How Board Monitoring and Mandated Clawbacks Shape Managers' Use of Discretion: Experimental Evidence

We use an experimental setting to examine how an internal governance mechanism-board monitoring- moderates managers' use of discretion in response to a regulatory governance mechanism-mandated clawbacks. Our study addresses a significant gap in the literature that has largely examined the effects of different governance mechanisms in isolation. We predict and find that mandated clawbacks increase managers' tendency to use operational discretion (relative to accounting discretion) when board monitoring is weak, but not when board monitoring is strong. Our results have important policy implications by demonstrating that a firm's internal environment may be more effective than rules in curtailing manager's opportunistic use of discretion.