The Adoption of Voluntary Clawback Provisions and the Broader Commitment Hypothesis

Abstract

“Clawback Provisions” are corporate governance mechanisms intended to reduce managers’ opportunistic behavior. Voluntary clawback provisions have been associated with many positive consequences in extant literature. A causal relation has been used to explain this association. However, because the clawbacks have rarely been enforced, doubts have been raised about the robustness of the clawback provisions. If the clawbacks are seldom enforced, how could they have an impact on the managers’ behavior? Denis (2012) proposes the possibility that the adoption of the clawback provisions serves as a signal of the board’s broader commitment to heighten higher financial integrity. We call this the Broader Commitment Hypothesis. Within this broader commitment framework, it is not the clawback provision in and of itself that leads to more accurate financial reporting. Rather, there are other things at work. We hypothesize and find that boards also change managers’ compensation scheme to incentivize them to promote reporting quality. In so doing, a firm’s financial reporting risk decreases, and managers have smaller proportion of unexercised options. Our overall evidence supports the Broader Commitment Hypothesis.

Keywords: Voluntary clawback; broader commitment hypothesis; Vega; exercisable options; proportion of bonus; financial reporting risk