the final rules. To ensure that issuers have a recovery policy that
meets the final rule requirements, issuers will likely incur legal and
consulting fees to develop or revise recovery policies, and to modify
the compensation packages of executive officers to conform to those
policies. We expect that these costs may decrease over time, after
initial development.
    We have received several comment letters describing direct
implementation costs. For example, several commenters have noted that
even those issuers that already have recovery policies would likely
incur some costs to revise those policies to comply with the final rule
requirements.\429\ One commenter indicated that issuers will likely
incur significant costs including legal fees and litigation risks
because they will need to revise existing policies.\430\ Another
commenter indicated that existing recovery plans include restrictions
that may prohibit or restrict amendments to those plans, and noted that
plan participants, particularly those no longer employed by the issuer,
may not consent to an amendment that results in significant economic
costs to themselves.\431\ We acknowledge that

issuers will incur direct implementation costs, and recognize that even
those issuers that have implemented recovery provisions will likely
incur costs to revise them and those costs will likely be higher for
issuers that have implemented recovery plans with restrictions that
prohibit or restrict amendments to those plans. We expect that these
costs will vary with the complexity of the compensation practices of
the issuer as well as the number of executive officers the recovery
policy will apply to, and may be initially substantial in a number of
cases. However, as stated above, we expect once issuers adopt a
recovery policy or revise their existing recovery policy, these costs
may decrease over time. We also note that issuers will have additional
time between adoption of these rules and exchange listing standards
implementing the rules to amend any contracts to accommodate recovery.
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    \429\ See, e.g., comment letter from CEC (noting that the rules
would impose additional implementation costs and require issuers to
adjust their policies); Davis Polk 3 (noting that issuers will incur
compliance costs associated with formulating recovery policies and
modifying them over time); and Pay Governance (noting that the new
rules will require substantive changes to many existing compensation
recovery policies). See also comment letter from FedEx Corporation
(Nov. 22, 2021) (noting that publicly traded corporations that
adopted compensation recovery provisions based on the proposed rule
issued in 2015 would incur implementation costs to adapt to the
expanded scope of the final rule).
    \430\ See comment letter from Bishop (stating that issuers that
have adopted recoupment policies specifying the ``3-year period
preceding the date on which the issuer is required to prepare an
accounting restatement'' will likely incur significant costs, such
as legal fees and litigation risks because the rule specifies
``three completed fiscal years immediately preceding the date the
issuer is required to prepare an accounting restatement'').
    \431\ See comment letter from SCG 1.
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2. Effects on U.S. Exchanges and Listings
    Rule 10D-1 would affect U.S. exchanges by requiring them to adopt
listing standards that prohibit the initial or continued listing of an
issuer that does not comply with the final rules. The requirement
places a direct burden on exchanges to amend applicable listing
standards. This burden could involve deploying legal and regulatory
personnel to develop listing standards that comply with the rule
requirements. Moreover, the exchanges are likely to incur some costs
associated with tracking the compliance of each issuer. We anticipate
these costs to be small as exchanges likely already have robust
compliance tracking systems and personnel that are dedicated to
ensuring listing standards are met.\432\ Finally, if an issuer chooses
not to implement a recovery policy or does not take action when
required under its recovery policy, the exchanges would incur costs to
enforce the listing standards required by the final rules and delist
the issuer for noncompliance. This would also result in a loss of the
revenue from listing if the issuer were ultimately delisted.\433\
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    \432\ See comment letter from NYSE, supporting the approach to
delisting in the Proposing Release, and describing the existing
functions of exchange personnel.
    \433\ If an issuer chooses to delist or is delisted by the
exchange or association, the issuer's securities may become less
liquid in the U.S. market, and the issuer's share price may be
negatively affected. For issuers that fail to adopt or implement a
recovery policy, delisting under the rule would be expected to
increase the issuer's cost of capital. We also note that other
factors may affect the decision for an issuer to delist and any
effect from the final rules would be incremental to these other
factors.
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    One commenter specifically requested an economic analysis
addressing whether the rule will create conditions that will lead to a
decrease in the number of U.S. public companies.\434\ While we
recognize that the rules are associated with costs for listed issuers,
we also recognize and describe the benefits for listed issuers
associated with the rules. In light of the significant uncertainty
regarding the net effects for issuers, it is unclear whether the net
effects of the rules would lead to a decrease in the number of issuers
listed on U.S. exchanges.
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    \434\ See comment letters from CCMC (noting that the number of
public companies has steadily declined to the point that it is half
what it was in 1996, and that a similar rate of decline in the
number of IPOs occurred concurrently, while the same period
experienced the explosion of the size of the proxy and emergence of
disclosure overload issues). See also comment letter from NACD
(noting that the rule might have a dampening effect on the market
for public companies themselves if it and other rules like it
influence private companies to remain private or push public
companies to go private).
---------------------------------------------------------------------------

    In the event that issuers alter their decisions regarding where to
list due to the final rules, revenue of U.S. exchanges may be affected.
For example, there could be revenue effects for U.S. exchanges if
issuers choose to list their securities on a foreign exchange without
such a compensation recovery policy requirement. More generally, if the
mandated listing requirements are perceived to be particularly
burdensome for listed issuers, this could adversely impact the
competitive position of U.S. exchanges vis-[agrave]-vis those foreign
exchanges that do not enforce similar listing standards. However, given
the costs associated with transferring a listing and the broad
applicability of the final rule to securities listed on U.S. exchanges,
we do not believe it is likely that the final rule requirements would
compel a typical issuer in the short-term to find a new trading venue
not subject to these requirements.\435\ The final rules may result in a
loss of potential revenue to exchanges to the extent that issuers, who
would have decided to list on an exchange in the absence of the final
rule requirements, choose to forgo listing or delay listing until the
issuers' circumstances change.\436\ The magnitude of this effect on
exchanges and issuers is not quantifiable given the absence of data. It
could be significant because the loss in potential revenue from the
total number of issuers that have chosen to forgo or delay listing
aggregates over time, thus having lasting impact on the exchanges'
revenue. Finally, the final rules apply to issuers who list securities
on a national securities exchange. As such there are unlikely to be
competitive effects among national securities exchanges due to all
national securities exchanges being affected by the final rule
requirements.
---------------------------------------------------------------------------

    \435\ We note that changes in laws in foreign jurisdictions
regarding compensation recovery after the publication of the final
rules in the Federal Register could potentially reduce the relative
value of a U.S. listing. We also note that the revenue effect on
U.S. exchanges resulting from the behavior of FPIs is unclear,
because while some FPIs may choose to delist as a result of the
final rules, it is at least theoretically possible that others may
choose to list because of them. Although issuers can voluntarily
adopt compensation recovery provisions without listing on a U.S.
exchange, the decision to list on a U.S. exchange after the adoption
of the final rule would reflect a stronger commitment to enforcing
such provisions. See Section IV.B.8.
    \436\ We note that capital formation could be hindered if an
issuer chooses to forgo or delay listing because of the final rules
and the alternative methods of raising capital result in less liquid
securities being issued or less thorough disclosures being required.
We also note that other factors may affect the decision for an
issuer to list and any effect from the final rules would be
incremental to these other factors.
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3. Costs of Recovery
    We recognize that, as a result of this rulemaking, issuers will
face costs to calculate the amount to be recovered should an event
trigger the compensation recovery provision. The calculations could be
done internally or the issuer could choose to retain an outside expert
to calculate this amount. The costs of calculating the amount to be
recovered likely will vary depending on the nature of the restatement,
the issuers' compensation structure, the type of compensation involved,
the periods affected, and the method selected for calculation.
    The costs of calculating an amount to be recovered are expected to
be higher when incentive-based compensation that is based on stock
price or TSR is subject to recovery. In this context, issuers will need
to determine the amount of compensation that was erroneously awarded
based on the extent to which an inflated stock price results from an
accounting error. One key input for such calculations would be the
difference between the historical stock prices and the ``but for''
stock price, where the ``but for'' stock price is the price at which
the security would have sold, absent the accounting error. This section
provides background information on methods to estimate the amount of
inflation in stock prices as a result of accounting errors.
    To reasonably estimate the ``but for'' price of the stock, there
are a number of possible methods with different levels of complexity of
the estimations and

related costs.\437\ One such method, which is often used in accounting
fraud cases to determine the effects of restatements on the market
price of an issuer's stock, is an ``event study.'' An event study
captures the market's view of the valuation impact of an event or
disclosure. In the case of a restatement, the event study estimates the
drop in the stock price attributed to the announcement \438\ that
restated financial information is required, separate from any change in
the stock price due to market factors.\439\ An event study therefore
measures the net-of-market drop in the stock price, which is a key
input to establish the ``but for'' price at which the security is
presumed to have traded in the absence of the inaccurate financial
statements. In the context of an event study, to determine the net-of-
market drop in the stock price, certain decisions need to be made, such
as determining the appropriate proxy for the market return and
statistical adjustment method (i.e., a model to account for the
potential difference in risk between the company and market); the model
estimation period; the date and time that investors learned about the
restatement; and the length of time it took for investors to
incorporate the information from the restatement into the issuer's
stock price.\440\ The effects of these design choices may vary from
case to case. Some of the potential choices may have no effect on the
results while other choices may significantly drive the results and
could generate considerable latitude in calculating a reasonable
estimate of the excess amount of incentive-based compensation that was
erroneously awarded.\441\
---------------------------------------------------------------------------

    \437\ The complexity of a particular methodology involves a
trade-off between the potential for more precise estimates of the
``but for'' price and the assumptions and expert judgments required
to implement such methodology.
    \438\ Event studies can have multiple event dates. For example
an event study can measure the stock price impact attributed to the
announcement that amended filings are required, as well as the stock
price impact attributed to when the actual amended filings are made
available for the investors to examine.
    \439\ Note that the ``announcement'' may take a variety of
forms. For instance, an analyst or reporter may publicly disclose
information about the company that serves as a corrective
disclosure, even if the company does not make an announcement. In
addition, since companies would generally not issue a Form 8-K
release for a ``little r'' restatement, the publication of revised
financials may serve as a public disclosure.
    \440\ The complexity of an event study depends on the
circumstances of the event and the particular approach taken. For
example, one event study could use a broad market index in
estimating a market model, while another event study could use a
more tailored index that may take into account industry specific
price movements but would require judgments on the composition of
the issuers in the more tailored index. For further discussion on
the complexities of event studies, see Mark L. Mitchell and Jeffrey
M. Netter, The Role of Financial Economics in Securities Fraud
Cases: Applications at the Securities and Exchange Commission, 49
Bus. Law 565 (Feb. 1994); S. P. Kothari and Jerold B. Warner,
Econometrics of Event Studies (B. Espen Eckbo ed.), Handbook Corp.
Fin. Empirical Corp. Fin vol. I (Elsevier/North-Holland 2004); and
John Y. Campbell et al., The Econometrics of Event Studies,
Princeton University Press (1997).
    \441\ Issuers may conduct event studies of restatement effects
for a variety of reasons, including the possibility of shareholder
litigation and government investigations. If an issuer has already
conducted an event study to estimate the amount of inflation in the
stock price due to a restatement, that would reduce the costs of
conducting an event study for purposes of compensation recovery
analysis while also limiting the latitude associated with utilizing
different design choices.
---------------------------------------------------------------------------

