Clawback Provisions Research Articles

The Value of Clawbacks

We examine whether the adoption of clawback provisions in executive compensation contracts improves the informativeness of accounting information. Contrary to conventional wisdom we find that clawbacks do not lead to improved financial reporting. Specifically, we document a significant decline in the market’s response to earnings surprises after the adoption of both fraud and performance based clawback provisions. In contrast, we find that the market’s reaction to earnings surprises reported by TARP firms after their mandatory clawback adoption is larger than it was in the three years prior to the adoption. In addition, there is evidence that voluntary adopters may be motivated to adopt clawback provisions by the recent occurrence of restatements. Taken together, our results provide a cautionary tale of how some types of clawbacks may produce an unintended consequence in terms of deteriorating the established relation between reported earnings and stock price.

Economic Determinants of the Voluntary Adoption of Clawback Provisions in Executive Compensation Contracts

We examine whether U.S. firms’ MA (2) firms that acquire targets with relatively poor accounting quality are more likely to adopt clawbacks; (3) clawbacks improve investor perception of MA and (4) executives are more responsive to the market when completing M&A deals if their compensation contracts include clawbacks. These results suggest that boards take a pro-active approach and consider factors that may lead to restatements when adopting clawbacks. Our results have implications for U.S. policymakers, as the Dodd-Frank Act of 2010 requires mandatory adoption of clawbacks. Our results also suggest that non-U.S. firms can reduce managerial incentives to manipulate post-takeover earnings by using clawbacks.

The Existence of Corporate Bond Clawbacks (IPOCs): Theory and Evidence

Clawback provisions allow the issuer to partially redeem a bond issue often within three years of issuance using proceeds only from new equity issues. Empirical evidence indicates the clawback provision is rarely exercised. This poses an interesting dilemma as clawback provisions are an expensive source of funding, often commanding yields that are significantly higher than traditional corporate bonds. We develop a simple model that provides a rationale for the scarcity of call redemptions and the higher yields of clawback bonds. The model predicts a relation between issuance of clawback bonds, cash flow volatility and the probability of renegotiation of clawback debt contracts that hinges on the existence of a separating equilibrium. Firms with stable cash flows and low growth opportunities issue bonds with clawback provisions while firms facing valuable growth opportunities prefer convertible bonds. The predictions of the model are tested and strongly supported by the empirical specifications.

The Long Arm of the Claw

ll public companies traded on U.S. stock exchanges will soon be required to have a clawback policy in place. Prior to the new law, a clawback provision required the top two executives at a publicly traded company to reimburse the company for any incentiveor equity-based compensation received over a certain period of time if that company had to issue a financial restatement as a result of company misconduct. But significant changes are coming, as dictated by the Dodd–Frank Wall Street Reform and Consumer Protection Act. The upshot for investors will depend on the details of the final regulations, which are still to be determined.

Recent Improvements in Corporate Governance through Executive Compensation Reform

There have been a lot of criticism on excessive executive compensation paid to high ranking corporate executives in poorly performed financial institutions amid recent financial crisis and global economic crisis. These criticisms can be tracked to Enron scandals in early stage of this century. In order to establish reasonable executive compensation system, U.S. has utilized SEC disclosure rules, IRS tax code and SOX clawback provision, however, these regulatory methods have revealed their inherent limitations in regulating compensation system effectively. From this perspective, many critics have stressed that there should be more fundamental reform methods, such as director reform and the adoption of Say-on-Pay system.In the same context, EESA and ARRA implemented corporate governance and executive compensation provisions in order to effectively regulated U.S. companies' compensation manipulation. The focus on this area is placed on the corporate governance reform in which corporate governance problems, including executive compensation, might be more effectively cured through this reform methods.Recent debates on this issue provide us with useful implications. As widely recognized, Korean compensation system does not mandate detailed compensation disclosure system regarding corporate executives/directors. Fair and transparent compensation system is essential elements in order to improve shareholders' and investors' value. Although corporate executives have rejected such a disclosure system on the ground of the protection of private information, we should note that these information be essential for investors as an important investment information.Furthermore, we should implement certain regulatory method to curtail influences by controlling shareholders and CEO on compensation setting process. Under the current provision of KCC, director compensation must be approved by shareholders in annual shareholder meeting. However, in practice, the direction of a shareholder meeting can be influenced by controlling shareholders. From this perspective, current reforming efforts of U.S. and Europena Countries provide us with useful implications.

