The Mitigating Effect of Audit Committee Financial Expertise on the Voluntary Adoption of Clawback Policies

Yan Zhang and Nan Zhou

Journal of Law, Finance, and Accounting, 2018, vol. 3, issue 1, 85-114

Abstract: Reflecting a directive in the Dodd-Frank Act, Proposed Rule 10D-1 issued by the SEC requires public firms to have a clawback policy that can be triggered by any accounting restatement, regardless of fault. Many companies argue that the proposed rules could harm executives with no knowledge of accounting errors. To shed light on this debate, we examine the association between financial expertise on audit committees and the voluntary adoption of clawback policies in the pre-Dodd-Frank period, separating audit committee financial expertise into accounting and non-accounting and classifying clawbacks into fraud-based and non-fraud based. Although firms with a restatement history are more likely to adopt fraudbased clawbacks, we find that audit committee financial expertise can mitigate the effect of restatement on the voluntary adoption of clawback policies. Accounting experts are more in favor of adopting fraud-based clawbacks when they are not associated with any previous accounting scandals, whereas both accounting experts and non-accounting financial experts are against adopting fraudbased clawbacks when they could be implicated by prior financial frauds. Thus, the mandatory clawback provisions under SEC Proposed Rule 10D-1 can improve the social welfare of firms with a restatement history by eliminating the mitigating effect of audit committee financial expertise on the adoption of clawback policies.

Date: 2018
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