Compensation Clawback Policies and Corporate Lawsuits

Abstract

Since the 2008 financial crisis, executive compensation has been the subject of increased regulation, including the mandatory adoption of compensation clawback policies by the Dodd Frank Act. By allowing firms to recoup compensation from managers who breach their fiduciary duty, clawbacks provide a form of discipline that potentially reduces the likelihood of managerial wrongdoing which, in turn, lowers the risk of corporate lawsuits. We examine the association between clawback provisions and corporate litigation and find that firms with higher litigation risk are more likely to adopt a clawback policy. In addition, after the adoption of clawback provisions, litigation risk significantly declines suggesting that clawback policies are effective in reducing the likelihood of corporate lawsuits. Furthermore, firms with clawback policies are more likely to have lawsuits against them dismissed or settled for lower amounts.

Keywords: Risk Management, Litigation Risk, Corporate Lawsuits, Clawback, Executive Compensation

JEL Classification: G30, G34, G38, K20, K22