Clawing Back Executive Compensation

Clawing Back Executive Compensation

James AngYingmei ChengSarah Fulmer

Source: Frydman and Jenter (2010) CEO Compensation, Working paper

Agency Problem

• Incentive compensation aligns management interest with shareholders – Mehran (1995); Jensen and Murphy (1990)

• Incentive compensation, particularly stock options, encourages management to manipulate earnings – Klinger et al. (2002)

CEO CompanyRestatement

PeriodTotal Incentive Compensation

Stock / Option Profits

Bernie Ebbers MCI (WorldCom) 1999-2002; $69.9 billion

$100 million $430 million “loan” for stock

Maurice Greenberg

AIG 2000-2005; $3.4 billion

$121.7 million

Richard Scrushy HealthSouth 1996-2002;$2.6 billion

$259 million $74 million

William McGuire United Health 1994-2005;$1.5 billion

$246.3 million $390 million

Paul Allaire Zerox 1997-2000;$1.4 billion

$41.6 million $35.3 million

Sanjay Kumar Computer Associates

1999-2000;$2.2 billion

$30.7 million

Joseph Nacchio Qwest Communications

2000-2001; $2.5 billion

$76.4 million $52 million

Solutions to Agency Problem• Monitoring by the Board of Directors

– The greater the CEO power, the less effective the Board monitoring – Hermalin and Weisbach (1998)

– Board monitoring weakens over the CEO’s tenure – Ryan et al. (2009)– Directors have an incentive to appease management – Bebchuck and

Fried (2003)• Shareholder Activism / Shareholder Litigation

– Shareholder activism is generally ineffective in changing corporate policy – Romano (2003); Klein and Zur (2009); Admati and Pfleiderer (2009)

• Government Intervention / Clawback Provisions– SOX Section 304– Dodd-Frank Section 954

Overview of Clawbacks• Contractual or Statutory provision that allows a firm to recover

fraudulently or erroneously paid compensation• SOX 304

– requires “misconduct” to trigger clawback– ALL incentive compensation AND profits from the sale of stock and

options for 12 months following misstatement• Dodd-Frank 954

– All exchange-listed firms must adopt Clawback Policies– Applies to all “material” restatements (does not require misconduct)– Only recovers “excess” incentive compensation– Does not apply to recover profits from sale of stock and options

Sarbanes Oxley (2002) Dodd-Frank (2010)

Legislative Objective

To recover total incentive compensation and profits from the sale of securities in the event of “material” restatement due to “misconduct”

To recover “excess” incentive compensation in the event of a “material” restatement, regardless of fault

Firms Covered All firms that restate earnings due to fraudulent inflation

All exchange-listed firms that restate earnings

Who is Covered? CEO and CFO All Current and Former “Executives”

Who Initiates Clawback Proceeding?

The SEC The Board

Recovery Period 12 months following the date the misreporting is issued Three years prior to restatement

Amount Recoverable

All Bonus All LTIP All Stock Grant All Option Grant Entire Stock Gain Entire Option Gain

Excess Bonus Excess LTIP Excess Stock Grants Excess Option Grants

NO Stock / Option Gain

Incentives to Manipulate• Earnings manipulation is more prevalent where CEOs are “incentivized” –

Bergstresser and Philippon (2006)

• Executives exercise “unusually large” amount of options and sell large amounts of stock during periods of misreporting – Erickson et al. (2006)

• Executives manipulate earnings to maintain stock prices or to prevent price decreases – Efendi et al. (2007); Johnson et al. (2008).

• Executives manipulate: (a) to prevent decline in earnings; (b) to avoid missing analyst forecasts; and (c) to avoid reporting negative earnings – Burgstahler and Dichev (1997)

• CEOs at poorly performing firms are more likely to be terminated – Warner et al. (1988); Arthuad-Day et al. (2006)

Hypothesis Development

• H1: The amount recoverable under Dodd-Frank will not be economically significant

• H2: CEOs manipulate earnings to profit from stock sales and option exercises

• H3: CEOs manipulate earnings to avoid termination

Current Incentive Compensation

• Firms engage in more manipulation where executives are “incentivized” – Bergstresser and Philippon (2006)

• The more Equity / Total Compensation, the greater probability of accounting fraud – Erickson et al. (2006)

