A new study from researchers in the University of Nebraska–Lincoln College of Business examines whether enforcement of a provision in the Dodd-Frank Wall Street Reform and Consumer Protection Act will make an impact on erroneous executive compensation. Dr. Thomas Omer, professor and Delmar Lienemann Sr. Chair of Accounting, and Dr. Thomas Kubick, associate professor of accountancy, published their findings in the The Accounting Review on clawbacks, provisions which intend to retrieve money from executives who profit from inaccurate financial reporting.
Omer, Kubick and co-author Dr. Zac Wiebe of the University of Arkansas, cast doubt on whether or not clawbacks are an effective tool for dealing with the situation. Although the legislation surrounding clawbacks is yet to be finalized, many firms voluntarily enacted policies to implement the spirit of the law.
“There are likely numerous reasons that corporations adopted the clawback policy early,” said Omer. “It could be a signal to the market that the corporation has good governance. However, because we are unaware of the potential reasons, the analyses we conducted attempted to address that unknown by equalizing characteristics of the treatment (adopters) and control firms (non-adopters). Our results reflect the difference in activities between the groups.”
A major component of the study shows that clawback adopters increased payments for auditor-provided tax services and in turn, company strategies shifted to aggressive tax savings measures. These adopters showed more likelihood of reporting a new subsidiary in a tax-haven country or increasing interlocks with companies with low effective tax rates. Kubick explained that prior research has documented the tax strategies as being effective for large multinationals.
“We find adopters appear to increase the usage of these strategies after implementing a clawback, providing a sense of what types of tax savings strategies these firms are using to lower their effective tax rates. Of course, it is possible that firms can use a variety of these as well as different strategies that are not directly observable,” said Kubick.
Kubick believes the current lack of specific SEC guidance on clawbacks might be one reason some firms have held back on adopting the policies. Omer pointed out that generally the more firms manipulated earnings expectations, the greater their need to engage in tax savings strategies.
“The point of the clawback policy is to punish executives that met earnings expectations by manipulating reported income. Thus, because the pressure is market-based, companies turned to activities that ultimately decrease U.S. tax revenues, and increase the odds of making earnings expectations without the need to manipulate earnings which would result in a clawback of compensation related to performance,” said Omer.
Another dynamic in play surrounds the Tax Cut and Jobs Act of December 2017, which dramatically reduced corporate tax rates. Omer says tax cuts may serve to lessen tax-based strategies to meet earnings goals compared to the pre-2017 environment.
“It will be interesting to see whether activities firms engaged in to lower their tax bill will continue with the reduced corporate tax rate, and what might change if the SEC fully implements the clawback policy,” he said. “Our earlier paper found that, while clawback adoptions tend to reduce accruals manipulation, they increase real-transaction management, whereby company operations are altered to achieve a temporary earnings boost – for example, through cutting research and development, or slashing prices or easing credit terms to accelerate sales.”
“The Effect of Voluntary Clawback Adoptions on Corporate Tax Policy,” appears in the January issue of The Accounting Review.
To learn more about the School of Accountancy, visit: https://business.unl.edu/accounting/.
Published: February 25, 2020