Curbing Earnings Management : Experimental Evidence on How Clawback Provisions and Board Monitoring Affect Managers’ Use of Discretion

We examine how clawback provisions and board monitoring affect managers' use of discretion to achieve earnings targets. Using an experiment, we find that when board monitoring is weak, imposing clawback provisions has little impact on the total amount of earnings management activity. This null result arises because, while clawbacks do curb the extent to which managers make accrual estimates in line with their own preferences (accrual earnings management), these provisions also increase managers' use of discretion when making operational decisions (real earnings management). In contrast, strong board monitoring results in less of both types of earnings management. Our results have important policy implications by demonstrating that, because of the ability to substitute accrual earnings management with real earnings management, mandated clawbacks (in the absence of strong board monitoring) alter how managers use their discretion, whereas strong board monitoring alters how much discretion managers are willing to use