Enforcement of Clawbacks

• Firms that voluntarily adopt clawback provisions have better financial reporting quality (deHaan et al., 2012) and lower probability of future restatement (Chan er al., 2011; Chen et al., 2012)

• No evidence of enforcement, even in firms that voluntarily adopt clawback provision- Addy et al. (2011); Babenko et al. (2012)



• H2: CEOs manipulate earnings to profit from stock sales and option exercises

• H3: CEOs manipulate earnings to avoid termination

Stock and Option Profits

• Insiders sell more stock during misreported period – Summers and Sweeney (1998); Beneish (1999); Beneish and Vargus (2002); Agrawal and Cooper (2006)

• CEOs exercise more options during misreported periods – Kedia and Philippon (2009); Burns and Kedia (2008); Efendi et al. (2007)

• Greater earnings management in years the CEO exercises options – Bergstressor and Philippon (2006)



• H2: CEOs realize economically significant indirect gains from the sale of previously awarded stock and option grants

• H3: CEOs receive indirect benefits from manipulating earnings by reducing their risk of being terminated

Probability of Termination

• CEO turnover increases following poor firms performance – Huson et al. (2001)

• CEOs who fail to meet analysts expectations face a higher risk of termination – Farrell and Whidbee (2003)

• 51% of CEOs are terminated within two years following a restatement – Desai et al. (2006)

• 93% of executives are terminated following SEC investigations for fraud – Karpoff et al. (2008)

Summary of Results

• H1: Effectiveness of Dodd-Frank– Can recover something from 93% of the CEOs– Potential to recover 73% of Direct Gains (i.e.

“excess incentive compensation”)• Economically small amount – average dollar amount

recoverable $153,00 per CEO, per fiscal year• The remaining 27% of Direct Gains are paid more than

three years prior to restatement; thus are unreachable under Dodd-Frank

– Capture less than 1% of total gain from manipulation (Direct and Indirect Gains)

Summary of Results

• H2: Gains from Insider Trading – Average CEO earns $3.7 million in stock gain and $3.8 million

in option gains (per CEO, per year)– Average CEO profits by nearly $18 million during the

misreported period

• H3: Probability of Termination– 18% of the sample are able to reduce their probability of

termination by at least 10%– 11% of the sample are able to reduce their probability of

termination by at least 50% as result of inflation. – Thus “survival” is a credible motive.

Sample SelectionRestatements for the Period 1998 to 2009 Restatements Firms Obs.1. Restatements identified in Audit Analystics 93852. Limit to "High Concern" Restatement -6924

24613. Restatement Period Is At Least One Full Fiscal Year -990

14714. Non-Duplicate / Non-Overlapping -99

13725. Compustat, CRSP, and Execucomp -1121

275 249 7246. SEC Edgar

Firms not in EDGAR -7 -15Firms that did not file amended 10-k -19 -65Firms without original 10-k in EDGAR -28 -68

7. Final SampleRestatments 211Firms 195Firm-Years 576CEOs 245

Data

• Compensation Data – Execucomp

• Financial Data – 10-k Reports (SEC EDGAR)

• Termination Data – Lexis-Nexis Searches– Parrino (1997) Methodology

• Stock and Option Data – Thomson Reuter’s Insider Filing Database

Variable N Mean Median Minimum Maximum Std. Dev. Total Assets Restatement Firms 576 14,819,132 1,323,456 24,564 1,009,569,000 84,745,505 Matched Firms 576 13,587,631 1,262,718 20,630 1,484,101,000 84,874,022Sales Restatement Firms Unrestated 576 5,057,002 *** 990,010 *** 30,103 98,615,000 10,882,077 Restated 576 4,655,684 987,793 *** 16,816 97,666,000 10,281,315 Matched Firms 576 4,383,850 1,022,686 1,857 133,585,000 12,082,016Net Income Restatement Firms Unrestated 576 216,686 *** 35,668 ** -4,023,000 24,730,000 1,490,035 Restated 576 36,314 *** 23,683 ** -48,909,000 24,728,000 2,589,670 Matched Firms 575 303,042 49,591 -2,142,800 17,046,000 1,373,860CEO Age Restatement Firms 576 54.80 54.00 28.00 79.00 7.94 Matched Firms 549 54.73 55.00 34.00 82.00 7.97CEO Tenure Restatement Firms 576 4.61 4.00 1.00 17.00 3.17 Matched Firms 576 4.73 4.00 1.00 14.00 3.21Salary Restatement Firms 576 654.02 581.42 0.00 3,961.17 391.48 Matched Firms 576 639.70 600.00 0.00 3,000.00 338.87Bonus Restatement Firms 573 715.81 366.28 0.00 10,000.00 1,226.27 Matched Firms 576 763.29 351.00 0.00 31,000.00 1,793.59LTIP Restatement Firms 573 343.24 *** 0.00 *** 0.00 29,254.41 1,910.34 Matched Firms 576 126.75 0.00 0.00 9,410.10 643.04Equity (stock and options) Restatement Firms 573 5,147.66 *** 1,262.62 0.00 290,594.86 18,358.09 Matched Firms 571 3,530.34 1,371.39 0.00 82,372.69 7,192.57Total Comp. Restatement Firms 576 6,830.19 ** 2,618.51 0.00 293,097.33 18,873.36 Matched Firms 571 5,065.41 2,892.81 0.00 83,660.71 7,743.58

