Clawback Provision of SOX, Financial Misstatements, and CEO Compensation Contracts

Section 304 of the Sarbanes-Oxley Act (hereafter, SOX), commonly known as the clawback provision, entitles the Securities and Exchange Commission (SEC) to sue the CEO and CFO in an attempt to recover their incentive compensation based on misstated financial reports. Although a stream of literature i...

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Bibliographic Details
Published inJournal of accounting, auditing & finance Vol. 34; no. 1; pp. 74 - 98
Main Authors Natarajan, Ramachandran, Zheng, Kenneth
Format Journal Article
LanguageEnglish
Published Los Angeles, CA SAGE Publications 01.01.2019
Warren Gorham Lamont
Subjects
Chief executive officers
Clawback
Compensation
Executive compensation
Forfeitures
Public Company Accounting Reform & Investor Protection Act 2002-US
Wages & salaries
United States > US
financial misstatements
Section 304
clawback provision
CEO compensation contracts
Sarbanes-Oxley Act (SOX)
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Summary:Section 304 of the Sarbanes-Oxley Act (hereafter, SOX), commonly known as the clawback provision, entitles the Securities and Exchange Commission (SEC) to sue the CEO and CFO in an attempt to recover their incentive compensation based on misstated financial reports. Although a stream of literature investigates the effects of voluntary firm-initiated clawback provisions, this study explores the effects of the mandatory SOX clawback provision on the likelihood of financial misstatements and CEO compensation. We find a significant decrease in the association between CEO in-the-money option value and the likelihood of a financial misstatement surrounding SOX, suggesting the SOX clawback provision has been effective in reducing financial misstatements arising from CEO in-the-money stock options. To examine the effects of the SOX clawback provision on CEO compensation, we identify a set of misstatement firms with a high restatement likelihood where the CEOs are most likely concerned with the impact of the SOX clawback provision on their compensation. We find that compared with control firms, these misstatement firms with a high restatement likelihood where the CEO is the chair of the board exhibit an increase in CEO salaries between the pre- and post-SOX periods, suggesting that in the post-SOX period, powerful CEOs are able to receive higher salaries which are not subject to the SOX clawback provision.
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ISSN:0148-558X
2160-4061
DOI:10.1177/0148558X16686740