The Existence of Corporate Bond Clawbacks (IPOCs): Theory and Evidence

Clawback provisions allow the issuer to partially redeem a bond issue often within three years of issuance using proceeds only from new equity issues. Empirical evidence indicates the clawback provision is rarely exercised. This poses an interesting dilemma as clawback provisions are an expensive source of funding, often commanding yields that are significantly higher than traditional corporate bonds. We develop a simple model that provides a rationale for the scarcity of call redemptions and the higher yields of clawback bonds. The model predicts a relation between issuance of clawback bonds, cash flow volatility and the probability of renegotiation of clawback debt contracts.

Clawback Provisions in Executive Compensation

Clawback Provisions in Executive Compensation

Gaming Performance Fees By Portfolio Managers

We show that it is very difficult to devise performance-based compensation contracts that reward portfolio managers who generate excess returns while screening out managers who cannot generate such returns. Theoretical bounds are derived on the amount of fee manipulation that is possible under various performance contracts.We show that recent proposals to reform compensation practices, such as postponing bonuses and instituting clawback provisions, will not eliminate opportunities to game the system unless accompanied by transparency in managers' positions and strategies. Indeed, there exists no compensation mechanism that separates skilled from unskilled managers solely on the basis of their returns histories.

Hedge fund investing: Beware of special relationships: The remorse of Beacon Hill Asset Management Investors

Beacon Hill Asset Management (BHAM) is a hedge fund that specializes in investing and trading mortgage-backed securities (MBS). The fund exploits arbitrage opportunities in the MBS market and does not take interest rate risk. The background of the fund management team is excellent, and its performance is stellar. Assets under management exceed US$2.0 billion. The investors include the top financial institutions. What could go wrong? The pressure to honor the commitment in a symbiotic relationship with the major investor in the fund advisory firm coerces the fund managers into committing fraudulent activities that they may not have committed otherwise. Asset Alliance Corp., a New York-based investment firm, payed $40 million for a 50 per cent ownership stake in BHAM in 1998. The purchase agreement included a claw-back provision. The provision stipulated that should BHAM fail to deliver the performance, BHAM must return up to half of the prior earnout fees to Asset Alliance. The Securities Exchange Commission (SEC) complaint alleged that the BHAM misrepresented the valuation of the securities in order to show steady and positive returns. The partners concealed the magnitude of the actual losses in order to save the operation of BHAM. The absence of a compliance officer and/or independent board facilitated the fraudulent activities, and investors' losses exceeded $400 million. In late 2004 the SEC settled the case and expected the disgorgement, prejudgment interest and penalties to be distributed to the fund investors. Investors in hedge funds and industry stakeholders should demand some form of independent oversight and investigate any special relationship the fund has with a third party, through the due diligence process.

The Relative Efficiency of Clawback Provisions in Compensation Contracts

Clawbacks are retractions of previously-awarded bonuses. In our model, the manager takes a first-period effort that stochastically determines a first-period signal and a second-period cash flow. Both the cash flow and the signal are noisy indicators of effort. The agent can manipulate the signal, i.e., manage earnings. The no-clawback contract pays the agent in the first period for a good signal. The clawback contract also rewards the good signal, but the payment is in the second period and may be lower if the cash realization is low. The agent is impatient and prefers a first-period payment. We find that the no-clawback contract dominates the clawback contract if the cash realization is relatively noisy, earnings management is difficult, or the agent is very impatient. Earnings management may be optimal even though the actual cash realization is contractible. A contract involving restricted stock is always dominated by the clawback contract. The results demonstrate that the optimal ex ante alignment of manager and shareholder interests does not imply perfect ex post alignment of manager and shareholder payoffs.

