The Effect of Voluntary Clawback Adoptions on Corporate Tax Policy

Abstract

Firms are adopting executive compensation recoupment (“clawback”) policies to discourage aggressive financial reporting choices. Recent research suggests clawbacks might encourage other, less aggressive, forms of earnings management. We suggest that managing effective tax rates (ETRs), through greater discretion or tax planning, is an alternative for meeting earnings expectations and examine whether ETR management is affected by clawback adoptions. Using a matched sample, we find that effective tax rates are lower after clawback adoption, suggesting that firms use ETR management to increase earnings following clawback adoption. We also find that increased ETR management after clawback adoption does not increase tax outcome volatility or reduce tax disclosure quality. In further tests, we find lower ETRs among clawback firms that barely beat earnings estimates. We also find some evidence of a tradeoff between accruals, or real, earnings management and ETR management.