CLAWBACK PROVISIONS IN REAL ESTATE INVESTMENT TRUSTS
Author | George D. Cashman,Christine A. Panasian,David M. Harrison |
Published date | 01 March 2016 |
DOI | http://doi.org/10.1111/jfir.12090 |
Date | 01 March 2016 |
CLAWBACK PROVISIONS IN REAL ESTATE INVESTMENT TRUSTS
George D. Cashman
Marquette University
David M. Harrison
University of Central Florida
Christine A. Panasian
Saint Mary’s University
Abstract
Using a sample of 195 unique real estate investment trusts (REITs), we examine factors
related to the adoption of clawback provisions within managerial compensation
contracts. In general, we find strong and consistent empirical evidence that clawback
provision are directly related to firm size, complexity, leverage, growth options,
monitoring incentives, and CEO performance incentives. We also find that clawbacks
are associated with enhanced market and accounting performance, with stronger
performance relations observed for adoption decisions tied directly to regulatory
mandates. In sum, we conclude compensation clawback provisions represent a value-
relevant, strategic governance mechanism for REITs.
JEL Classification: G00, G30, G34
I. Introduction
During the 1990s, a string of high-profile accounting scandals brought renewed attention
to the potential agency conflicts corporate managers face with respect to disclosing a
firm’s true financial position. This conflict arises because investors are primarily
concerned with long-run wealth maximization, whereas managers frequently focus on
short-term performance (Shleifer and Vishny 1988). This misalignment is often
exacerbated by performance incentives included in managerial compensation contracts.
To the extent managers engage in nefarious business or accounting practices to meet
short-run performance benchmarks, seemingly well-intentioned compensation plans
may actually be self-defeating.
1
We thank Drew Winters, the editor, and an anonymous referee for valuable comments and suggestions
throughout the review process. In addition, we thank Nga Nguyen, Nga Trinh, and Kyle Allenfor valuable research
assistance. Any remaining errors are, as always, our own.
1
For example, consider a privately informed CEO of a firm that is preparing a capital offering. If the CEO
discloses negative information, the offering will be more difficult to complete and/or the cost of capital will
increase. But if the CEO conceals this information, the offering is more likely to succeed and lower the firm’s short-
run financing costs. However, once the obfuscation is eventually discovered the firm is likely to lose trust,
credibility, and goodwill in the marketplace. Ultimately, such actions are likely to hinder or prevent the firm from
being able to raise capital on attractive terms (if at all) in the future.
The Journal of Financial Research Vol. XXXIX, No. 1 Pages 87–114 Spring 2016
87
© 2016 The Southern Finance Association and the Southwestern Finance Association
RAWLS COLLEGE OF BUSINESS, TEXAS TECH UNIVERSITY
PUBLISHED FOR THE SOUTHERN AND SOUTHWESTERN
FINANCE ASSOCIATIONS BY WILEY-BLACKWELL PUBLISHING
One contracting mechanism designed to mitigate the short-term focus of
managers is the compensation clawback provision. Such provisions allow the firm, or a
related third party, to recapture a portion of executive compensation in the event ethical
misconduct (such as financial misrepresentation, which results in the restatement of
company financials) is subsequently discovered. Although such provisions have
technically been around for decades, if not centuries, their widespread use and adoption
in U.S. financial markets is a relatively recent phenomenon.
2
Notably, Equilar (2012)
reports that the adoption of clawback provisions among Fortune 100 firms has grown
from less than 20% of firms in 2006 to over 80% of firms by year-end 2010.
This dramatic growth in the use of clawbacks is driven, in large part, by two
major pieces of recent financial legislation that contain explicit provisions regarding the
use of clawbacks. First, Section 304 of the Sarbanes–Oxley Act of 2002 (SOX) stipulates
that both the chief executive officers (CEOs) and chief financial officers (CFOs) of
issuing firms are subject to clawbacks of both equity- and incentive-based compensation,
as well as trading profits, in the event of financial restatements resulting from misconduct
and material noncompliance with existing securities laws. Second, Section 954 of the
Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd–Frank)
dramatically expands the scope of such clawbacks by extending the number of
executives subject to clawbacks from simply the CEO and CFO to all current and former
executive officers. It also expands the relevant time frame for recapturing “erroneously
awarded compensation”from 12 months (under SOX) to 36 months. Additionally, unlike
the widely criticized SOX Section 304 provisions, which lack an unambiguous
enforcement mechanism, Dodd–Frank Section 954 clearly stipulates that firms failing to
adopt or comply with such clawback or recapture provisions will be prohibited from
listing their shares on any national securities exchange.
3
As such, the majority of publicly
traded firms have a direct financial incentive to comply with these mandates.
Furthermore, these incentives would appear to be particularly strong for real
estate investment trusts (REITs) and the markets in which they raise capital. Specifically,
REITs are subject to unique regulations that limit their ability to retain earnings while
ensuring disperse ownership. Unique regulations combined with an operating
environment in which firms regularly employ substantial leverage, exhibit entrenched
managerial teams, and pursue large-scale, irreversible investment projects suggests that
the credibility of firm disclosures would be of unique and utmost importance within this
market sector.
Given the potential importance of these new regulations to both executive
compensation and firm disclosure policies, the purpose of the current article is to
examine: (1) what factors lead to the adoption of a clawback provision and (2) how the
market responds to the presence of a clawback provision. In line with the aforementioned
arguments highlighting the importance of such provisions within REIT markets, we
conduct our analyses within this industry.
2
See, for example, Fisk (2001) and Babenko et al. (2015) for additional discussion and analysis of the history
and background of clawback provisions.
3
Although passed and signed into law on July 21, 2010, final implementation rules for many provisions of
Dodd–Frank are still pending.
88 The Journal of Financial Research
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