    Calculating the ``but for'' price can be complicated when stock
prices are simultaneously affected by information other than the
announcement of a restatement on the event date.\442\ Because certain
executive officers may have influence over the timing of the release of
issuer-specific information, they may have the ability to affect the
estimation of a reasonable ``but for'' price. For example, if an
accounting restatement is expected to have a negative effect on an
issuer's stock price, certain executive officers may have an incentive
and the ability to contemporaneously release positive information in an
attempt to mitigate any reduction in the issuer's stock price. The
strategic release of confounding information may make it more difficult
for the board of directors to evaluate the effect of the restatement on
the stock price.
---------------------------------------------------------------------------

    \442\ Confounding information potentially affecting an issuer's
stock price on the event date could include other plans released by
the issuer related to potential corporate actions (e.g., mergers,
acquisitions, or capital raising), announcements of non-restatement
related performance indicators, and news related to macro-economic
events (e.g., news about the industry the issuer operates in,
changes to the state of the economy, and information about expected
inflation).
---------------------------------------------------------------------------

    As discussed above, the final rules do not require an event study
to calculate a reasonable estimate of the erroneously awarded
compensation tied to stock price to be recovered after an accounting
error leading to a restatement. Instead, the final rules permit an
issuer to use any reasonable estimate of the effect of the restatement
on stock price and TSR. In addition, we note that an issuer may need to
incur the direct costs associated with implementing a methodology to
reasonably estimate the ``but for'' price prior to determining whether
any amount of incentive-compensation is required to be recovered under
the final rules. In choosing a methodology to derive a reasonable
estimate of the effect of the accounting restatement on stock price and
TSR, issuers would likely weigh the costs of implementing any
methodology and the potential need to justify that estimate, under
their unique facts and circumstances. We have received a number of
comments regarding the costs of calculating the recoverable amount. For
example, some commenters noted that determining the amount of
compensation that was based on or derived from the financial reporting
measure may be challenging because incentive compensation award amounts
may include multiple metrics, and reflect judgment and discretion
rather than a formulaic calculation.\443\ In addition, commenters
indicated that the calculations will expose managers and boards of
directors to litigation risk.\444\
---------------------------------------------------------------------------

    \443\ See comment letters from Chevron; Coalition; Osler; and
TELUS.
    \444\ See, e.g., comment letters from Chevron; and Coalition. To
the extent that issuers perceive more costly estimation methods to
be a preferred approach in the context of potential litigation, the
risk of litigation may increase the costs of compliance with the
final rules.
---------------------------------------------------------------------------

    Commenters have also noted that issuers will face additional costs
associated with estimating the amount of incentive-based compensation
when the compensation is linked to stock price and TSR because of the
complexity of the calculations.\445\ A number of commenters requested
additional guidance and examples of calculations,\446\ and some
expressed concern that issuers may consider moving away from TSR-based
incentive plans to avoid the potential costs and uncertainty that may
result should a recovery be triggered.\447\ Some commenters noted that
there would be increased litigation risk regarding recoveries of
compensation linked to stock price and TSR due to the potential range
of reasonable estimates.\448\
---------------------------------------------------------------------------

    \445\ See, e.g., comment letters from CAP; CEC 1; Chevron;
Compensia; NAM; SH&P (stating that incentive compensation based on
performance metrics such as stock price or total shareholder return
cannot be accurately recalculated); Pearl Meyer; Davis Polk 1; and
Kovachev. For example, CAP noted that estimates of the impact of the
restatement when stock price/TSR metrics are involved, ``will be
extremely difficult to put into practice and will force Boards to
hire outside experts to perform the calculations. We predict that
this will benefit professional service firms willing to perform the
analyses, but will return little value to shareholders.''
    \446\ See, e.g., comment letters from Chevron; Compensia; Hay
Group; Pay Governance; Pearl Meyer; and WAW.
    \447\ See comment letters from Compensia; and WAW.
    \448\ See, e.g., comment letters from Chevron; Coalition;
Compensia; IBC (stating ``[o]ften [the methods] produce ranges of
numbers, rather than a definite amount, introducing more uncertainty
and opportunity to second guess the company's decision on how much
to recover, therefore opening the door for potential additional
shareholder derivative litigation''); and Pearl Meyer (noting the
possibility of challenges from interested parties, including current
executive officers as well as individuals who were executive
officers at some point during the lookback period but are no longer
holding such position).

---------------------------------------------------------------------------

    Since there is considerable variation in incentive compensation
plans as well as restatements, and in addition, issuers may choose
different reasonable approaches to calculation, we cannot estimate the
total costs of calculating the amounts to be recovered. Nor can we
estimate the likelihood that companies will move away from TSR-based
incentive plans.\449\ These uncertainties also may undermine issuers'
incentives to enforce their recovery policies and make it more
difficult for exchanges to monitor compliance.\450\ This effect may be
partially or entirely mitigated by the requirement for issuers to
provide documentation to the relevant exchange of any reasonable
estimates used or attempts to recover compensation, which will assist
exchanges in monitoring compliance and incentivize issuers to carefully
document the considerations that went into the determination to enforce
(or not enforce) their recovery policy.
---------------------------------------------------------------------------

    \449\ See Section IV.B.5 for additional discussion of the
economic effects of the potential decision to move away from
incentive based compensation that is subject to recovery, such as
TSR-based incentive plans.
    \450\ Due to the discretion that an issuer may have in choosing
both the method and the assumptions underlying the method to
estimate a ``but for'' price, it may be difficult for an exchange to
determine if the ``but for'' price resulted in a reasonable estimate
of the erroneously awarded compensation required to be recovered.
This may make it more difficult for exchanges to monitor compliance.
---------------------------------------------------------------------------

    Although the costs of hiring outside experts may vary depending on
the circumstances, we estimate that if outside professionals are
retained to assist with the calculations, they will likely charge
between $80 and $1,800 per hour for their services.\451\ One commenter
indicated that the expert fees will be closer to $800 per hour when
determining the impact of an accounting restatement on stock price or
TSR.\452\ Another commenter indicated that the cost of an event study
may range from $100,000 to $200,000.\453\
---------------------------------------------------------------------------

    \451\ The range is based on comment letters from TCA and Davis
Polk 1 as well as the SEAK, Inc., 2021 Survey of Expert Witness Fees
report indicating that the hourly fee for case review/preparation
ranges from $80 to $1,800 with an average fee of $422 per hour. See
SEAK, Inc., 2021 Survey of Expert Witness Fees, SEAKexperts.com Blog
(July 25, 2022, 3:54 p.m.), available at https://
blog.seakexperts.com/expert-witness-fees-how-much-should-an-expert-
witness-charge/
#:~:text=According%20to%20SEAK%27s%202021%20Survey,experts%20respondi
ng%20is%20%24500%2Fhour. We note that this range is also roughly
consistent with the 90th percentile of wage information compiled by
the U.S. Bureau of Labor Statistics, Occupational Employment
Statistics for the Financial and Investment Analyst occupation. As
of May 2021, the median hourly wage for a financial and investment
analyst was $44.03 and the 90th percentile hourly wage was $80.08.
    \452\ See comment letter from TCA.
    \453\ See comment letter from Davis Polk 1 (citing a study by
Marsh & McLennan Companies).
---------------------------------------------------------------------------

    We acknowledge the costs and the potential complexity associated
with calculating amounts to be recovered and acknowledge that the
hourly rate may exceed its estimated values in some cases, depending on
the complexity of the calculations. In addition, we recognize the
likelihood of higher costs associated with the recovery calculations
for incentive-based compensation linked to stock price and TSR as well
as the widespread use of this type of incentive-based
compensation.\454\ However, we are adopting the new rule and rule
amendments to implement the statutory mandates of Section 10D, which is
intended to require the return of executive compensation that was
awarded erroneously to the issuer and its shareholders. The costs of
calculating amounts to be recovered may be mitigated as issuers
exercise flexibility to determine the method of calculation that is
most appropriate given the circumstances. Also the costs of calculating
recovery amounts may be lower to the extent that the calculations would
have been performed in the context of the restatement, because the
effect of the misstatement on management's compensation is a
qualitative factor in a materiality analysis.\455\
---------------------------------------------------------------------------

    \454\ See supra note 393.
    \455\ See supra, note 80.
---------------------------------------------------------------------------

    Depending on the circumstances, there may be other costs associated
with enforcing the mandatory recovery policy. If the current or former
executive officer is unwilling to return erroneously awarded
compensation, the issuer may incur legal expenses to pursue recovery
through litigation or arbitration.\456\ However, if the direct expense
paid to a third party to assist in enforcing the recovery policy from
an executive or former executive officer would exceed the erroneously
paid incentive-based compensation, the final rules allow the issuer,
under certain circumstances, to determine that recovery would be
impracticable, and therefore not pursue the recovery. This may mitigate
the direct costs of enforcement to issuers.\457\ Finally, if an issuer
does not take action when required under its recovery policy, then the
issuer may also incur costs associated with the listing exchange's
proceedings to delist its securities.
---------------------------------------------------------------------------

    \456\ Issuers may incur additional costs associated with the
rules to the extent that they create an impediment to litigation
settlements because they do not include an exception for releases of
potential recoupment claims. This may impose costs directly on
issuers and indirectly on the economy as litigation could
potentially be prolonged. See, e.g., comment letter from SCG 1.
    \457\ Since the final rule will permit issuers to forgo recovery
from tax-qualified retirement plans, we expect that issuers and plan
participants will avoid the costs associated with such recovery.
---------------------------------------------------------------------------

4. Effects on Financial Reporting
    In seeking to maximize the value of their financial investments,
shareholders rely on the financial reporting quality of issuers to make
informed investment decisions about the issuer's securities. High-
quality financial reporting should provide shareholders with an
assessment of the issuer's performance and should be informative about
its value. Erroneous financial reporting can mislead investors about
the issuer's value. For instance, improper financial reporting may
overstate demand for the issuer's products, or exaggerate its ability
to manage costs. An accounting restatement due to material
noncompliance with any financial reporting requirement under the
securities laws may cause shareholders to question the accuracy of
those estimates and may lead shareholders and other prospective
investors to substantially revise their beliefs about the issuer's
financial performance and prospects with potentially significant
effects on firm value.
    While incentive-based compensation is typically intended to provide
incentives to executives to maximize the value of the enterprise, thus
aligning their incentives with shareholders, it may also provide
executives with incentives that conflict with shareholders' reliance on
high-quality financial reporting. For example, in some instances,
executives might have incentives to pursue impermissible accounting
methods under GAAP that result in a material misstatement of financial
performance, to realize higher compensation.\458\ This potential for
deliberate misreporting reflects a principal-agent problem that is
detrimental for shareholders.\459\

Although civil and criminal penalties already create disincentives to
deliberate misreporting, the recovery requirements under the final
rules will reduce the financial benefits to executive officers who
choose to pursue impermissible accounting methods, and thus may add
another disincentive to engage in deliberate misreporting. The
magnitude of this effect will depend on the particular circumstances of
an issuer.
---------------------------------------------------------------------------