Descriptive Statistics

Variable N Mean Median Minimum Maximum Std. Dev. Total Assets Restatement Firms 576 14,819,132 1,323,456 24,564 1,009,569,000 84,745,505 Matched Firms 576 13,587,631 1,262,718 20,630 1,484,101,000 84,874,022Sales Restatement Firms Unrestated 576 5,057,002 *** 990,010 *** 30,103 98,615,000 10,882,077 Restated 576 4,655,684 987,793 *** 16,816 97,666,000 10,281,315 Matched Firms 576 4,383,850 1,022,686 1,857 133,585,000 12,082,016Net Income Restatement Firms Unrestated 576 216,686 *** 35,668 ** -4,023,000 24,730,000 1,490,035 Restated 576 36,314 *** 23,683 ** -48,909,000 24,728,000 2,589,670 Matched Firms 575 303,042 49,591 -2,142,800 17,046,000 1,373,860CEO Age Restatement Firms 576 54.8 54 28 79 7.94 Matched Firms 549 54.73 55 34 82 7.97CEO Tenure Restatement Firms 576 4.61 4 1 17 3.17 Matched Firms 576 4.73 4 1 14 3.21Salary Restatement Firms 576 654.02 581.42 0 3,961.17 391.48 Matched Firms 576 639.7 600 0 3,000.00 338.87Bonus Restatement Firms 573 715.81 366.28 0 10,000.00 1,226.27 Matched Firms 576 763.29 351 0 31,000.00 1,793.59LTIP / Non-Equity Restatement Firms 573 378.26 *** 0 *** 0 29,254.41 191.58 Matched Firms 576 126.75 0 0 9,410.10 643.04

Restatement Firms 573 5,147.66 *** 1,262.62 0 290,594.86 18,358.09 Matched Firms 571 3,530.34 1,371.39 0 82,372.69 7,192.57Total Comp. Restatement Firms 576 6,830.19 ** 2,618.51 0 293,097.33 18,873.36 Matched Firms 571 5,065.41 2,892.81 0 83,660.71 7,743.58

Variable N Mean Median Minimum Maximum Std. Dev. Total Assets Restatement Firms 576 14,819,132 1,323,456 24,564 1,009,569,000 84,745,505 Matched Firms 576 13,587,631 1,262,718 20,630 1,484,101,000 84,874,022Sales Restatement Firms Unrestated 576 5,057,002 *** 990,010 *** 30,103 98,615,000 10,882,077 Restated 576 4,655,684 987,793 *** 16,816 97,666,000 10,281,315 Matched Firms 576 4,383,850 1,022,686 1,857 133,585,000 12,082,016Net Income Restatement Firms Unrestated 576 216,686 *** 35,668 ** -4,023,000 24,730,000 1,490,035 Restated 576 36,314 *** 23,683 ** -48,909,000 24,728,000 2,589,670 Matched Firms 575 303,042 49,591 -2,142,800 17,046,000 1,373,860CEO Age Restatement Firms 576 54.8 54 28 79 7.94 Matched Firms 549 54.73 55 34 82 7.97CEO Tenure Restatement Firms 576 4.61 4 1 17 3.17 Matched Firms 576 4.73 4 1 14 3.21Salary Restatement Firms 576 654.02 581.42 0 3,961.17 391.48 Matched Firms 576 639.7 600 0 3,000.00 338.87Bonus Restatement Firms 573 715.81 366.28 0 10,000.00 1,226.27 Matched Firms 576 763.29 351 0 31,000.00 1,793.59LTIP / Non-Equity Restatement Firms 573 378.26 *** 0 *** 0 29,254.41 191.58 Matched Firms 576 126.75 0 0 9,410.10 643.04

