The Advisors' Blog

– Liz Dunshee

Recently, I blogged about the business case for adopting robust clawback policies. One of the arguments against doing that is research that shows executives subject to clawbacks might be more likely to resist needed restatements. But according to a new 7-year study of the Russell 3000, that concern is overstated. This “CFO.com” article explains the findings (also see this Cooley blog):

The study, by Peter Kroos and Frank Verbeeten of the University of Amsterdam and Mario Schabus of the University of Melbourne, finds clawback adoption to be associated not with weakened ties between pay and company performance but “with greater CFO bonus incentives tied to accounting measures.” On average, the sensitivity of CFO bonus pay to a company’s return on assets nearly doubles following clawback adoption. Such sensitivity is found to be less pronounced for other top executives.

These developments, the study concludes, have occurred because companies are not only boosting bonuses based on accounting integrity, they’re also increasing bonus pay for strategic output that improves performance. In short, CFOs have less incentive to manage earnings through accounting then they did previously because (1) they’re getting paid for accounting integrity, and (2) they prefer not to jeopardize the bonus money extended for the more creative aspects of their job.

“Prior to clawback adoption,” the professors write, “firms have been under-incentivizing CFOs’ decision-making duties to emphasize the role CFOs have as watchdogs for financial reporting integrity. The implementation of clawbacks could enable firms to incentivize CFOs’ decision-making duties more appropriately … without increasing their propensity to misreport.”

The study also finds that when a company has control weaknesses and other signs of accounting manipulation, there’s a weaker correlation between CFO incentives and clawback policies.