Recovering Bonuses After Restated Financials: Adopting Clawback Provisions

We investigate the emergence of provisions to recover bonuses made in the event of restated financials. These provisions are sometimes termed 'clawbacks.' Errant financial statements, and associated bonuses, have made headlines and the SEC recently changed Regulation S-K to require that compensation committees disclose their policies regarding bonus recovery in the event of errant financial statements. Some, but not all, companies quickly developed policies to recover (clawback) bonuses. We construct an index of the relative influence of management and independent monitoring on governance. We find that management influence (reflected as a low index) makes a clawback provision less likely. On the other hand, more independent monitoring (as reflected in a high index) increases the likelihood of a company adopting a clawback provision. Higher noise in the accounting system makes a clawback less likely and if the risk of restatements has been high recently then a clawback provision is more likely. Accounting conservatism does not appear to be a factor in the presence or absence of clawback provisions.

Equitable Clawback: An Essay on Restoration of Executive Compensation

The remedy of restoration of compensation, known in the agency context as the faithless servant doctrine, provides for the corporate principal's recovery of compensation previously paid or payable to corporate officers and other agents who have breached their fiduciary obligations. Although a limited clawback provision was one of the reforms enacted as part of the Sarbanes-Oxley Act, courts have refused to imply a private remedy, and, even if they were to do so, it would be of limited utility. Given the many variations of the clawback concept, including the demands for clawback of AIG and Merrill Lynch bonuses and of pre-bankruptcy returns paid to Madoff investors, I have chosen to distinguish the equitable remedy of restoration of compensation as equitable clawback. My essay contends that the remedy's increased recognition and broader use would add primacy to individual versus entity liability, and, consequently, help reestablish the link between executive wealth and executive responsibility.

An empirical analysis of the determinants and pricing of corporate bond clawbacks

This paper presents empirical analysis of the factors that affect a firm's decision to use a clawback provision in debt and the yield impact of including the clawback provision. The results show that relatively smaller firms with low credit rating and low profitability favor the usage of clawback provisions. We also find that debt with clawback provisions have the highest yield spread followed by callable bonds and straight debt. Convertible bonds that offer investors the option to convert to equity have lower yield spread. This implies that issuers can trade off flexibility for higher interest cost and that the clawback feature may be a significant financial innovation which reduces information asymmetry and creates an entry point for small firms to gain access to the public bond markets.

Financial Contracting and Re-Rating Experience, the Cases of Make Whole, Claw Back and Other Wise Ordinary Callable Bonds

The literature states that ordinary callable bonds help resolve several agency issues while make whole and claw back bonds are supposed to resolve the underinvestment problem. The justification for refinements of the classic call option is not clear as firstly, the classic call option seems able to handle the underinvestment problem anyway and secondly, the existing empirical evidence does not examine whether make whole and claw back bondholders actually benefit from the resolution of agency problems. We find evidence that firms’ do select make whole and claw back provisions to better confront the underinvestment problem for below investment grade bonds.

Re-Thinking the CEO Incentive Bonus

This article addresses the following key points: The incentive bonus component of CEO compensation programs is usually pegged to a performance measurement, such as the company's ROE, ROA, EPS, or some other internal benchmark. It may be more relevant when computing the bonus to compare the performance of the company's stock price relative to the stock price movement of a universe of similar companies. To more closely align the CEO's interests with those of the shareholders, the incentive bonus should be subject to a claw-back provision in the event of underperformance.

