M&A decisions and US Firms' voluntary adoption of clawback provisions in executive compensation contracts

Abstract

We examine whether US firms' MandA decisions influence the likelihood of voluntary adoption of clawback provisions in executive compensation contracts and whether clawback adoption improves subsequent MandA decisions. Because prior research finds that poor MandA decisions are associated with future earnings restatements, we predict that clawback adoption is more likely after these transactions. We further conjecture that MandA decisions will improve after clawback adoption, as its presence reduces executives' willingness to manipulate post-acquisition earnings. Consistent with our expectations, we find that (1) firms with more negative MandA announcement returns are more likely to adopt clawbacks; (2) firms that acquire targets with relatively poor accounting quality are more likely to adopt clawbacks; (3) clawbacks improve investor perception of MandA quality; and (4) executives are more responsive to the market when completing MandA 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 US policymakers, as the Dodd-Frank Act of 2010 requires mandatory adoption of clawbacks. Our results also suggest that non-US firms can reduce managerial incentives to manipulate post-takeover earnings by using clawbacks.