The Effect of Voluntary Clawback Adoption on Non-GAAP Reporting

Abstract

In this paper, we examine the effect of voluntary adoption of clawback provision on non-GAAP earnings disclosures. The extant literature documents that the voluntary adoption of clawback provisions improves financial reporting quality by increasing the costs of misstating GAAP earnings. However, managers may respond to perception of reduced discretion over GAAP reporting by increasing their reliance on non-GAAP earnings disclosures. We find that managers more frequently disclose non-GAAP earnings after the voluntary adoption of clawback provisions, relative to a propensity-matched sample of control firms. In addition, we find that the quality of non-GAAP earnings exclusions deteriorates after voluntarily adopting clawbacks, consistent with a more opportunistic use of non-GAAP reporting. Our results extend the growing literature on clawback adoption and suggest that the improvement in GAAP reporting quality associated with clawbacks may be achieved at the expense of deterioration in the quality of non-GAAP earnings. This unintended consequence has implications related to the mandatory adoption of clawbacks required under the Dodd-Frank Act of 2010.