    \458\ We also note that some estimates and judgments permissible
under GAAP may allow executive officers to realize higher
compensation, without resulting in a material misstatement of
financial performance and thus without triggering recovery
consistent with Section 10D.
    \459\ Among other decisions, executive officers must decide the
extent of internal resources and personal attention to devote to
achieving high-quality financial reporting and assuring that the
financial disclosure is informative about the performance and
condition of the issuer. To the extent that the expected costs and
benefits associated with any level of investment decision in
financial reporting quality would ultimately be reflected in the
issuer's firm value, in absence of a principal-agent problem,
executive officers would likely decide to allocate the value
maximizing amount of resources to producing high-quality financial
statements and, as a result, the level of information value of the
financial reporting would likely be optimal. A principal-agent
problem, however, reduces the executive officer's incentive to
allocate the appropriate amount of resources to produce high-quality
financial statements, which reduces the information value of
financial reporting. In addition, the issuer may not realize all of
the benefits from high quality financial reporting. For example,
accurate financial reporting by one issuer provides a useful
benchmark to investors in evaluating other issuers. As a result,
issuers may underinvest in the production of high-quality financial
statements, relative to the benefits for investors.
---------------------------------------------------------------------------

    The final rules may also provide executive officers with an
increased incentive to take steps to reduce the likelihood of
inadvertent misreporting.\460\ Most directly, because executive
officers are less likely to benefit from reporting errors, they have
stronger incentives to increase the amount of time and resources they
spend on the production of high-quality financial reporting, and may
also, for instance, increase the staffing of the internal audit
function.\461\ These actions would reduce the likelihood of an
accounting error that requires restatement.
---------------------------------------------------------------------------

    \460\ One commenter noted while intentional reporting errors are
relatively infrequent between 1996 and 2005 (1% error rate),
unintentional misstatements are far more frequent (2.89% error
rate). See comment letter from Vivian Fang.
    \461\ See, e.g., comment letters from NYCRS; Fried; and Public
Citizen 1. We recognize that there may be some limit beyond which
the utilization of additional resources in order to further limit
the likelihood of small, inadvertent accounting errors may not be
the optimal use of these resources. It is unclear where the current
expenditures of issuers stand relative to these limits. We also
recognize that financial reporting decisions may be outside of the
scope of responsibilities of some of the executive officers who will
be subject to compensation recovery as a result of the final rules,
see Section II.C.1.
---------------------------------------------------------------------------

    Research studies provide mixed results on the impact of
compensation recovery on financial reporting accuracy and reliability.
Several studies have analyzed outcomes after the implementation of a
voluntary recovery policy, finding results that are consistent with
issuers devoting more resources to internal control over financial
reporting.\462\ In addition, some studies show that adoption of
voluntary recovery provisions is associated with improved managerial
decision making.\463\ However, we acknowledge that multiple studies
find that the adoption of recovery provisions may lead to outcomes such
as real earnings management to achieve short-term earnings goals.\464\
To the extent that the final rules lead some issuers to increase real
earnings management, investors and issuers could bear increased costs.
---------------------------------------------------------------------------

    \462\ See Michael H.R. Erkens et al., Not All Clawbacks Are the
Same: Consequences of Strong Versus Weak Clawback Provisions, 66 J.
Acct. & Econ. 291 (2018) (finding that companies that voluntarily
adopt stronger clawback measures experience improvements in
reporting quality); Lillian H. Chan et al., The Effects of Firm-
Initiated Clawback Provisions on Earnings Quality and Auditor
Behavior 54 J. Acct. & Econ. 180 (2012) (finding that after the
adoption of clawback provisions, incidence of accounting
restatements declines, firms' earnings response coefficients
increase, and auditors are less likely to report material internal
control weaknesses, charge lower audit fees, and issue audit reports
with a shorter lag); DeHaan, et al., supra note 62 (finding
improvements in financial reporting quality following clawback
adoption, including decreases in meet-or-beat behavior and
unexplained audit fees, a decrease in restatements, a significant
increase in earnings response coefficients and a significant
decrease in analyst forecast dispersion). See also Henry K. Mburu
and Alex P. Tang, Voluntary Clawback Adoption and Analyst Following,
Forecast Accuracy, and Bias, 18 J. Acct & Fin. 106 (2018) (finding
that voluntary adoption of compensation recovery provisions leads to
an increase in analyst coverage and analyst accuracy, as well as
reduced optimistic bias by analysts); Mark A. Chen et al., The Costs
and Benefits of Clawback Provisions in CEO Compensation, 4 Rev.
Corp. Fin. Stud. 108 (2015) (finding lower earnings variability and
reduced aggressiveness in financial reporting after voluntary
adoption of a compensation recovery provision); Bradley Benson et
al., Will the Adoption of Clawback Provisions Mitigate Earnings
Management?, 18 J. Acct. & Fin. 61 (2018) (finding that when
compensation recovery provisions are implemented by a company with
an independent board, earnings quality improves).
    \463\ See, e.g., Yu-Chun Lin, Do Voluntary Clawback Adoptions
Curb Overinvestment?, 25 Corp. Govern. Int'l Rev. 255 (2017)
(finding that compensation recovery provisions mitigate
overinvestment); Dina El-Mahdy, The Unintended Consequences of
Voluntary Adoption of Clawback Provisions on Managerial Ability, 60
Acct. & Fin. 2493 (2020) (finding that voluntary adoption of
compensation recovery provisions is associated with an increase in
productivity as measured by revenues generated for a given level of
costs); Thomas Kubrick, Thomas Omer, and Zac Wiebe, The Effect of
Voluntary Clawback Adoptions on Corporate Tax Policy, 95 Acct. Rev.
259 (2020) (finding that adoption of compensation recovery
provisions may lead to more effective tax planning and lower
effective tax rates); Anna Brown et al., M&A Decisions and US Firms'
Voluntary Adoption of Clawback Provisions in Executive Compensation
Contracts, 42 J. Bus. Fin. & Acct. 237 (2015) (finding that adoption
of compensation recovery provisions leads to improved decisions in
the context of mergers and acquisitions); Matteo P. Arena and Nga
Nguyen, Compensation Clawback Policies and Corporate Lawsuits, 27 J.
Fin. Reg. & Compliance 70 (2019) (finding that after the adoption of
compensation recovery provisions, litigation risk significantly
declines). One paper finds that firms' investment risk decreases
with the voluntary adoption of a compensation recovery provision,
but notes that this effect may be either value-increasing or value-
decreasing, depending on the circumstances. See Yu Chen and Carol
Vann, Clawback Provision Adoption, Corporate Governance, and
Investment Decisions, 44 J. Bus. Fin. Acct. 1370 (2017) (finding
that after adopting a compensation recovery provision, firms'
abnormal investment decreases and the firms' investments are less
risky).
    \464\ See, for instance, Lilian Chan et al., Substitution
between Real and Accruals Based Earnings Management after Voluntary
Adoption of Compensation Clawback Provisions, 90 Acct. Rev. 147
(2015) (finding that the total amount of earnings management does
not decrease after recovery provisions are adopted, and that
companies are more likely to lower research and development expenses
to achieve short term earnings goals after adoption). Similar
results are provided by Gary Biddle et al., Clawback adoptions,
managerial compensation incentives, capital investment mix and
efficiency, (working paper Dec. 2021), available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3042973 (retrieved from
SSRN Elsevier database). A related paper, Dichu Bao et al., Can
Shareholders Be at Rest After Adopting Clawback Provisions? Evidence
from Stock Price Crash Risk, 35 Contemp. Acct. Res., 1578 (2018),
finds that voluntary recovery provision adoption is associated with
an increase in stock price crash risk, that after the adoption some
companies reduce the readability of their Form 10-K filings, and
increase real earnings management through abnormal production costs,
abnormal expenses, and abnormal cash flows. See also Hangsoo Kyung
et al., The Effect of Voluntary Clawback Adoption on non-GAAP
Reporting, 67 J. Acct. & Econ. 175 (2019) (finding that issuers
adopting recovery provisions increase the frequency of disclosure of
non-GAAP earnings, and non-GAAP exclusion quality decreases after
the adoption); Thompson, supra note 69 (finding that issuers with
compensation recovery provisions are more likely to report
misstatements as ``little r'' restatements instead of ``Big R''
restatements). Consistent with the possibility that the rules as
proposed may create incentives to reduce research and development
expenditures, Bakke et al., supra note 413, find that the stock
price reaction to the Proposing Release was less positive for
issuers with high cash flow activity and companies engaged in
research and development activity, and it was negative for issuers
that have already adopted a compensation recovery provision and are
engaged in research and development. See also comment letter from
Fried (noting the potential to incentivize executive officers ``to
shift from value-reducing earnings manipulation to even more
destructive real earnings management'').
---------------------------------------------------------------------------

    Executive officers may also take other steps to reduce the
likelihood of inadvertent misreporting. An executive officer could
change the business practices of the issuer, thereby affecting the
opportunity for an accounting error to arise. For example, an executive
officer could simplify delivery terms of a project or a transaction in
order to use accounting standards that are more straightforward to
apply and perhaps require fewer accounting judgments, which may reduce
the likelihood of accounting errors. As another example, the executive
officer could make accounting judgments on loan loss reserves that are
less likely to result in

an accounting restatement. Taking steps such as these does not
necessarily affect the selection of the project or transaction the
issuer chooses to undertake (although it could, as discussed below),
but could result in greater investor confidence in the quality of
financial reporting and information value of the financial statements,
and thus have a positive impact on capital formation.\465\
---------------------------------------------------------------------------

    \465\ One academic study finds that, when market competition is
weak, the information environment affects the expected returns of
equity securities. In particular, when financial disclosure quality
is low, as measured by scaled accruals quality, issuers with low
market competition, as measured by the number of shareholders of
record, have a higher expected return. All else being equal, higher
expected returns make raising capital more costly for the company.
See Christopher S. Armstrong et al., When Does Information Asymmetry
Affect the Cost of Capital, 49 J. Acct. Rsch. 1, (Mar. 2011). The
academic literature has developed a measure of the quality of
financial reporting denoted accruals quality. This measure
quantifies how well accruals are explained either by the cash flow
from operations (past, current, and future periods) or accounting
fundamentals. For details on the construction and interpretation of
the measure, see Patricia M. Dechow and Ilia D. Dichev, The Quality
of Accruals and Earnings: The Role of Accrual Estimation Errors, 77
Acct. Rev. 35, (2002); and Jennifer Francis et al., The Market
Pricing of Accruals Quality 29 J. Acct. & Econ. 295, (2005).
---------------------------------------------------------------------------

    As a result of the final rules, we believe that the increased
incentives to generate high-quality financial reporting may improve the
overall quality of financial reporting. For some issuers that are
already producing high-quality financial reports, there may be limits
to the benefits of incremental increases in financial reporting
quality. However, we believe that a substantial number of issuers will
benefit from an increase in the quality of financial reporting. These
improvements could result in increased informational efficiency,
enhanced investor confidence that may result in greater market
participation, and a reduced cost of raising capital, thereby
facilitating capital formation.\466\ While we lack the data to quantify
the potential benefits to shareholders from a reduced likelihood of an
accounting error, evidence suggests that penalties imposed by the
market for accounting restatements can be substantial. For example, one
recent study \467\ found that over the period 2008 to 2015 the market
value of equity of the average issuer declined by 3.3% upon
announcement of a ``Big R'' financial restatement, and by 0.3% upon
announcement of a ``little r'' restatement.
---------------------------------------------------------------------------

