Can Shareholders Be at Rest After Adopting Clawback Provisions? Evidence from Stock Price Crash Risk

Abstract

Using a propensity score matched sample for the period from 2003 to 2012 and a difference-in-difference research design, we find that stock price crash risk increases after firms voluntarily adopt clawback provisions in managers’ compensation contract. Our results reveal that total upward (but not downward) earnings management increases for clawback adopters, and the increase in crash risk is driven by firms with more income-increasing total earnings management after adopting clawback provisions. These results suggest that the heightened crash risk is attributable to the increased magnitude of total upward earnings management subsequent to clawback adoption. In addition, we find that the positive association between clawback adoption and crash risk is more pronounced for firms with low institutional holdings and with high equity incentive for CEOs, where the opportunity and incentive to hoard bad news are higher.