Clawback provisions and insider trading profits

Mitigating managerial rent extraction in the form of excess pay and insider trading profits based on financial misreporting is an important governance issue. Clawback provisions allow companies to recover excess pay related to misreported earnings when accounting restatements occur in subsequent periods. We examine whether clawback provisions effectively restrict insider trading profits through improved financial reporting quality. Our finding is that insider trading profits decrease after clawback adoption, and this effect is more prominent when clawback provisions are adopted to improve rather than signal already high levels of financial reporting quality. Moreover, we find that offering managers additional explicit pay to compensate for the increased compensation risk imposed by clawback provisions enhances the effectiveness of these provisions in curbing insider trading profits. Overall, our findings support the efficacy of clawback provisions in mitigating rent extraction through insider trading.