The Effects of Clawbacks on Auditors’ Propensity to Propose Restatements and Risk Assessments
- 53 Downloads
Both the Sarbanes–Oxley Act of 2002 and the Dodd-Frank Act of 2010 include clawback provisions that require executives to pay back incentive compensation earned on financial statements that are restated in a subsequent period. Such provisions intend to reduce unethical reporting behavior by executives who otherwise might be more inclined to misstate financial statements to boost incentive-based compensation. However, such provisions could promote rather than deter unethical behavior. In particular, Pyzoha (Account Rev 90(6):2515–2536, 2015) finds that, under certain conditions, executives are less willing to restate financial statements in the presence of a clawback policy. Similarly, auditors might also act unethically by being less likely to propose restatements in the presence of clawbacks to avoid upsetting management. To examine this possibility, this study reports the results of three experiments that examine the effect of clawback provisions on auditor judgment. Contrary to expectations, our three experiments, along with supplemental qualitative evidence (surveys and interviews of practicing auditors) consistently indicate that clawbacks do not affect auditors’ propensity to propose restatements. These results suggest that a decrease in the number of restatements in a clawback environment will not be due to auditors acting unethically to appease management. The effects of clawbacks on auditors’ risk assessments, however, are less conclusive. As such, we offer potential post hoc explanations to guide future research.
KeywordsClawback SOX Dodd-Frank Auditing Restatements Independence
We thank the auditors who participated in the study and interviews, our expert panel, Regan Schmidt (discussant), three anonymous reviewers, and attendees at the University of Waterloo’s 3rd Biennial Symposium on Accounting Ethics, for their constructive feedback, and Miami University for financial support.
Compliance with Ethical Standards
All procedures performed in studies involving human participants were in accordance with the ethical standards of the institutional and/or national research committee and with the 1964 Declaration of Helsinki and its later amendments or comparable ethical standards.
Informed consent was obtained from all individual participants included in the study.
- Arens, A., Elder, R., Beasley, M., & Hogan, C. (2017). Auditing and assurance services: An integrated approach (16th ed.). London: Pearson.Google Scholar
- Bazerman, M., Morgan, K., & Loewenstein, G. (1997). The impossibility of auditor independence (pp. 89–94). Summer: Sloan Management Review.Google Scholar
- Buckless, F. R., & Ravenscroft, S. P. (1990). Contrast coding: A refinement of ANOVA in behavioral analysis. The Accounting Review, 65, 933–945.Google Scholar
- Cohen, J., Gaynor, L., Montague, M., & Wayne, J. (2017). The effect of framing on information search and information evaluation in auditors’ fair value judgments. Working paper, Boston College, University of South Florida, and Wake Forrest University.Google Scholar
- Equilar. (2016). Compensation and Governance Outlook 2016: Shareholder Engagement drives changes to proxy disclosures. Redwood City, CA: Equilar Inc.Google Scholar
- Financial Accounting Standards Board (FASB). (2005). Accounting Changes and Error Corrections. Statement of Financial Accounting Standards No. 154. Norwalk, CT: FASB.Google Scholar
- Guggenmos, R. D., Piercey, M. D., & Agoglia, C. P. (2018). Custom contrast testing: Current trends and a new approach. Forthcoming—The Accounting Review. Google Scholar
- Hackenbrack, K., & Nelson, M. (1996). Auditors’ incentives and their application of financial accounting standards. The Accounting Review, 71(1), 43–59.Google Scholar
- Lindsay, R. M., & Ehrenberg, A. S. C. (1993). The design of replicated studies. The American Statistician, 47(August), 217–228.Google Scholar
- Messier, W. F., & Quilliam, W. C. (1992). The effect of accountability on judgment: Development of hypotheses for auditing. Auditing, 11(Supplement), 123–138.Google Scholar
- Pratt, J., & Stice, J. (1994). The effects of client characteristics on auditor litigation risk judgments, required audit evidence, and recommended audit fees. The Accounting Review, 69(4), 639–656.Google Scholar
- Public Company Accounting Oversight Board (PCAOB). (2010). PCAOB Release No. 2010-004. Audit Risk. Auditing Standard No. 8. Washington, DC: PCAOB.Google Scholar
- Pyzoha, J. S., & Jenkins, J. G. (2016) Clawback to the future: A guide to preparing for SEC clawback rules. Working paper, Miami University and Virginia Tech.Google Scholar
- Pyzoha, J. S., Taylor, M. H., & Wu, Y. (2017). Can auditors pursue firm-level goals nonconsciously on audits of complex estimates? An examination of the joint effects of tone-at-the-top messaging and management’s specialist. Working paper, Miami University, Case Western Reserve University, and Texas Tech University.Google Scholar
- Reffett, A., Ballou, B., Heitger, D., & Heitger, L. (2017) An experimental examination of experienced and inexperienced auditors’ reporting decisions versus initial judgments for management estimates. Working paper, Miami University and Missouri State University.Google Scholar
- Rosenthal, R. (1976). Experimenter effects in behavioral research (2nd ed.). New York, NY: Wiley.Google Scholar
- Securities and Exchange Commission (SEC). (2010). An insider’s view of the SEC: Principles to guide reform. October 18. Speech, US Securities and Exchange Commission, Berkeley.Google Scholar
- Securities and Exchange Commission (SEC). (2011a). SEC obtains settlement with CEO to recover compensation and stock profits he received during company’s fraud. (March 3). Washington, DC: SEC. https://www.sec.gov/news/press/2011/2011-61.htm.
- Securities and Exchange Commission (SEC). (2011b). Former CEO to Return $2.8 million in bonuses and stock profits received during CSK auto accounting fraud. (November 15). Washington, DC: SEC. https://www.sec.gov/news/press/2011/2011-243.htm.
- Securities and Exchange Commission (SEC). (2015a). SEC charges CSC and former executives with accounting fraud. (June 5). Washington, DC: SEC. https://www.sec.gov/news/pressrelease/2015-111.html.
- Securities and Exchange Commission (SEC). (2015b). SEC proposes rules requiring companies to adopt clawback policies on executive compensation. (July 1). Washington, DC: SEC. https://www.sec.gov/news/pressrelease/2015-136.html.
- Stice, J. (1991). Using financial and market information to identify pre-engagement factors associated with lawsuits against auditors. The Accounting Review, 66, 516–553.Google Scholar
- Trompeter, G. (1994). The effect of partner compensation schemes and generally accepted accounting principles on audit partner judgment. Auditing: A Journal of Practice and Theory, 13(2), 56–68.Google Scholar
- U.S. House of Representatives. (2002). The Sarbanes-Oxley Act. Public Law 107-204 [H.R. 3763]. Washington, DC: Government Printing Office.Google Scholar
- U.S. House of Representatives. (2010). The Dodd-Frank Wall Street Reform and Consumer Protection Act. Public Law 111-203 [H.R. 4173]. Washington, DC: Government Printing Office.Google Scholar
- White, R. A. (1977). The influence of the experimenter motivation, attitudes and methods of handling subjects in psi test results. In B. B. Wolman (Ed.), Handbook of parapsychology (pp. 273–304). New York, NY: Van Nostrand Reinhold.Google Scholar