Ex Post Settling Up of Financial Misreporting and CEO Compensation

Yuyeon Ahn, Soong Soo Han, Jeong Hwan Joo and Taejin Kim

Journal of Business Finance & Accounting, 2025, vol. 52, issue 5, 2335-2362

Abstract: In the early years of their terms of service, CEOs tend to face greater concerns about their careers and uncertainties regarding their abilities, leading them to inflate earnings in an attempt to influence their perceived abilities. We find that financial misreporting decreases to a greater extent after firms with shorter tenured CEOs adopt clawback provisions, which allows boards to recoup excess compensation based on misstated earnings. Moreover, following the adoption of clawback provisions by firms with shorter tenured CEOs, the sensitivity of CEO annual pay to poor accounting performance diminishes, along with a reduced sensitivity of CEO equity portfolio to stock returns and an increased sensitivity to stock return volatility. Our evidence suggests that clawback provisions are particularly effective in curbing financial misreporting among CEOs who face greater career concerns and ability uncertainties. In response, boards adjust the compensation contracts of these CEOs to mitigate the incremental compensation risk imposed by the adoption of clawback provisions.

Date: 2025
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