    \466\ In addition, to the extent that investors cannot
differentiate between issuers with high quality financial reporting
and issuers with low quality financial reporting, they may
underinvest in issuers with high quality financial reporting. But an
improvement in the reporting of issuers with low quality financial
reporting would raise the average issuer's quality of financial
reporting. This improvement for the average issuer may mitigate the
underinvestment in issuers with high quality financial reporting and
therefore lower their cost of capital as well.
    \467\ See Choudhary et al., supra note 61. See also Christine
E.L. Tan et al., An Analysis of ``Little r'' Restatements, 29 Acct.
Horizons 667 (2015) and Susan Scholz, Financial Restatement: Trends
in the United States: 2003-2012, Center for Audit Quality, (July 24,
2014), available at https://www.thecaq.org/financial-restatement-trends-united-states-2003-2012.
---------------------------------------------------------------------------

    More broadly, the availability of more informative or accurate
information regarding the financial performance of issuers may also
have the effect of increasing the efficient allocation of capital among
corporate issuers. Because investors will be better informed about the
potential investment opportunities at any given point in time, they
will be more likely to allocate their capital according to its highest
and best use. This would benefit all issuers, even those whose
financial reporting would not be affected by the final rule
requirements on exchanges' listing standards. In particular, issuers
whose financial reporting is unaffected may have better access to
capital by virtue of investors being able to make more informed
comparisons between them and issuers whose financial reporting would
become more accurate as a result of the final rule requirements.\468\
In contrast, without the final rules, investors may improperly assess
the value of the issuers whose financial reporting is based on
erroneous information, which could result in an inefficient allocation
of capital, inhibiting capital formation and competition.
---------------------------------------------------------------------------

    \468\ See Brian J. Bushee et al., Economic Consequence of SEC
Disclosure Regulation: Evidence From the OTC Bulletin Board, 39 J.
Acct. & Econ. 233 (2005).
---------------------------------------------------------------------------

    We are aware, however, that these potential benefits of the final
rules are not without associated costs. Under the final rules, as a
commenter asserted, the increased allocation of resources to the
production of high-quality financial reporting may divert resources
from other activities that may be value enhancing.\469\ Moreover, while
the increased incentive to produce high-quality financial reporting and
thus reduce the likelihood of accounting errors should increase the
informational efficiency of investment opportunities, it may also
encourage, as a few commenters noted, executive officers to forgo
value-enhancing projects if doing so would decrease the likelihood of a
financial restatement.\470\ For example, when choosing among investment
opportunities for the issuer, executive officers may have an increased
incentive to avoid those projects that would require more complicated
accounting judgments, because such projects may be more likely to
trigger a restatement.\471\ That is, the final rules may reduce
incentives for an executive officer to choose projects for which it is
more difficult to generate high-quality financial reporting.\472\ This
could have a beneficial impact on the value of the issuer to the extent
that the forgone projects would have resulted in lower value than those
that were ultimately chosen.\473\ The final rules may also be value-
enhancing to listed issuers by reducing the likelihood of accounting
errors because executive officers may be

incentivized to ensure that greater care is exerted in preparing
accurate financial statements, thus avoiding the costs associated with
a restatement.
---------------------------------------------------------------------------

    \469\ See, e.g., comment letter from NACD (noting the proposal
could divert resources to financial reporting that would otherwise
be used for other value enhancing activities).
    \470\ Projects that increase the volatility of cash flows from
operations, the volatility of sales revenue, or percentage of soft
assets have been associated with an increased likelihood of a
restatement. See Patricia M. Dechow et al., Predicting Material
Accounting Misstatements, 28 Contemp. Acct. Rsch. 17 (Spring 2011).
Consistent with these findings that riskier operations are
associated with an increased likelihood of restatements, Babenko et
al. find that firms that adopt a recovery provision subsequently
reduce their research and development spending, file fewer patents,
and decrease their capital expenditures. The authors also find that
firms adopting a recovery provision subsequently hold more cash,
issue less net debt, and experience an increase in credit rating.
See, e.g., comment letters from Fried; NACD; and NAM.
    \471\ For example, the issuer could select projects that do not
add to the complexity of the required reporting systems, or select
projects that have a shorter performance period and therefore may
involve less difficult accounting judgments about the expected
future costs. See comment letter from NAM.
    \472\ See Babenko et al. The study finds that executives respond
to the implementation of a compensation recovery policy by reducing
firm risk. For example, the authors report that issuers spend less
on research and development, and file for fewer patents. This is
consistent with executives changing their project selection policy
as the result of implementing a compensation recovery policy. We
note, however, that the determination of whether or not to select a
particular project is likely related to many characteristics of the
project. These characteristics could include the value the project
creates, the cash flows the project returns in the near term, and
the strategic objectives of the issuer.
    \473\ See Babenko et al. The authors address the question of
whether the reduction in risk associated with the voluntary adoption
of a compensation recovery policy is beneficial for shareholders.
They find a positive and significant relation between adoption of
such a policy and long-term stock and accounting performance and a
positive and significant short-term stock-market reaction around the
date of the adoption. The stock market response to compensation
recovery policy adoption, as well as stock and accounting
performance over the year subsequent to adoption, are significantly
larger the greater the reduction in actual and predicted firm risk
associated with the recovery provision. See also California Public
Employees' Retirement System (Nov. 22, 2021) (``CalPERS 2'') (noting
that ``clawback policies potentially mitigate excessive risk-taking
that certain compensation may incentivize'').
---------------------------------------------------------------------------

    As described above, some studies suggest that a compensation
recovery policy could result in an increased likelihood of an executive
officer making suboptimal operating decisions in order to affect
specific financial reporting measures as a result of the decreased
incentive to use accounting judgments to affect those financial
reporting measures.\474\ For example, if an executive officer is under
pressure to meet an earnings target, rather than manage earnings
through accounting judgments, an executive officer may elect to reduce
or defer to a future period research and development or advertising
expenses. This could improve reported earnings in the short-term, but
could result in a suboptimal level of investment that adversely affects
performance in the long run.
---------------------------------------------------------------------------

    \474\ See supra note 464. See also Sohyung Kim et al., Other
Side of Voluntary Clawback Provisions in Executive Compensation
Contracts: Evidence From the Investment Efficiency, 25 Rev. Pacific
Basin Fin. Mkts. & Policies 1 (2022) (finding evidence that the
voluntary adoption of compensation recovery policies decreases the
investment efficiency in the post-adoption period, especially for
issuers whose ex ante probability of underinvestment is high).
---------------------------------------------------------------------------

    Under the final rules, if it appears that previously issued
financial statements may contain an accounting error, there would be a
potential incentive for issuers or individual executive officers (to
the extent they are in a position to do so) to cause the company to
avoid characterizing the accounting error in such a way that would
trigger application of the final rules. Such an incentive exists
because compensation recovery is only required after the conclusion
that an accounting restatement is required to correct an error in
previously issued financial statements that is material to the
previously issued financial statements or that would result in a
material misstatement if the error were corrected in or left
uncorrected in the current period. To the extent that these incentives
discourage the timely and accurate reporting of material accounting
errors, it could result in loss of confidence in financial information
disclosures by investors and hinder capital formation.
    However, we note that there are serious consequences, including
criminal penalties, that help to deter either a delay or
mischaracterization. In addition, the rule discourages delays by
defining the trigger date as the date on which the issuer concludes, or
reasonably should have concluded, that the issuer's previously issued
financial statements contain an error that requires a restatement. In
addition, the inclusion of ``little r'' restatements eliminates the
incentive to mischaracterize ``Big R'' restatements as ``little r''
restatements. Finally, oversight by audit committees and outside
auditors may serve as an additional mitigating factor.
5. Effects on Executive Compensation
    When setting the compensation for executive officers, the board of
directors of an issuer frequently incorporates into the total
compensation package a payout that is tied to one or more measures of
the issuer's performance.\475\ The purpose of tying compensation to
performance is to provide an incentive for executive officers to
maximize the value of the enterprise, thus aligning their incentives
with other shareholders. The proportion of the compensation package
that relies on performance incentives generally depends on factors such
as the level of risk inherent in the issuer's business activities, the
issuer's growth prospects, and the scarcity and specificity of
executive talent needed by the issuer. It also may reflect personal
preferences influenced by characteristics of the executive such as age,
wealth, and aversion to risk. In particular, the executive officer's
risk aversion may make compensation packages with strong performance
incentives undesirable for the executive officer because of the less
predictable payments. These factors contribute not only to the
magnitude of the expected compensation, but also to how an executive
views and responds to the compensation.\476\
---------------------------------------------------------------------------

    \475\ Executive compensation may be tied to issuer performance
implicitly, as in the case of awards of options or restricted stock
that have only service-based vesting conditions, or more explicitly,
as in the case of incentive-based compensation with market or
performance conditions that affect the amount of compensation or
whether it vests.
    \476\ Executive officers typically have personal preferences
regarding the form of compensation received. To the extent that
executive officers have different levels of risk aversion, they can
arrive at different personal valuations of the same incentive-based
compensation package. Hence, more risk-averse executive officers may
require additional compensation when paid in the form of less
certain incentive-based compensation.
---------------------------------------------------------------------------

    Several commenters have indicated that the requirements of the
final rules could meaningfully affect the size and composition of the
compensation packages awarded to executive officers of listed
issuers.\477\ In particular, some commenters argued that the final
rules would encourage executive officers to favor compensation that
would not be subject to potential recovery, such as base salary, over
incentive-based compensation.\478\ The Commission acknowledges that the
composition of executive compensation could be impacted by the final
rules. On the one hand, the final rules could encourage greater use of
certain kinds of incentive-based compensation. The implementation of a
mandatory recovery policy may make it less costly for the issuer to use
the types of incentive-based compensation that would be subject to
recovery (those with explicit market or performance conditions tied to
the issuer's financial reporting or stock price).\479\ Most directly,
such a policy would reduce the cost of such compensation by recovering
overpayments associated with misstatements. Further, adopting a
recovery policy may reduce the potential incentives that may arise from
incentive-based compensation to engage in practices resulting in
inaccurate reporting.
---------------------------------------------------------------------------

    \477\ See, e.g., comment letters from TCA; Ensco; WAW; NAM; CAP;
NACD; and American Vanguard.
    \478\ See, e.g., comment letters from American Vanguard, NAM,
and WAW. Further, some commenters argued that the final rules would
encourage the use of incentive-based compensation tied to
performance measures that fall outside the scope of the rules, such
as strategic measures, subjective measures, or operational measures.
See, e.g., comment letter from Ensco.
    \479\ This effect was observed in a recent study examining
voluntarily adopted compensation recovery provisions. See, e.g.,
Peter Kroos et al., Voluntary Clawback Adoption and the use of
Financial Measures in CFO Bonus Plans, 93 Acct. Rev. 213 (2018)
(finding that adoption of compensation recovery provisions is
associated with greater CFO bonus incentives because such
compensation recovery provisions serve as an effective check on the
ability of CFOs to manipulate the performance metrics that could
influence their performance-based compensation). The final rule,
which conditions initial and continued listing of securities on
compliance with the recovery policy, substantially increases the
incentives of board members to enforce the policy relative to
voluntarily adopted recovery provisions.
---------------------------------------------------------------------------

