The Effect of Voluntary Clawback Adoptions on Corporate Tax Policy

Abstract

ABSTRACTCompanies are adopting executive compensation recoupment (“clawback”) policies to discourage aggressive financial reporting choices. Recent research suggests clawback policies encourage other means of meeting earnings expectations. We suggest that reducing income tax expense is a means of meeting earnings expectations. We find that effective tax rates are lower after clawback adoption due to increased investments in tax planning. We identify three tax planning activities that clawback companies invest in to lower effective tax rates: purchases of auditor-provided tax services, increased connections to other low-tax companies, and use of tax havens. We provide evidence that effective tax rate decreases do not result from use of opportunistic income tax accruals, and that decreases are stronger among companies that adopt robust clawback policies. Additional tests indicate lower tax outcome volatility and longer, more readable tax footnotes following clawback adoption. Our results suggest a positive spillover effect of clawback adoption on corporate tax policy.