A corporate bond innovation of the 90s: The clawback provision in high-yield debt

This paper examines a recent financial innovation in corporate bond contracts, referred to as the clawback provision. A clawback provision in debt contracts gives the issuer an option to redeem a specified fraction of the bond issue within a specified period at a predetermined price and with funds that must come from a subsequent equity offering. We argue that issuers use clawback provisions to mitigate the wealth losses that would otherwise occur when new equity is offered. Consistent with the hypotheses, the evidence shows that bond offerings are more likely to include a clawback provision if their issuers are private, have more intangible assets, have fewer liquid assets, and are unregulated. We also estimate the price of clawback provisions and find that yield spreads on bonds with clawback provisions are a median of 86 basis points higher relative to what they otherwise would be.

Clawbacks and the Administration of Economic Development Policy in the Midwest

Over the past decade, competition for private investment among the American states has attracted much negative comment. Clawbacks have been proposed as a way of imposing controls on the provision of state economic development subsidies. Clawbacks stipulate that a publicly subsidized firm not achieving agreed-upon employment performance targets must pay back a portion of the subsidy it received. This article reviews the arguments made in favor of clawbacks and presents new data on clawback usage in major midwestern grant and loan incentive programs that indicate clawback provisions are reasonably widely used. However, there is considerable divergence in the operation and organization of clawbacks across programs, and there appears to be little agreement on how firm employment performance should be evaluated. Most directors of state grant and loan programs feel that the inherent riskiness of business should be taken into account when deciding whether clawback sanctions should be applied to under performing firms.

A TEST FOR PRICE INTEGRATION IN THE EC LAMB MARKET

The purpose of this paper is to test for price integration in the British‐French markets for lamb in the period after the introduction of the EC sheepmeat regime in 1980. A Holmes‐Hutton rank order procedure is used to determine if price changes in one market cause price changes in the other market and thus define an integrated market. Using weekly price data for the period 1983‐86, the results indicate that the British‐French lamb markets are integrated in that a price change in one market is fully reflected in price changes in the other. However, there is considerable lag time in response to price changes. This may be attributed to less than perfect substitution between the British and French product, to the ex post nature of the clawback provision that existed in the British price support system during the period of analysis, and to informal trade barriers.

Contractual Resolution of Bondholder-Stockholder Conflicts in Leveraged Buyouts

L EGAL scholars and economists have long recognized that the interests of stockholders and bondholders often conflict. Since bondholders own fixed claims that are senior to the residual and limited liability claims of stockholders, the two classes of security holders often differ over corporate policies, including policies about cash distributions to stockholders, the issuance of additional debt, and the riskiness of investment projects.' Although bondholder-stockholder conflicts have been the source of much litigation during this century, U.S. courts generally have maintained that these conflicts should be resolved explicitly in bond contracts. For example, in 1981 in Broad v. Rockwell International Corp.,2 a federal court stated that it "will not rewrite a term of a [bond] contract by interpretation when that term is clear and unambiguous on its face." In Katz v. Oak Industries3 the Delaware Court of Chancery restated the common-law tradition: "Arrangements among a corporation, the under-

Adding a Stick to the Carrot: Location Incentives with Clawbacks, Recisions, and Recalibrations

The escalation of incentive awards to attract and retain new business has emerged as a major concern in state and local development policy. This article addresses claw-back provisions, a largely neglected part of the bargaining process between governments and businesses in the location of new plants and offices. Just as private business transactions work within a framework of legally binding contracts, clawbacks provide some recourse to reclaim all or some of a financing package when a firm fails to meet performance requirements. Besides analyzing clawbacks, the authors identify three related areas for policy intervention: penalties, recisions, and recalibrations. The aim of this article is to show that U.S. policymakers can avoid expensive mistakes if they tie incentives to written guarantees of job creation and other benefits. European regional policymakers have used a carrot-and-stick approach to industrial recruitment. Increasingly, state and city governments in the United States also recognize that public-private bargaining requires some form of reasonable, guaranteed quid pro quo.