A
N/A
8
0
N/A
7.05 (5.11) 3.43 (3.48) 3.24 (3.32) 0.74 (1) 0.44 (0) 0.35 (0)
4.52 (2.81) 2.70 (2.72) 2.13 (2.06) 0.63 (1) 0.12 (0) 0.16 (0)
0.000 (0.000) 0.000 (0.000) 0.000 (0.000) 0.000 (0.000) 0.000 (0.000) 0.000 (0.000)
10.02 (10) 0.803 (0.818) 13.60 (13.16) 0.777 (0.791) 0.94 (0.18) 4.00 (4.09)
9.22 (9) 0.710 (0.727) 9.80 (8.16) 0.712 (0.756) 2.38 (0.37) 3.94 (4.03)
0.000 (0.000) 0.000 (0.000) 0.000 (0.000) 0.000 (0.000) 0.000 (0.000) 0.056 (0.127)
Clawback Policy Clawback Depth of Employee Coverage Clawback Breadth of Action Covered Clawback Liquidity Clawback Long-Term Horizon Clawback Complexity Compensation Total Compensation Equity-Based Pay Long-Term Pay Golden Parachute PV Equity PV Cash Governance and Enforceability Board Size Board Independence Number of Analysts Institutional Ownership CEO Ownership Enforceability Index
Table 8: Logit Analysis of Determinants of Adopting a Clawback Provision Logistical analysis of various factors that determine the adoption of a clawback policy. The dependent variable equals one in any year a firm reported a clawback policy and zero otherwise. Three different specifications are included. Panel A tests the hypotheses on detectability, expropriability, and financing costs. Panel B tests the hypotheses of whether compensation structure affects clawback adoption. Panel C presents a model with governance characteristics and the full model specification. The sample consists of S&P 1,500 firms over the years 2000 – 2011. We use keyword searches of 10-Ks, 8-Ks, and corporate proxy statements (DEF14A) to identify reports of clawbacks. Appendix A contains the variable definitions. All models include intercept, year and industry fixed effects. Significance at the 1%, 5%, and 10% level is denoted by ***, **, and *, respectively. Standard errors are adjusted for clustering at the firm level. Panel A: Base Case, Detectability, Expropriability, and Financing
Independent Variables Past Earnings Restatement Past Class Action Lawsuit Firm Size Past Stock Return Volatility R&D/Assets Cash Flow/Assets
Logit of Clawback Adoption Base Case/ Detectability Malfeasance (2) (1) H1+ 0.05 0.09 (0.40) (0.68) H1+ 0.36*** 0.33** (2.58) (2.20) 0.52*** (13.89) 0.51* (1.91) 1.76 (1.62) 2.59*** (4.08)
H2+ H2+ H2+
H2+
Investment/Assets
H2+
Number of Business Segments
H2+
Leverage
0.51*** (11.74) 0.54* (1.83) 1.65 (1.46) 2.35*** (3.33)
Expropriability (3)
H3+
H3+
Financing (4)
0.05 (0.40) 0.36*** (2.58)
0.07 (0.59) 0.36** (2.55)
0.52*** (13.89) 0.51* (1.91) 1.76 (1.62) 2.59*** (4.08)
0.45*** (9.96) 0.62** (2.26) 1.89* (1.67) 2.36*** (3.62)
-0.94 (-0.64) 0.02** (2.12) 0.19 (0.58)
H4+ H4+
Investment Grade Debt
0.25 (0.81) 0.40*** (3.12)
Control Variables Past Stock Return Tobin’s Q Enforceability Index Industry/Year Fixed Effects Pseudo R2 p-value of χ2 Observations
0.13* (1.89) -0.18*** (-3.01) 0.01 (0.37) Yes/Yes 0.351
