Monthly Archives: January 2020

January 2, 2020

Clawbacks: Turning Restatements Into a Rare Species?

John blogged a few months ago that 70% of restatements are now “Little r” revisions, according to data from Audit Analytics. This WSJ article reports on a couple of studies that analyze the potential connection between the presence of clawback provisions & performance awards, on the one hand, and management’s discretion to “restate” versus “revise” financials, on the other. Here’s an excerpt (also see earlier work from Francine McKenna, which the study cites, and CLS “Blue Sky” blog):

A study by Ms. Thompson found that almost half—45%—of Little r revisions from August 2004 through 2015 that she analyzed met at least one of the guidelines for them to be considered Big R restatements.

Her research points to one potential motivation: “clawbacks” that allow companies to recoup compensation from executives in the event of a Big R restatement. Companies with such clawbacks were more than twice as likely as others to use revisions for potentially material errors, her analysis found.

Although the article tries to also draw a link between “Little r” revisions and performance awards, the data doesn’t directly connect declines in performance award metrics like EPS to a company’s decision to carry out a “Big R” restatement versus a “Little r” revision. The article points out that in at least one situation, Corp Fin was deferential to a company’s decision to correct an accounting error via a revision even though the error had flipped one quarter’s earnings per share from negative to positive and the company used an annual EPS metric in its long-term incentive plan.

Also see this article suggesting that executives who are subject to clawback policies are more likely to push for tax savings – e.g. through use of tax havens. It wouldn’t seem there’s much downside to that for shareholders, but for companies that follow GRI Sustainability Reporting Standards, it’s relevant to know that GRI is recently announced a new “tax disclosure standard” to promote transparency of tax practices that could impact funding of government services & sustainability initiatives.

Corporate Governance Ratings: Internal Audit Enters The Game

Recently, the Institute of Internal Auditors announced a new “corporate governance index” that annually rates listed companies – based on surveys of Chief Audit Execs. Here are the results of the inaugural review.

While I’m not sure I can get behind the claim that this is “the first to truly probe – and grade – core actions and responsibilities that are crucial to successful, ethical, and sustainable organizational practices among American businesses,” it’s somewhat unique in highlighting auditors’ views (see page 7 for a take on that group’s role in corporate governance). Since my mom spent most of her career as an internal auditor, I can attest that these folks often have different perspectives & opinions than those of us on the legal side.

But don’t take my word for it! This note accompanies the finding that companies are vulnerable to corporate governance weaknesses because they have no formal monitoring or evaluation mechanism (which incidentally is the category of “worst performance”):

CAEs also reported that, if the evaluation is not conducted by internal audit, it is most often done by the general counsel’s office or under the direction of the nominating/governance committee, at which point it is more likely to be a compliance “check-the-box” exercise relative to listing exchange requirements and other laws and regulations.

Anyway, the surveyed companies averaged a “C+” grade and the report is pretty emphatic that there’s room for improvement (with all due respect to my auditor friends, if there’s anyone more “glass half empty” than us lawyers, my money is on CAEs). The grading is based on eight “Guiding Principles of Corporate Governance” – and helpfully, you can see the actual survey questions and the overall grade that each question generated. Here’s a finding that we can probably all agree is troubling:

When presented with specific scenarios in which the CEO wants to delay reporting negative news, respondents believed that only 64% of board members at their company would push back on the CEO, meaning more than one-third (36%) of board members would not. Similarly, CAEs gave a D (67) to the issue that board members should be asking whether information presented to them is accurate and complete.

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Liz Dunshee