    On the other hand, as noted by some commenters, the final rules
could discourage the use of certain kinds of incentive-based
compensation. As noted at the beginning of this section, risk-averse
executive officers prefer predictable compensation, and the mandatory
implementation of a recovery policy that meets the requirements of the
final rules would introduce an additional source of uncertainty in the
compensation of the executive officer.\480\ In addition, the expected
value of executive compensation subject to the rule could decrease
because, to the extent any such compensation is erroneously awarded, it

must be recovered. Therefore, because incentive compensation based on
financial metrics could be both more uncertain and lower in expected
value, executives may seek a shift away from such compensation and
towards base salary or other forms that are not recoverable, such as
options or restricted stock with time-based vesting, incentive-based
compensation tied to operational metrics, or bonuses awarded at the
discretion of the board. To the extent these forms of compensation have
reduced incentive alignment between executive pay and shareholder
interests, i.e., pay-for-performance sensitivity,\481\ this potential
shift in compensation composition, as noted by several commenters, may
lessen the alignment with the interests of shareholders.\482\
---------------------------------------------------------------------------

    \480\ The ``no-fault'' nature of the recovery policy, which
mandates that executive officers return erroneously awarded
compensation even if they had no role in the accounting error, along
with the issuer's choice of a calculation methodology and the
variation in assumptions that underlie it could also add to this
uncertainty.
    \481\ Pay-for-performance sensitivity is a measure of incentive
alignment used in academic research. The measure captures the
correlation of an executive officer's compensation with changes in
shareholder wealth. See, e.g., Michael Jensen and Kevin Murphy,
Performance Pay and Top Management Incentives, 98 J. Pol. Econ. 225
(1990).
    \482\ See, e.g., comment letter from Davis Polk 3 (suggesting
that decreasing the use of accounting-based incentive compensation
by increasing base salary may weaken the alignment between
executives' incentives and those of the company and shareholders).
See also comment letters from TCA; Ensco; Pearl Meyer; WAW; NAM;
CAP; NACD; and American Vanguard.
---------------------------------------------------------------------------

    We acknowledge this potential cost but believe a number of factors
and findings mitigate this concern. First, as noted earlier in this
section, the issuer, in contrast to the executive, has incentives to
push for more incentive-based compensation. This is because erroneous
payments can now be recouped, and incentive-based compensation will
generate less temptation to manipulate financial metrics, potentially
leading to more accurate reporting. Thus issuer incentives could offset
executive desire to shift away from incentive-based compensation.
Second, it is not obvious that a shift away from incentive-based
compensation covered by this rule lessens the alignment with the
interests of shareholders. Less incentive-based compensation reduces
incentives for financial misreporting, contributing to more reliable
financial statements, which benefits issuers and shareholders. In
addition, recent evidence indicates some investor dissatisfaction with
performance-based pay \483\ as well as a growing interest in
nonfinancial metrics pay.\484\ Third, to the extent that financial
reporting quality improves because of the rule and reduces the
likelihood of a restatement, this may reduce the uncertainty in
executive compensation resulting from the rule. Lastly, other factors,
such as shareholder engagement, other governance controls, and market
forces play an important role in the level and design of executive
compensation and may mitigate changes due to the final rules.\485\
---------------------------------------------------------------------------

    \483\ See, e.g., Council of Institutional Investors, Policies on
Corporate Governance Sec.  5 Executive Compensation (rev. Mar. 7,
2022), available at https://www.cii.org/corp_gov_policies#exec.
    \484\ See, e.g., ISS Governance, 2021 Global Benchmark Policy
Survey (Oct. 2021), available at https://www.issgovernance.com/file/publications/2021-global-policy-survey-summary-of-results.pdf
(reporting that while there has been an upsurge in interest in
environmental, social, and governance (ESG) metrics in executive
compensation, some observers have criticized the increasing use of
poorly defined ESG metrics).
    \485\ Recent regulatory changes have not always impacted
executive compensation in ways that may have been expected, perhaps
because of the offsetting effect of heightened investor engagement
on pay structure since the introduction of say-on-pay votes. See,
e.g., Lisa De Simone, Charles McClure and Bridget Stomberg,
Examining the Effects of the TCJA on Executive Compensation (Apr.
15, 2022). Kelley School of Business Research Paper No. 19-28,
available at https://ssrn.com/abstract=3400877 (finding no evidence
that the repeal of a long-standing exception under Section 162(m) of
the tax code that allowed companies to deduct executives' qualified
performance-based compensation in excess of $1 million reversed a
related shift in executive compensation away from cash compensation
and towards performance pay). In addition, the board, via the
compensation committee, has oversight over executive compensation,
and typically weighs a number of considerations in determining how
best to incentivize performance. See, e.g., Alex Edmans, et al.,
Executive Compensation: A Survey of Theory and Evidence (Eur. Corp.
Governance Inst. (ECGI) Fin. Working Paper No. 514/2016), available
at https://ssrn.com/abstract=2992287 (retrieved from SSRN Elsevier
database) (describing the influences of boards, executives, and
institutional factors such as legislation, taxation, accounting
policy, compensation consultants, and proxy advisory firms on
compensation outcomes).
---------------------------------------------------------------------------

    Separate from changes to the composition of compensation, the size
of total compensation may also be impacted by the rule. In response to
potential increased uncertainty, risk-averse executives may demand an
offset to bear this uncertainty. Executives may also demand higher
total compensation to offset the expected loss from potential recovery.
This possibility was noted by a number of commenters, who suggested
this increase in executive compensation would harm shareholders.\486\
---------------------------------------------------------------------------

    \486\ See, e.g., comment letters from TCA; Ensco; Pearl Meyer;
WAW; NAM; NACD; and American Vanguard.
---------------------------------------------------------------------------

    We acknowledge that an increase in executive pay is a possibility.
Some research suggests that as a result of recovery provisions, the
total compensation of executive officers may increase, but other
studies do not support this hypothesis.\487\ The extent of any such
increase will depend on the structure and conditions of the labor
market for executive officers as well as other economic factors,
including the negotiating environment and particular preferences of
executives. We also note that although executives may demand and
receive an increase in total compensation relative to the baseline to
offset potential losses from recovery, their new compensation
agreements would reasonably be expected to tie more closely to true
firm performance, as misstatement-driven determinants of pay are
replaced by base pay or pay tied to accurate financial or operational
metrics. This could improve alignment between executives and
shareholders. In addition, improved financial reporting quality that
may result from the rule and reduced likelihood of a restatement would
benefit the issuer and shareholders, mitigating costs associated with
any increase in executive compensation. Finally, as noted earlier in
this section, shareholder engagement, other governance controls, and
market forces may mitigate changes due to the final rules.
---------------------------------------------------------------------------

    \487\ See DeHaan et al., supra note 62; Chen et al., supra note
462 (finding that compensation recovery provisions are associated
with higher CEO compensation); and Kroos et al., supra note 479. See
also Ramachandran Natarajan and Kenneth Zheng, Clawback Provision of
SOX, Financial Misstatements, and CEO Compensation Contracts, 34 J.
Acct., Auditing & Fin. 74 (2019) (finding that compared with control
firms, companies with a high restatement likelihood where the CEO is
the chair of the board exhibit an increase in CEO salaries between
the pre- and post-Sarbanes-Oxley Act periods, suggesting that in the
post-Sarbanes-Oxley Act period influential CEOs are able to receive
higher salaries that are not subject to the Sarbanes-Oxley Act
Section 304 clawback provision). By contrast, Erkens et al., supra
note 462, finds results suggesting that while CEO incentive-based
compensation may be reduced for adopters of strong compensation
recovery provisions, for those companies, CEO total compensation is
also reduced. The authors suggest that the findings may indicate
that the adoption of strong compensation recovery provisions is
associated with a broader reform package. Similarly, Iskandar-Datta
et al., supra note 426, find no evidence that compensation recovery
provisions entail costs in the form of higher CEO compensation
following adoption nor do they influence the design of compensation
contracts.
---------------------------------------------------------------------------

    A number of commenters stated that the final rules may affect the
competition among issuers to hire and retain executive officers, as
well as recruitment for specific board committees.\488\ Increased
uncertainty

that reduces the perceived value of the expected incentive-based
compensation of an executive officer, or expectation of lower total
compensation due to recovery, could cause listed issuers to have more
difficulty attracting talented executives. As a result, listed issuers
could potentially experience a comparative disadvantage relative to
companies that are not covered (i.e., unlisted issuers and private
companies).\489\
---------------------------------------------------------------------------

    \488\ See, e.g., comment letter from Compensia (noting that no-
fault recovery would have dramatic adverse effects on issuers such
as individuals negotiating to avoid executive officer status). In
addition, Compensia contends that the rule would put increased
pressure on the boards and managers responsible for reviewing
financial statements and executive compensation, making audit
committee and compensation committee service less attractive. See
also comment letters from Ensco; Kovachev; NAM; Pearl Meyer; and
American Vanguard. Another commenter, however, suggests that
clawback rules should not impede the ability of issuers to recruit
executives. See comment letter from Occupy.
    \489\ See, e.g., comment letter from IBC (noting that narrowing
the market of available and interested executives in any increment
is not in the shareholders' best interest). See also comment letter
from Davis Polk 3 (noting that having compensation subject to change
for matters out of their control (``no-fault'') could lower
executives' morale and satisfaction, causing executives to shy away
from working with public companies). See also comment letters from
NAM; and American Vanguard.
---------------------------------------------------------------------------

    While we acknowledge this possibility, this concern is mitigated if
the potential impacts to compensation discussed earlier in this
section, that total executive compensation may increase or shift to
forms that are not recoverable, manifest to some degree. To the extent
issuers adjust total compensation for executive officers and design
alternative incentive packages, we expect that the competitiveness of
listed issuers in the executive labor market may remain unchanged. In
addition, studies have shown that listed firms offer higher total
executive compensation than unlisted firms of comparable size and other
characteristics.\490\ We thus believe it is unlikely executives will
significantly disfavor listed firms from their choice set of employment
opportunities.
---------------------------------------------------------------------------

    \490\ See Huasheng Gao and Kai Li, A Comparison of CEO Pay-
Performance Sensitivity in Privately-Held and Public Firms, J. Corp.
Fin. 35 (2015) available at https://www.sciencedirect.com/science/article/pii/S0929119915001261 (finding that CEOs in public firms are
paid 30% more than CEOs in comparable private firms).
---------------------------------------------------------------------------

    One commenter suggested that ``clawback risk may deter executives
from undertaking or approving business strategies with more complex
accounting methods, since the complexity may add to the likelihood of a
reporting error and corresponding clawback of their compensation.''
\491\ We acknowledge this concern but note research shows that adoption
of voluntary recovery provisions is associated with improved managerial
decision making.\492\
---------------------------------------------------------------------------

    \491\ See comment letter from NAM.
    \492\ As noted above, some research shows that adoption of
voluntary recovery provisions is associated with improved managerial
decision making. See supra notes 463 and 473.
---------------------------------------------------------------------------

