Section 304 of the Sarbanes-Oxley Act (hereafter, SOX), commonly referred to as the clawback provision, entitles the SEC to sue the CEO and CFO in an attempt to recover bonuses or equity compensation received based on misstated financial reports that are subsequently restated. This paper investigates the effects of the clawback provision on the likelihood of accounting misstatements and the CEO compensation structure. Efendi et al. (2007, JFE) document a positive association between CEO in-the-money stock option value and the likelihood of a financial misstatement They attribute this result to the agency costs of overvalued equity (Jensen, 2005). This association reduces significantly post SOX, consistent with the increase in the risk of clawback of CEO compensation due to financial misstatements. I also find that firms with high restatement likelihood exhibit a greater increase in CEO salary and a greater decrease in CEO option grants between the pre- and post-SOX periods, as compared to firms with low restatement likelihood. Finally, the above effects of the clawback provision on CEO compensation are greater for firms with weaker corporate governance.
|School||THE UNIVERSITY OF TEXAS AT DALLAS|
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