Will the Adoption of Clawback Provisions Mitigate Earnings Management?

Abstract

This paper examines the effects of voluntary adoption of clawback provisions on earnings quality. Our findings suggest neither a voluntary disincentive mechanism (clawback provisions) nor an enhanced monitoring mechanism (independent boards) can completely eliminate managers’ rent extraction behaviors, in isolation. Yet, when they are coupled together, the results are the best. Specifically, a more independent board increases the likelihood of voluntary adoption of clawback provisions. The board independence also ensures improvement of earnings quality post the voluntary adoption. No such results can be observed with a less independent board. Our study provides the insights whether corporate executives can be sanctioned at firm-level by discretions of the board of directors.