6. Effects of Disclosure and Tagging Requirements
    Under the final rules, the listed issuer's recovery policy would be
required to be filed as an exhibit to the issuer's annual report on
Form 10-K, 20-F or 40-F or, for registered management investment
companies, on Form N-CSR. To the extent that listed issuers that
currently have compensation recovery policies might not disclose the
existence or the specific terms of that policy, there may be direct
benefits of this disclosure requirement separate from any pecuniary
recovery following an accounting restatement. The disclosure
requirements are intended to inform shareholders and the listing
exchange as to the substance of a listed issuer's recovery policy and
how the listed issuer implements that policy in practice. For instance,
the disclosure requirements include the date of and amount of
erroneously awarded compensation attributable to the accounting
restatement, certain estimates that were used in determining the
amount, and the amounts that have been collected, are still owed, and
are forgone. The final rules also require issuers to indicate by a
check box on the cover page of their annual reports whether the
financial statements of the registrant included in the filing reflect
correction of an error to previously issued financial statements and
whether any of those error corrections are restatements that required a
recovery analysis.
    The final rules also require the disclosure (including the cover
page check boxes) be provided in Inline XBRL, a structured (i.e.,
machine-readable) data language. This may facilitate the extraction and
analysis (e.g., comparison, aggregation, filtering) of the disclosed
information across a large number of issuers or, eventually, over
several years. XBRL requirements for public operating company financial
statement disclosures have been observed to mitigate information
asymmetry by reducing information processing costs, thereby making the
disclosures easier to access and analyze.\493\ While these observations
are specific to operating company financial statement disclosures and
not to disclosures outside the financial statements, such as the
compensation recovery disclosures, they suggest that the Inline XBRL
requirements could directly or indirectly (i.e., through information
intermediaries such as financial media, data aggregators, and academic
researchers) provide investors with increased insight into information
related to compensation recovery at specific issuers and across
issuers, industries, and time periods.\494\ Additionally, requiring
Inline XBRL tagging of the compensation recovery disclosure benefits
investors by making the disclosures more readily available and easily
accessible to investors, market participants, and others for
aggregation, comparison, filtering, and other analysis, as compared to
requiring a non-machine readable data language such as ASCII or HTML.
---------------------------------------------------------------------------

    \493\ See, e.g., Jeff Zeyun Chen et al., Information Processing
Costs and Corporate Tax Avoidance: Evidence From the SEC's XBRL
Mandate (Jan. 11, 2021), 40 J. Acct. & Pub. Pol'y 2 (finding XBRL
reporting decreases likelihood of firm tax avoidance because ``XBRL
reporting reduces the cost of IRS monitoring in terms of information
processing, which dampens managerial incentives to engage in tax
avoidance behavior''); see also Paul A. Griffin et al., The SEC's
XBRL Mandate and Credit Risk: Evidence on a Link Between Credit
Default Swap Pricing and XBRL Disclosure, Am. Acct. Ass'n Ann.
Meeting, (2014) (finding XBRL reporting enables better outside
monitoring of firms by creditors, leading to a reduction in firm
default risk); see also Elizabeth Blankespoor, The Impact of
Information Processing Costs on Firm Disclosure Choice: Evidence
from the XBRL Mandate, 57 J. Of Acc. Res. 919, 919-967 (2019)
(finding ``firms increase their quantitative footnote disclosures
upon implementation of XBRL detailed tagging requirements designed
to reduce information users' processing costs,'' and ``both
regulatory and non-regulatory market participants play a role in
monitoring firm disclosures,'' suggesting ``that the processing
costs of market participants can be significant enough to impact
firms' disclosure decisions'').
    \494\ See, e.g., Nina Trentmann, Companies Adjust Earnings for
Covid-19 Costs, But Are They Still a One-Time Expense?, Wall St. J.
(Sept. 24, 2020, 3:54AM) (citing an XBRL research software provider
as a source for the analysis described in the article), available at
https://www.wsj.com/articles/companies-adjust-earnings-for-covid-19-costs-but-are-they-still-a-one-time-expense-11600939813 (retrieved
from Factiva database); see also XBRL Int'l, Bloomberg Lists BSE
XBRL Data (Mar. 17, 2019), available at https://www.xbrl.org/news/bloomberg-lists-bse-xbrl-data/; see also Rani Hoitash and Udi
Hoitash, Measuring Accounting Reporting Complexity With XBRL, 93
Acct. Rev. 259 (2018), available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2433677 (retrieved from SSRN Elsevier
database).
---------------------------------------------------------------------------

    The compliance costs associated with the final rules, which apply
only to listed issuers, would include costs attributable to the Inline
XBRL tagging requirements. Various preparation solutions have been
developed and used by operating companies to fulfill XBRL requirements,
and some evidence suggests that, for smaller companies, XBRL compliance
costs have decreased over time.\495\ The incremental

compliance costs associated with Inline XBRL tagging requirements under
the final rules are mitigated by the fact that most issuers subject to
the tagging requirements are or will be subject to other Inline XBRL
requirements for other disclosures in Commission filings, including
financial statement and cover page disclosures in certain periodic
reports and registration statements.\496\ Such issuers may be able to
leverage existing Inline XBRL preparation processes and expertise in
complying with the Inline XBRL tagging requirements under the final
rules.
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    \495\ An AICPA survey of 1,032 reporting companies with $75
million or less in market capitalization in 2018 found an average
cost of $5,850 per year, a median cost of $2,500 per year, and a
maximum cost of $51,500 per year for fully outsourced XBRL creation
and filing, representing a 45% decline in average cost and a 69%
decline in median cost since 2014. See Michael Cohn, AICPA Sees 45%
Drop in XBRL Costs for Small Companies, Acct. Today (Aug. 15, 2018),
available at https://www.accountingtoday.com/news/aicpa-sees-45-drop-in-xbrl-costs-for-small-reporting-companies (retrieved from
Factiva database). In addition, a 2018 NASDAQ survey of 151 listed
registrants found an average XBRL compliance cost of $20,000 per
quarter, a median XBRL compliance cost of $7,500 per quarter, and a
maximum XBRL compliance cost of $350,000 per quarter in XBRL costs.
See Letter from Nasdaq, Inc. (Mar. 21, 2019) (to the Request for
Comment on Earnings Releases and Quarterly Reports); see Request for
Comment on Earnings Releases and Quarterly Reports, Release No. 33-
10588 (Dec. 18, 2018) [83 FR 65601 (Dec. 21, 2018)].
    \496\ See 17 CFR 229.601(b)(101), General Instruction C.4 of
Form N-CSR, and 17 CFR 232.405.
---------------------------------------------------------------------------

    With the new disclosures, investors may have a better understanding
of the incentives of the issuer's executive officers, owing to more
complete disclosure of the issuer's compensation policies, including
its recovery policy. Moreover, while listed issuers will be required to
adopt and comply with a recovery policy satisfying the requirements of
the final rules, issuers will have the choice to implement recovery
policies that are more extensive than these requirements. For example,
issuers may choose to establish more stringent recovery policies (e.g.,
a longer look-back period, more forms of compensation subject to
recovery, or more individuals covered) to provide a positive signal to
the market regarding their approach to executive compensation. If
variation in the scope of issuers' recovery policies emerges across
issuers, disclosure of those policies may marginally improve allocative
efficiency by allowing investors to make more informed investment
decisions based on a better understanding of the incentives of the
executive officers. The requirement to publish recovery policies may
make such variation more likely to emerge.\497\
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    \497\ In the absence of a mandatory requirement for issuers to
implement and disclose a recovery policy, investors may be uncertain
about whether the implementation of a voluntary recovery policy by
an issuer is a credible signal of the issuer's approach to executive
compensation. By increasing the likelihood of a recovery policy
being enforced, the final rules may make the signal more credible
and allow issuers to differentiate themselves based on variation in
the scope of a recovery policy.
---------------------------------------------------------------------------

    Further, if at any time during the last completed fiscal year a
listed issuer's recovery policy required an issuer to recover
erroneously awarded compensation, the final rules will require the
issuer to disclose details of the recovery efforts under Item 402(w) of
Regulation S-K. These disclosures will allow existing and prospective
shareholders to observe whether issuers are enforcing their recovery
policies consistent with Section 10D. This will also help exchanges
monitor compliance. Similarly, the requirement to disclose instances in
which the board does not pursue recovery and its reasons for doing so
(e.g., because the expense of enforcing recovery rights would exceed
the amount of erroneously awarded compensation or because the recovery
would violate a home country's laws), would permit shareholders to be
aware of the board's actions in this regard and thus potentially hold
board members accountable for their decisions.
    As a commenter noted, there are a number of direct costs for
issuers resulting from the disclosure requirements of the final
rules.\498\ First, issuers will incur direct costs to file their
compensation recovery policies as an exhibit to their Exchange Act
annual reports. For purposes of our Paperwork Reduction Act Analysis,
we estimate that the exhibit filing requirement would impose a minimal
burden of 0.4 hours per issuer. Second, if an issuer is required to
recover erroneously awarded compensation, or if there is an outstanding
balance from application of the recovery policy to a prior restatement,
the issuer would incur a direct cost to prepare and disclose the
information required by Item 402(w) of Regulation S-K, Item 6.F of Form
20-F, or paragraph B.19 of Form 40-F, as applicable (or, for registered
management investment companies, Item 18 to Form N-CSR and Item
22(b)(20) of Schedule 14A) and the corresponding narrative. For
purposes of our PRA, we estimate that the final disclosure requirement,
including costs to tag the required disclosure in Inline XBRL, as
described above, would impose a burden of 25 hours per issuer.\499\
---------------------------------------------------------------------------

    \498\ See, e.g., comment letter from IBC (noting that the
``necessity for additional disclosures as well as the XBRL
requirement increase the administrative cost to the registrant due
to the substantial increase in the amount of information required
for disclosure and the complexity of formatting data in XBRL'')
    \499\ See Section V.C., for a more extensive discussion of these
disclosure burdens, including the monetization and aggregation
across issuers of these direct costs.
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7. Indemnification and Insurance
    Many of the benefits discussed above would result from an executive
officer's changes in behavior as a result of incentive-based
compensation being at risk for recovery should a ``Big R'' or ``little
r'' restatement be required. These benefits would be substantially
undermined if the issuer were able to indemnify the executive officer
for the loss of compensation.\500\ Moreover, as a commenter noted,
shareholders would bear the cost of providing such
indemnification.\501\ Therefore, the indemnification provision
prohibits listed issuers from indemnifying current and former executive
officers against the loss of erroneously awarded compensation or paying
or reimbursing such executives for insurance premiums to cover losses
incurred under the recovery policy.\502\
---------------------------------------------------------------------------

    \500\ Several commenters offered suggestions on this issue, see
Section II.E.2.
    \501\ See, e.g., comment letter from Rosanne D. Balfour,
discussing this potential outcome.
    \502\ As an example of the type of indemnification that is
prohibited, one commenter noted that when Wilmington Trust was
required to recover $2 million from an executive under the TARP
clawback rules, the company responded by increasing the executive's
base salary by 25%. See comment letter from Kovachev. See also the
discussion infra at note 368.
---------------------------------------------------------------------------