Restatement Firms 573 5,147.66 *** 1,262.62 0 290,594.86 18,358.09 Matched Firms 571 3,530.34 1,371.39 0 82,372.69 7,192.57Total Comp. Restatement Firms 576 6,830.19 ** 2,618.51 0 293,097.33 18,873.36 Matched Firms 571 5,065.41 2,892.81 0 83,660.71 7,743.58

Equity (stock and options)

Descriptive Statistics

Results

• Effectiveness of Dodd-Frank–Direct Gains (i.e. “Excess Incentive

Compensation”)

• Stock and Option Gains

• Probability of Termination

• CEOs are rewarded for positive performance and shielded from negative performance – Gaver and Gaver (1998)– Examine positive and negative performance variables separately

Cash Incentive = α + β1Log(Assets) + β2NI_Pos + β3NI_Neg + ε

Equity Incentive = α + β1Log(Assets) + β2Ret_Pos + β3Ret_Neg + ε

Direct Gains

Column Intercept Log(Assets) NI_Pos NI_Neg Ret_Pos Ret_Neg Fixed Effects Year Industry N R2

Cash Incentive (1) (2)

-2082.952 *** -2121.138 *** (-13.96) (-12.22) 183.126 *** 195.572 *** (16.28) (16.86)

0.365 *** 0.361 *** (8.32) (8.41) 0.292 *** 0.182 *** (3.84) (2.58)

No Yes No Yes

21,021 21,021 0.2048 0.3078

Equity Incentive (3) (4)

-7076.540 *** -8626.300 *** (-22.13) (-23.06) 569.140 *** 615.850 *** (24.51) (25.12)

57.470 ** 78.980 *** (2.41) (3.02)

-478.540 *** 26.670 (-5.84) (0.32)

No Yes No Yes

19,481 19,481 0.1462 0.2962

Column Intercept Log(Assets) NI_Pos NI_Neg Ret_Pos Ret_Neg Fixed Effects Year Industry N R2

Direct Gains• Dodd-Frank Section 954:

“in excess of what would have been paid to the executive officer under the accounting restatement”

• Direct Gain (i.e. “Excess Incentive Comp.”) = Unrestated Compensation – Restated Compensation

• Methodology: Apply regression coefficients to estimate “Unrestated” Compensation and “Restated” Compensation

– “Restated” stock returns based on what price would have been absent manipulation• Johnson et al. (2008) find stock prices drop 14.9% upon disclosure of fraud; • Desai et al. (2006); Palmrose (2004); Kedia and Philippon (2009) find 3-day market returns of -10%

to -11% upon restatement announcement;• Burk (2010) finds 1-day decline of 5.5%.• Lower Bound = 5%; Upper Bound = 15%

Direct Gains

• Methodology: Apply regression coefficients to estimate (1) “Unrestated” Compensation and (2) “Restated” Compensation

“Direct Cash Gain” = Cash-Based IncentiveUnrestated – Cash-Based IncentiveRestated α + β1Log(Assets) + [β2NIU_Pos + β3NIU_Neg] – [β2NIR_Pos + β3NIR_Neg] + ε

“Direct Equity Gain” = Equity-Based IncentiveUnrestated – Equity-Based IncentiveRestated α + β1Log(Assets) + [β2RetU_Pos + β3RetU_Neg] – [β2RetR_Pos + β3RetR_Neg] + ε

Variable N Mean Median Min Max Std. Dev.ΔNet Income 576 -180,370 *** -11,985 *** -52,997,000 215,000 2,329,513Direct Cash Gain 576 85.03 ** 2.24 *** 0 23,504.48 1,035.16Direct Equity Gain 576 67.98 *** 2.05 *** 0 3,028.46 236.07Total Direct Gain 576 153.02 *** 49.82 *** 0 23,504.48 1,057.46

