Multiperiod managerial contracts with clawback provisions

Considering the trade-off between reporting accuracy and production efficiency, in this paper, I study the impacts of clawback provisions where, within the clawbacks, if the long-term reported earnings do not meet the predetermined earnings threshold, the manager cannot earn his/her long-term compensation. He/she will only receive the fixed compensation and needs to return the portion of his/her period-one performance-based compensation over the recouped compensation threshold when the first-period reported earnings are higher than the recouped compensation threshold. Within a principal-agent model, this paper shows that first, depending on the level of realized earnings in period one, mandatory adoption of such clawbacks motivates a risk-averse manager to use an enriched reporting strategy menu. Second, adopting the clawbacks will induce the manager to engage in lower or higher short-term effort but lower long-term effort relative to the case without clawbacks. However, a higher recouped compensation threshold will motivate the risk-averse manager to a higher short-term effort. Then, to recalibrate the manager’s effort incentives to be the same as in the case of no clawbacks but restrain his/her misreporting incentives, this study shows that a firm should grant a risk-averse manager a lower short-term fixed pay level but a higher long-term pay level relative to the case without clawbacks. Besides, the performance pay rates for the two periods must be sufficiently different in order to control the manager’s misreporting incentives. Finally, this paper discusses the empirical implications of the results and provides the policy implications regarding the efficiency of meeting or beating earnings thresholds when managerial contracts contain clawback provisions.