The Costs and Benefits of Clawback Provisions in CEO Compensation

Abstract

We analyze the costs and benefits of clawback provisions that enable firms to recover incentive compensation from top management if financials are restated. In a simple contracting model, we find that a clawback provision effectively lengthens the horizon of incentives and curbs misreporting. However, such a provision can add noise to the underlying performance measure, reducing managerial effort and firm value. Our empirical tests support the model’s predictions regarding which types of firms are likely to voluntarily use clawback provisions. We also document that clawback provisions are associated with higher reporting quality, greater CEO pay-for-performance sensitivity, and higher CEO compensation.