Panel A: All Restatement Firm Years


Variable N Mean Median Min Max Std. Dev.ΔNet Income 93 -846,438 *** -7,209 *** -52,997,000 215,000 5,745,809Direct Cash Gain 93 389.8 4.29 0 23,504.48 2,548.33Direct Equity Gain 93 43.26 0 0 860.97 100.58Total Direct Gain 93 433.07 57.49 0 23,504.48 2,544.67

Panel B: Fraud Restatement Firm Years


• SOX Section 304: “any bonus or other incentive-based or equity-based compensation . . . and any profits realized from the sale of securities”

(1)

Gain

Firm-year observations 576 400 69.44% 93 16.15%Number of Firms 195 193 98.97% 32 16.41%Number of CEOs 245 228 93.06% 40 16.33%

Aggregate 88,135.29 64,674.32 73.38% 40,272.66 45.69% Mean (per CEO) 359.74 281.19 78.17% 164.05 45.60% Median (per CEO) 99.90 74.62 74.69% 96.34 96.43%

Indirect Gain Aggregate 4,386,021.30 0.00 0.00% 1,152,915.55 26.28% Mean (per CEO) 17,902.13 0.00 0.00% 4,705.78 26.28% Median (per CEO) 0.00 0.00 0.00% 35.54 ---

(2)Subject to Dodd-Frank Clawbacka

(3)Subject to SOX

Clawbackb

Direct Gain

Dodd-Frank Clawback

Results

• Effectiveness of Dodd-Frank–Excess Incentive Compensation

• Stock and Option Gains (Indirect Gains)



• Methodology: – Collect insider trading from Thomson Reuters

• Insider transactions for 217 firm-year observations: – 175 stock gains (98 CEOs)– 158 option gain (93 CEOs)

Stock Gain = (Price Paid – Basis) x Shares

Option Gain = (Market Price – Exercise Price) x Options


Panel A: ALL CEOs

Variable N Mean Median Min Max Std. Dev.Stock Gain 576 3,766.211 *** 0.000 *** 0.000 397,841.776 22,406.741 Per CEO 245 8,747.328 *** 0.000 *** 0.000 674,065.681 48,511.814Option Gain 576 3,848.410 *** 0.000 *** 0.000 322,263.805 21,083.007 Per CEO 245 8,938.241 *** 0.000 *** 0.000 504,853.812 45,172.799


Number Gain ($)Total Options 91,053,812 2,408,588,584 Expiring with 12 Months 33,821,189 37.14% 661,072,427 27.45% Newly Exercisable 3,627,108 3.98% 79,578,477 3.30%

(1)

Gain




(2)Subject to Dodd-Frank Clawbacka

(3)Subject to SOX

Clawbackb

(1)




Dodd-Frank Clawback

Dodd-Frank Clawback

Recovery Under Clawback Provisions Dodd-Frank Sarbanes Oxley $64.6 million $1.19 billion

of $4.4 billion Total Gains (Direct and Indirect)

Results

• Effectiveness of Dodd-Frank–Excess Incentive Compensation

• Stock and Option Gains


• Fired = α + β1Log(Assets) + β2Tenure + β3NI + β4Neg_NI + β5NI_Down + β6Loss2 + ε

• Fired = • Neg_NI =

• NI_Down =

• Loss2 =

1 if CEO fired (involuntary turnover) 0 otherwise (no turnover or voluntary)

1 if net income is negative0 otherwise

1 if net income decreased from prior year 0 otherwise

1 if net income is negative for prior two years 0 otherwise

Intercept -3.201 *** -3.294 *** -3.224 *** -3.384 ***(-10.21) -11.08 (-10.57) (-10.55)

Log_AT 0.077 *** 0.067 *** 0.059 *** 0.07 ***-4.41 -4.36 -3.74 -4.27

[0.003] [0.003] [0.002] [0.003]Tenure -0.002 0 -0.006 -0.005

(-0.36) (-0.07) (-0.93) (-0.75)[-0.000] [-0.000] [-0.000] [-0.000]

NI -0.143 *** -0.032 -0.015 -0.019(-3.15) (-0.96) (-0.44) (-0.55)

[-0.001] [-0.000] [-0.000] [-0.000]Neg_NI 0.528 *** 0.449 *** 0.37 ***

-10.16 -7.98 -5.85[0.031] [0.025] [0.019]

