Clawback provisions and insider trading profits 

By | January 23, 2024

The issue of agency conflicts between shareholders and managers remains a prominent challenge. This struggle often manifests through rent extraction, where managers exploit opportunities for excess pay or insider trading profits. Scholars have explored various mechanisms to mitigate these conflicts, with one notable approach being the implementation of clawback provisions. This post delves into the intricate relationship between clawback provisions, financial misreporting, and insider trading profits, shedding light on their impact and the underlying mechanisms at play. 

Understanding Clawback Provisions 

Clawback provisions serve as a tool for companies to counteract financial misreporting. By allowing the recovery of excess bonuses and equity grants in the event of restatements, these provisions aim to enhance financial reporting quality and transparency. Previous studies have indicated that clawback provisions generally improve financial reporting quality and act as a deterrent to pay-related agency conflicts. However, questions linger about their effectiveness in curbing insider trading profits linked to financial misreporting. 

The Transparency and Substitution Channels 

We posit that clawback provisions influence insider trading profits through two distinct channels: the transparency channel and the substitution channel. The transparency channel operates on the premise that enhanced financial reporting quality and transparency after the adoption of clawback provisions limit profitable insider trades based on private information. Conversely, the substitution channel suggests that since clawback provisions do not necessarily recover insider trading profits, managers might turn to insider trading as an alternative source of compensation. 

Methodology and Analysis 

To explore these channels, our study analyzes the effects of clawback provisions on insider trading profits over a propensity score-matched sample. Employing a propensity score matching method, we reduce biases related to various factors, including governance structure, managerial incentives, and financial reporting quality, that may influence both clawback provision adoptions and insider trading profits.  

Key Findings 

Our findings indicate a nuanced impact of clawback provisions on insider trading profits, with a notable decrease in profits from insider sales. We also find evidence suggesting that clawback provisions are more effective in curbing insider trading profits when they are adopted to improve financial reporting quality, rather than when such provisions merely signal already high financial reporting quality. Moreover, our analysis reveals that the effects of clawback provisions on insider trading profits are more prominent in firms that provide managers with additional explicit pay to compensate for the increased compensation risk imposed by clawback provisions, mitigating managers’ need to pursue insider trading profits as an alternative source of compensation. Collectively, these results support the transparency channel through which clawback provisions reduce insider trading profits by enhancing financial reporting quality.  

Contributions and Implications 

Our study contributes valuable insights to the related literatures in two key aspects. First, our study provides new evidence that clawback provisions can reduce insider trading profits by enhancing financial reporting quality, even though insider trading profits based on financial misreporting are generally beyond the scope of clawback provisions. Second, this study provides evidence that an ex-post settling up mechanism, aimed at recovering excess compensation based on financial misreporting, is more effective in mitigating rent extraction from insider trading when firms increase total explicit pay to compensate insiders for the increased compensation risk imposed by the mechanism.   

The recent decision by the U.S. Securities and Exchange Commission (SEC) to mandate all companies listed on the U.S. stock exchanges to establish listing standards that require listed companies to adopt clawback provisions triggered by accounting restatements underscores the heightened relevance of our study. Our findings align closely with this current regulatory movement, offering additional evidence that clawback provisions effectively curb financial misreporting and informed trading by insiders. This post serves as a timely guide, navigating the terrain where corporate governance, compensation contracts, and insider trading intersect. 

Jeong Hwan Joo is an Associate Professor at the Ulsan National Institute of Science and Technology.  

Hangsoo Kyung is an Assistant Professor at the Hong Kong Polytechnic University.   


This post was adapted from their paper, “Clawback Provisions and Insider Trading Profits,” available on SSRN.  


One thought on “Clawback provisions and insider trading profits 

  1. jmecheria

    How do clawback provisions serve as a mechanism to address agency conflicts between shareholders and managers, particularly in the context of financial misreporting and insider trading? Furthermore, how does the study’s analysis shed light on the effectiveness of clawback provisions in reducing insider trading profits, and what implications does this have for corporate governance and regulatory frameworks, especially in light of recent mandates by regulatory bodies such as the U.S. Securities and Exchange Commission (SEC)?


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