The Effect of Clawback on Managerial Use of Expectations Management and Market Consequences

Since 2007, voluntary adoption of compensation Clawback provisions has grown prevalent among U.S. listed firms. By 2014, approximately 50% of Russell 3000 firms had adopted such policies. Clawback provisions allow adopting firms to recoup incentive-based compensation paid to executives if misstatements in prior financial reports are later discovered. Researchers assert that Clawbacks could impose unintended consequences on adopting firms. I contribute to this argument by providing empirical evidence that Clawback firms are more likely to issue downward earnings guidance to lower analysts-set earnings goals. This is consistent with the notion that Clawback adoptions encourage managers to use methods other than accruals management to achieve earnings goals without risking triggering a Clawback. I also find a significantly weaker market reaction to downward guidance issuance and earnings surprises announcements post-Clawback. These results are robust to controlling for the decision to adopt a Clawback provision voluntarily. Overall, my findings suggest that although the stock market provides less pressure to meet earnings goals post-Clawback, opportunistic managers continue to fixate on playing the “numbers game” and they do so by managing analyst expectations.