NI Down 0.227 *** 0.27 ***-4.66 -5.42

[0.010] [0.012]Loss2 0.267 ***

-3.43[0.014]

Year FE Yes Yes Yes YesInd. FE Yes Yes Yes YesN 20,029 20,029 18,815 17,507LR Chi2 71.65 176.17 191.93 195.69Prob> Chi2 0 0 0 0

Pseudo R2 0.0188 0.0462 0.0515 0.0558

Model 1

Intercept -3.201 *** -3.294 *** -3.224 *** -3.384 ***(-10.21) -11.08 (-10.57) (-10.55)

Log_AT 0.077 *** 0.067 *** 0.059 *** 0.07 ***-4.41 -4.36 -3.74 -4.27

[0.003] [0.003] [0.002] [0.003]Tenure -0.002 0 -0.006 -0.005

(-0.36) (-0.07) (-0.93) (-0.75)[-0.000] [-0.000] [-0.000] [-0.000]

NI -0.143 *** -0.032 -0.015 -0.019(-3.15) (-0.96) (-0.44) (-0.55)

[-0.001] [-0.000] [-0.000] [-0.000]Neg_NI 0.528 *** 0.449 *** 0.37 ***

-10.16 -7.98 -5.85[0.031] [0.025] [0.019]

NI Down 0.227 *** 0.27 ***-4.66 -5.42

[0.010] [0.012]Loss2 0.267 ***

-3.43[0.014]


Pseudo R2 0.0188 0.0462 0.0515 0.0558

Intercept -3.201 *** -3.294 *** -3.224 *** -3.384 ***(-10.21) -11.08 (-10.57) (-10.55)

Log_AT 0.077 *** 0.067 *** 0.059 *** 0.07 ***(4.41) (4.36) (3.74) (4.27)

[0.003] [0.003] [0.002] [0.003]Tenure -0.002 0 -0.006 -0.005

(-0.36) (-0.07) (-0.93) (-0.75)[-0.000] [-0.000] [-0.000] [-0.000]

NI -0.143 *** -0.032 -0.015 -0.019(-3.15) (-0.96) (-0.44) (-0.55)

[-0.001] [-0.000] [-0.000] [-0.000]Neg_NI 0.528 *** 0.449 *** 0.37 ***

(10.16) (7.98) (5.85)[0.031] [0.025] [0.019]

NI Down 0.227 *** 0.27 ***(4.66) (5.42)

[0.010] [0.012]Loss2 0.267 ***

(3.43)[0.014]

Year FE Yes Yes Yes YesInd. FE Yes Yes Yes YesN 20,029 20,029 18,815 17,507LR Chi2 71.65 176.17 191.93 195.69Prob> Chi2 0 0 0 0Pseudo R2 0.0188 0.0462 0.0515 0.0558

Intercept -3.201 *** -3.294 *** -3.224 *** -3.384 ***(-10.21) -11.08 (-10.57) (-10.55)

Log_AT 0.077 *** 0.067 *** 0.059 *** 0.07 ***(4.41) (4.36) (3.74) (4.27)

[0.003] [0.003] [0.002] [0.003]Tenure -0.002 0 -0.006 -0.005

(-0.36) (-0.07) (-0.93) (-0.75)[-0.000] [-0.000] [-0.000] [-0.000]

NI -0.143 *** -0.032 -0.015 -0.019(-3.15) (-0.96) (-0.44) (-0.55)

[-0.001] [-0.000] [-0.000] [-0.000]Neg_NI 0.528 *** 0.449 *** 0.37 ***

(10.16) (7.98) (5.85)[0.031] [0.025] [0.019]

NI Down 0.227 *** 0.27 ***(4.66) (5.42)

[0.010] [0.012]Loss2 0.267 ***

(3.43)[0.014]


Pseudo R2 0.0188 0.0462 0.0515 0.0558

Model 1 Model 2 Model 3 Model 4

ΔProb = ProbUnrestated – ProbRestated

ProbRestated

ΔProb < -12.763% “Termination Avoidance CEOs”

> 10% > 20% > 30% > 40% > 50% > 60% > 70% > 80%Number of CEOs 100 89 86 81 61 21 16 2Percent of Sample 17.73% 15.78% 15.25% 14.36% 10.82% 3.72% 2.84% 0.35%