    Although reimbursement of insurance premiums by issuers would be
prohibited, the insurance market may develop an insurance product that
would allow an executive officer, as an individual, to purchase
insurance against the loss of incentive-based compensation when the
material accounting error is not attributable to the executive. In that
event, an executive officer would be able to hedge some of the risk
that results from a recovery policy. If an executive officer purchased
this type of insurance policy, the benefits of the issuer's recovery
policy could be reduced to the extent that insurance reduces the
executive officer's incentive to ensure accurate financial reporting.
However, to the extent an insurance policy does not cover losses
resulting from the recovery of compensation attributed to a material
accounting error that resulted from inappropriate actions by the
insured executive officer, then incentives would remain for the
executive to avoid inappropriate actions.
    The development of this type of private insurance policy for
executive officers would also have implications for issuers. Overall,
it could make it less costly for an issuer to compensate an executive
officer after implementing a recovery policy. If an active insurance

market develops such that the executive officer could hedge against the
uncertainty caused by the recovery policy, then market-determined
compensation packages would likely increase to cover the cost of such
policy. While the indemnification provision prohibits issuers from
reimbursing a current or former executive officer for the cost of such
insurance policy, a market-determined compensation package would likely
account for the hedging cost and incorporate it into the base salary of
the executive officer's compensation. This increase may be less than
the increase in the market-determined compensation packages if an
insurance policy was unavailable because an insurance company may be
more willing to bear uncertainty than a risk-averse executive.
8. Effects May Vary for Different Types of Issuers
    The effects of the final rules may vary across different types of
listed issuers. In particular, the effects of implementing a recovery
policy could be greater (or lower) on SRCs, relative to non-SRCs, to
the extent that SRCs have different compensation structures, financial
reporting complexity, or quality than other issuers. Analysis by
Commission staff indicates that SRCs, on average, use a lower
proportion of incentive-based compensation than non-SRCs, suggesting a
lower potential impact of the final rules on SRCs.\503\ On the other
hand, as discussed in Section IV.A., only 34% of SRCs currently have a
recovery policy in place in contrast to 71% of larger domestic issuers.
As a result, SRCs may experience more dramatic benefits as well as
larger costs, relative to the baseline. There is also evidence that
companies that are typically required to restate financial disclosures
are generally smaller than those that are not required to restate
financial disclosures, suggesting that there could be a greater
incidence of restatements and recoveries at SRCs.\504\ Academic studies
suggest that the likelihood of reporting a material weakness in
internal control over financial reporting decreases as the size of the
issuer increases.\505\ This may imply that, relative to non-SRCs, the
final rules may cause executive officers at SRCs to devote
proportionately more resources to the production of high-quality
financial reporting. Finally, to the extent that implementation of the
final rules entails fixed costs, SRCs, because of their smaller size,
would incur a greater proportional compliance burden than larger
issuers.
---------------------------------------------------------------------------

    \503\ Commission staff analyzed the composition of total
compensation paid to all named executive officers whose compensation
was reported in the Summary Compensation Table for 50 randomly
selected SRCs and 50 randomly selected non-SRCs in fiscal year 2021.
Staff found that, on average, SRCs pay 47% of total compensation in
base salary versus 20% for non-SRCs; SRCs pay 19% of total
compensation in stock awards versus 45% for non-SRCs; SRCs pay 7% of
total compensation in non-equity incentive plan compensation versus
18% for non-SRCs; SRCs pay 6% of total compensation as a bonus
versus 2% for non-SRCs; and SRCs pay 16% of total compensation in
option awards versus 8% for non-SRCs. Since the Summary Compensation
Table does not provide sufficient information to determine if stock
awards or non-equity incentive plan compensation would constitute
``incentive-based compensation'' as defined in the rule, these
differences should be taken as maximum estimated differences of
incentive-based compensation for named executive officers. Staff did
not find significant differences between SRCs and non-SRCs in the
percent of compensation paid in nonqualified deferred compensation,
or in other compensation. We also note that the final rule covers a
broader set of employees than the named executive officers required
to report within the Summary Compensation Table.
    \504\ See Susan Scholz, Financial Restatement: Trends in the
United States 2003-2012, Ctr. Audit Quality, Washington, DC, (2013).
    \505\ See, e.g., Jeffrey T. Doyle et al., Determinants of
Weaknesses in Internal Control Over Financial Reporting, 44 J. Acct.
& Econ. 193 (2007) available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=770465 (retrieved from SSRN Elsevier
database).
---------------------------------------------------------------------------

    The final rules also may affect EGCs differently than non-EGCs.
Relative to non-EGCs, EGCs can be characterized as having higher
expected growth in the future and potentially higher risk investment
opportunities.\506\ As such, relative to non-EGCs, the market
valuations of EGCs may be driven more by future prospects than by the
value of current assets. As discussed above, a recovery policy could
reduce the incentive of an executive officer to invest in certain
value-enhancing projects that may increase the likelihood of a material
accounting error, including both ``Big R'' and ``little r''
restatements. This reduced incentive could have a greater impact for
EGCs, relative to non-EGCs, to the extent that executive officers at
EGCs are more likely to forgo value-enhancing growth opportunities as a
result of the final rules, which as discussed above, may have a larger
impact on the market value of equity of EGCs, relative to non-EGCs.
However, EGCs also tend to be smaller than non-EGCs,\507\ which may
imply that EGCs have a higher likelihood of an accounting restatement
and a higher likelihood of reporting a material weakness in internal
control over financial reporting. Similar to SRCs, this may imply that,
relative to non-EGCs, the final rules may cause executive officers at
EGCs to devote proportionately more resources to the production of
high-quality financial reporting. Also, as discussed in Section IV.A.,
only 19% of EGCs currently have a recovery policy in place compared to
71% of larger domestic issuers . As a result, EGCs may experience more
dramatic changes relative to the baseline.
---------------------------------------------------------------------------

    \506\ In an analysis of 446 EGCs with fiscal year 2021 data
available in the Standard & Poor's Compustat and the CRSP monthly
stock returns databases, Commission staff found that on average EGCs
have higher research and development expenses as a percent of total
assets. For this analysis staff set book-to-market to the 0.025 and
0.975 percentile for values outside of that range; staff set
research and development to the 0.975 percentile for values above
that level; and staff restricted the analysis to companies that
issued common equity and were listed on NYSE, NYSE MKT, or NASDAQ.
    \507\ Using the same dataset referenced in note 322, staff found
the average market capitalization of EGCs is approximately $1.5
billion while the average market capitalization of non-EGCs is
approximately $14.6 billion. Staff also found the smallest EGCs tend
to be relatively close in market capitalization to the smallest non-
EGCs, with the 10th percentile of the distributions of the market
capitalization of EGCs and non-EGCs being approximately $40.6
million and $60.5 million, respectively. Conversely, staff found the
largest EGCs tend to have substantially lower market capitalizations
than the largest non-EGCs, with the 90th percentile of the
distributions of the market capitalization of EGCs and non-EGCs
being approximately $2.9 billion and $21.9 billion.
---------------------------------------------------------------------------

    Some commenters have noted that SRCs and EGCs may face
disproportionate costs.\508\ One commenter noted that these companies
may benefit disproportionately,\509\ and another commenter indicated
that the benefits may be lower for companies immediately following the
IPO process.\510\ We acknowledge that SRCs and EGCs may face
disproportionate costs of compliance as compared to other companies,
but also note that our baseline analysis suggests that fewer of these
companies may have implemented compensation recovery policies \511\ and

consequently may realize disproportionate benefits.\512\
---------------------------------------------------------------------------

    \508\ See, e.g., comment letter from ABA 1 (indicating that SRCs
and EGCs are likely to bear significant costs in enforcing a
mandatory compensation recovery policy and that the proposed rule
would create a costly incentive for newly public issuers to avoid
the use of incentive based compensation); CCMC 2 (indicating that
the costs would be disproportionate); Compensia (indicating that
SRCs and EGCs would face disproportionate costs); Mercer (indicating
that the rule could impede the facilitation of capital formation for
SRCs and EGCs); and NACD (suggesting the rule ``puts an inordinate
burden on smaller companies, which cannot always afford the kind of
compliance costs entailed by new rules'').
    \509\ See, e.g., comment letter from Public Citizen 1
(suggesting that ``the chance for manipulation [at SRCs] is perhaps
even greater at such companies than at larger firms with a wider and
arguably more vigilant shareholder base'').
    \510\ See, e.g., comment letter from Compensia (suggesting that
for EGCs, ``the likelihood of a financial restatement in the period
immediately following an IPO would be minimal given the degree of
scrutiny the issuer must undergo during the offering process'').
    \511\ See Section IV.A.
    \512\ See supra note 413.
---------------------------------------------------------------------------

    In addition, we recognize that there may be additional specific
costs and benefits for FPIs. While we believe the typical issuer is
unlikely to transfer listing in the short-term as a result of the final
rules, the potential response of FPIs is less clear. On one hand, by
virtue of listing on a U.S. exchange, an FPI has demonstrated
willingness to list outside of the issuer's home country. The issuer
presumably chose to list on a U.S. exchange because the particular U.S.
exchange is an advantageous trading venue for the issuer's securities.
    Commenters have noted that the final rules would increase the
compliance burden on FPIs and could thereby potentially reduce the
advantage of listing on a U.S. market.\513\ One commenter noted that
the final rules would cause a competitive disadvantage for domestic
issuers as compared to foreign issuers,\514\ and others noted that they
may encourage foreign governments to pass laws that disadvantage or
penalize U.S. corporations.\515\ In addition, commenters noted that
U.S. corporations operating in jurisdictions outside the United States
would face similar compliance hurdles as FPIs.\516\
---------------------------------------------------------------------------

    \513\ See, e.g., comment letters from CCMC 1; and Coalition. See
also, e.g., comment letter from Freshfields (noting that the rules
will require FPIs to identify and keep track of executive officers
consistent with Section 16, and stating that, as a result of such
requirements, the Economic Analysis in the Proposing Release
understates the compliance burden for FPIs, especially if the FPI
becomes subject to two clawback regimes); and Kaye Scholer (stating
that the proposal does not give due consideration to or address the
complications that would arise where an FPI is also required to
recover compensation under home country rules, such as situations
where the home country has a different definition of incentive-based
compensation). In addition, see comment letter from UBS (noting that
it may lose attractiveness as an employer as a result of the
proposed rules).
    \514\ See comment letter from Bishop.
    \515\ See comment letters from CCMC 1; and Coalition.
    \516\ See, e.g., comment letters from CCMC 1; and Coalition.
---------------------------------------------------------------------------

    We recognize that FPIs may bear additional compliance costs, as
noted by commenters, relative to non-FPI listed issuers. As a result,
FPIs could choose to delist from U.S. exchanges.\517\ Further, FPIs
that are not currently listed on U.S. exchanges, but are considering
listing on a non-home country exchange, may choose to list on another
non-home foreign exchange because of the increased burden of our final
rules. At the same time, we understand that one of the benefits of
listing on a U.S. exchange is that an issuer can signal the high
quality of its corporate governance, which is achieved by subjecting
itself to the rigorous corporate governance rules and regulations of a
U.S. exchange.\518\ By listing on U.S. exchanges, many FPIs may gain
the ability to raise capital at a reduced cost compared to their home
market. Hence, some FPIs seeking access to U.S. capital markets may
view the requirements as beneficial.
---------------------------------------------------------------------------