Percent Decrease in Probability of Termination

Probability of Termination

• Gain from Delayed Termination: (ΔTerminationRisk for CEOk) x (CEOk Compt-1) x (Number of Years)

– Average gain of $22.47 million (per CEO)– Aggregate gain of $1.55 billion (aggregate)

Variable N Mean Median Min Max Std. Dev.Δ Net Income 191 -490,285.87 ** -18,780 *** -52,997,000 215,000 4,024,320.09Direct Gain 191 305.91 ** 55.85 *** 0.00 23,504.48 1,802.20Indirect Gain Stock Gain 191 8,105.29 *** 0 *** 0.00 397,841.77 38,009.54 Option Gain 191 9,382.29 *** 0 *** 0.00 322,263.81 35,414.68Total Gains 191 17,792.96 *** 94.12 *** 0.00 572,261.07 64,683.49

Variable N Mean Median Min Max Std. Dev.Δ Net Income 169 -28,765.82 *** -4,088 *** -632,631 26,072 86,455.52Direct Gain 169 68.81 *** 42.22 *** 0.00 893.12 126.21Indirect Gain Stock Gain 169 2,028.29 *** 0.00 *** 0.00 41,260.03 5,768.91 Option Gain 169 1,380.30 *** 0.00 *** 0.00 65,617.82 5,852.13Total Gains 169 3,477.40 *** 79.22 *** 0.00 76,416.40 9,504.08

Variable N Mean Median Min Max Std. Dev.Δ Net Income 216 -24,943.54 -1,922.50 *** -3,818,000 55,436 259,990.84Direct Gain 216 83.7 *** 13.37 *** 0.00 3028.79 276.99Indirect Gain Stock Gain 216 1,289.11 *** 0.00 *** 0.00 30,754.91 3,836.72 Option Gain 216 886.09 *** 0.00 *** 0.00 34,063.51 3,581.57Total Gains 216 2,258.90 *** 82.75 *** 0.00 67,847.21 6,904.05

Panel A: S&P 500 Firms

Panel B: S&P Mid-Cap 400 Firms

Panel C: S&P Small-Cap 600 Firms

Robustness

Panel A: S&P 500 Firms

Firm-year observations 133 69.63% 44 23.04%Number of Firms 59 98.33% 14 23.33%Number of CEOs 74 91.36% 21 25.93%

Aggregate 47,836.31 81.87% 38,034.88 65.10% Mean (per CEO) 646.44 90.72% 199.14 27.95% Median (per CEO) 97.56 72.68% 89.09 66.37%

Panel B: S&P Mid-Cap 400


Aggregate 6,796.48 58.46% 1441.51 12.40% Mean (per CEO) 101.44 61.06% 8.53 5.13% Median (per CEO) 74.13 71.43% 7.25 6.99%

Panel C: S&P Small-Cap 600


Aggregate 10,041.53 55.54% 796.27 4.40% Mean (per CEO) 112.83 59.28% 3.69 1.94% Median (per CEO) 64.7 78.98% 23.83 35.19%

190.3281.92

(1)

Total Gain

(2)Subject to Dodd-Frank Clawback

Direct Gain18,079.65

2167695

Subject to Dodd-Frank Clawback

Total Gain Subject to SOX Clawback

103.78


166.13

69

16959

Total Gain Subject to Dodd-Frank Clawback

Subject to SOX Clawback

712.54134.24


1916081

(3)Subject to SOX

Clawback

Robustness

• Post-Dodd-Frank Period• NEED TO ADD NOTES

Conclusion• Problem: CEOs inflate earnings for personal gain

– Average CEO increases wealth by $18 million as a result of misreporting. – Only a small portion of Total Gains subject to clawback– A large portion of CEOs are able to avoid or delay termination by

misreporting

• Purpose of Section 954: To hold executives accountable by removing incentive to manipulate

• Limitations: does not require recovery profits from the sale of stock and option exercises

Conclusion• Result: Dodd-Frank has broad reach but limited

application. – Potential to recover something from 93% of CEOs– Potential to recover 73% of Direct Gains – Does not reach Indirect Gains – Limited recovery of less than 1% of Total Gains

• Effectiveness: – Depends on how vigorously boards willing to purse executives.

• Personal and professional relationships• Cost of litigation > Amount recoverable

Clawing Back Executive Compensation

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