    \517\ See supra note 261, describing feedback from commenters
who note that the rules may create potential disincentives for FPIs
to list on U.S. exchanges. See also comment letter from Davis Polk 1
(noting that ``adoption of Section 404 of the Sarbanes-Oxley Act of
2002 led 51.6% of foreign firms to consider delisting from U.S.
exchanges, and led 76.8% of small foreign firms to consider
delisting, with 98 foreign firms de-listing in 2002,'' citing SEC
Office of Economic Analysis, Study of the Sarbanes-Oxley Act of 2002
Section 404 Internal Control over Financial Reporting Requirements
(Sep. 2009), available at https://www.sec.gov/news/studies/2009/sox-404_study.pdf.)
    \518\ See, e.g., Craig Doidge et al., Why do Foreign Firms Leave
U.S. Equity Markets?, 65 J. Fin., 1507 (2010), (noting that by
subjecting themselves to U.S. laws and institutions, insiders of
foreign firms credibly bond themselves to avoid some types of
actions that might decrease the wealth of minority shareholders.)
But see comment letter from Kaye Scholer (arguing that U.S.
standards for corporate governance may not be more rigorous than
other jurisdictions, and further that it is not clear that FPIs list
on a U.S. exchange to signal their high quality corporate governance
rather than to access U.S. capital markets or to provide more
liquidity for their stock).
---------------------------------------------------------------------------

    We also recognize that the final rule may have different effects on
listed funds. One commenter noted that listed funds' financial
statements are less complex than operating company financial statements
and that accounting restatements are relatively rare for funds.\519\
The commenter also stated that the proposal could affect more than the
small number of internally managed listed funds that the Commission
estimated in the proposal, because some externally managed listed funds
may pay some or all of the funds' chief compliance officers'
compensation.
---------------------------------------------------------------------------

    \519\ See comment letter from ICI.
---------------------------------------------------------------------------

    We recognize that there is a wide range of complexity in issuer
financial reporting. Issuers with less complex financial reporting,
such as some listed funds, may realize fewer benefits from the final
rule. We also anticipate that such issuers may experience fewer costs,
as fewer compensation contracts may be affected, and potential trigger
events would be relatively rare. In addition, we recognize that listed
funds that pay for their chief compliance officers' compensation would
be affected by the final rule, and that as a result, the number of
affected funds likely exceeds the estimate provided in the Proposing
Release.

C. Alternatives

    Below we discuss possible alternatives to the final rules we
considered and their likely economic effects.
1. Exemptions for Certain Categories of Issuers
    We considered exempting (or permitting the exchanges to exempt)
SRCs and EGCs from proposed Rule 10D-1. As discussed above, the final
rules may impose certain disproportionate costs on SRCs and EGCs.
However, smaller issuers, SRCs and EGCs, may have an increased
likelihood of reporting an accounting error and may be more likely to
report a material weakness in internal control over financial
reporting.\520\ As more fully discussed in Section II.A.3, while the
Commission has the authority to exercise its discretion to exempt such
issuers, Congress did not direct the Commission to consider
differential treatment for recovery of incentive-based compensation
that was not earned and should not have been paid for SRCs or EGCs. As
such, we see no reason why shareholders of smaller issuers should not
benefit from recovery of erroneously awarded compensation in the same
manner as shareholders of larger issuers.
---------------------------------------------------------------------------

    \520\ See, Choudhary et al., supra note 61 (finding that future
restatements are less likely for larger firms). See also comment
letter from Public Citizen 1 (arguing that the risk of manipulation
is greater at smaller companies).
---------------------------------------------------------------------------

    A number of commenters suggested that we consider exempting FPIs,
arguing that home countries would generally have a greater interest in
determining whether issuers should have recourse against executive
officers.\521\ Another commenter suggested that some issuers may be
required to implement two different recovery policies, and also noted
that FPIs are not currently required to identify Section 16 officers.
As a result, the commenter stated that the economic analysis in the
Proposing Release understated the costs for FPIs.\522\
---------------------------------------------------------------------------

    \521\ See, e.g., comment letters from the ABA 1; Bishop; and
Davis Polk 1.
    \522\ See supra footnotes 32 through 37; see also comment letter
from Freshfields (``we expect all UK companies that are FPIs either
already have a clawback in place, or will implement one when their
directors' remuneration policy is next submitted for shareholder
approval,'' and ``we believe that the Economic Analysis in the
Release understates the compliance burden for FPIs especially if the
FPI becomes subject to two clawback regimes'').
---------------------------------------------------------------------------

    As discussed previously in the context of FPIs generally, the
potential effect of the final rules on FPIs is difficult to predict. On
the one hand, due to the potential differences in home

country law, the final rule requirements may be especially burdensome
for FPIs relative to non-FPIs.\523\ On the other hand, there is
evidence that many FPIs may be listing on U.S. exchanges in part to
credibly signal to investors their willingness and ability to be
subjected to stricter governance standards.\524\ While FPIs may face a
relatively higher burden from the final rules, they also may experience
a relatively higher benefit. As more fully discussed in Section II.A.3,
while the Commission has the authority to exercise its discretion to
exempt such issuers, the concerns expressed by commenters do not in our
view justify exempting all FPIs from the obligation to recover
incentive-based compensation that was erroneously awarded. Moreover,
the recovery requirements will help to encourage reliable financial
reporting by listed issuers, which is as important for investors in
FPIs as for other issuers. Studies have shown that foreign companies
present a similar risk of restatement as other companies \525\ and that
U.S. issuers who are non-accelerated filers accounted for approximately
53% of restatements.\526\ To the extent that recovery under Rule 10D-1
would be wholly inconsistent with a foreign regulatory regime, we have
included an impracticability accommodation, as discussed in Section
II.C.3.b., which may alleviate some of the implementation challenges
faced by FPIs.
---------------------------------------------------------------------------

    \523\ We note that if recovery of erroneously awarded
compensation would violate home country laws that were in effect as
of the date of publication of Rule 10D-1 in the Federal Register,
the final rules may permit the board of directors discretion to
forgo recovery as impracticable, subject to certain conditions.
    \524\ See Craig Doidge et al., supra note 518.
    \525\ See supra note 56.
    \526\ See A Twenty-Year Review.
---------------------------------------------------------------------------

    Certain commenters also suggested we unconditionally exempt listed
funds, rather than the conditional exemption we are adopting. Listed
funds, unlike most other issuers, are generally externally managed and
often have few, if any, employees that are compensated by the fund
(i.e., the issuer). As discussed above, the final rules are designed to
reflect the structure and compensation practices of listed funds by
requiring funds to implement compensation recovery policies only when
they in fact award incentive-based compensation covered by Section 10D.
As such, we believe the rules are appropriately tailored as applied to
funds in that they will only apply to the small subset of listed funds
that award incentive-based compensation covered by Section 10D.
2. Excluding Incentive-Based Compensation Tied to Stock Price
    The final rule encompasses incentive-based compensation tied to
measures such as stock price and TSR because improper accounting
affects such financial reporting measures and in turn results in excess
compensation. As discussed above, the final rules may result in issuers
incurring significant costs to recover incentive-based compensation
tied to stock price. If incentive-based compensation tied to stock
price were excluded from the final rules, issuers would not incur the
costs associated with recovery. However, a significant component of the
total performance-based compensation would be excluded from the scope
of the final rules without generating the related potential benefits.
In addition, the exclusion of performance-based compensation tied to
stock price would provide issuers with an incentive to shift
compensation away from forms subject to recovery to forms tied to
market-based metrics such as stock price and TSR that would not be
subject to recovery.
    The economic effect of any incentive to shift away from
compensation subject to recovery is difficult to predict due to the
nature of incentive-based compensation tied to stock price. On one
hand, incentive-based compensation tied to metrics that are market-
based, such as stock price or TSR, could be highly correlated with the
interests of shareholders and therefore may be beneficial to
shareholders. On the other hand, because market-based measures may be
influenced by factors that are unrelated to the performance of the
executive officer, these metrics may not fully capture or represent the
effort and actions taken by the executives. In particular, market-based
measures incorporate expectations about future earnings, which may not
be closely tied to the executive officer's current performance. In
contrast, the use of accounting-based measures, such as those derived
from revenue, earnings, and operating income, can be tailored to match
a specific performance period and provide direct measures of financial
outcomes.\527\ To this end, accounting-based measures of performance--
although not directly tied to issuer value enhancement--may better
capture the effect of an executive officer's actions during the
relevant performance period. Therefore, if incentive-based compensation
tied to stock price were excluded, the incentive to substitute away
from accounting-based measures to market-based measures of performance
may result in compensation that is less tied to the consequences of an
executive officer's actions during the performance period. Since
changes in compensation practices away from the current market
practices may be either beneficial to issuers or not, depending on
whether current practices are optimal, it is unclear that shifting
compensation toward forms tied to market-based metrics would be
beneficial.
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    \527\ All of the seven most frequently used metrics to award
compensation in short-term incentive plans were accounting-based
measures. Those measures are operating income, revenue, cash flow,
EPS, return measures, operating income margin, and net income. See
Meridian Report. See also supra note 356.
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    The optimal compensation package may contain a mix of incentive-
based compensation tied to market-based measures and accounting-based
measures. Empirically, the use of market-based performance metrics is
more prevalent in long-term incentive plans than in short-term
incentive plans.\528\ Using market-based measures of performance in
short-term incentive plans may be undesirable for the executive officer
in that the stock price may be volatile and may not reflect the
executive's efforts to enhance firm value in the performance period.
The relatively higher use of market-based measures in long-term
incentive plans could reflect that in the long-term the executive
officer's efforts to enhance firm value may be more likely to be
incorporated in the market value of the firm. Short-term and long-term
performance-based compensation may act as complements, with the
different performance measures used to award each type reflecting the
compensation committee's effort to align the executive officer's
interests with those of the shareholders. The exclusion of incentive-
based compensation tied to stock price may affect the relative mix of
short-term and long-term performance-based compensation, or the
performance measures that each type is linked to, and consequently may
adversely affect the incentives of the executive officer.
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    \528\ See Meridian Report.
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3. Including Only ``Big R'' Restatements as Trigger Events
    The Commission considered adopting final rules that would provide
that recovery is required with respect to only ``Big R'' restatements
that correct errors that are material to previously issued financial
statements. Under that alternative, ``little r'' restatements would not
trigger a potential recovery.
    As discussed above, some commenters have provided feedback

indicating that there are substantial benefits associated with
including ``little r'' restatements as trigger events, including the
likelihood that the final rules will provide stronger incentives for
managers to monitor the accuracy of financial statements.\529\ Were we
to include only ``Big R'' restatements, those benefits would not be
realized. However, other commenters have noted that the inclusion of
``little r'' restatements as trigger events may increase the costs of
compliance with the final rules compared to an alternative of including
only ``Big R'' restatements.\530\ Although it is possible that certain
compliance costs may be higher as a result of the inclusion of ``little
r'' restatements in the scope of potential trigger events, as discussed
above, not every restatement would trigger a recovery of compensation
that was earned as a result of meeting performance measures.\531\ In
addition, issuers are already required to perform a materiality
analysis on each error that is identified in order to determine how to
account for and report the correction of that error, and in that
context, issuers may have already calculated the impact of the error on
executive compensation. Furthermore, the broader scope of encompassing
``little r'' restatements addresses concerns that issuers could
manipulate materiality and restatement determinations to avoid
application of the compensation recovery policy.\532\
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    \529\ See supra note 84.
    \530\ See supra note 88. Also, as noted in the Second Reopening
Release, the inclusion of ``little r'' restatements as potential
trigger events increases the number of potential trigger events.
    \531\ We expect that recovery of incentive-based compensation
that is tied to TSR would be relatively small and infrequent as a
result of ``little r'' restatements, since these restatements are
less likely to be associated with significant stock price reactions.
See Choudhary et al., supra note 61 (finding an average stock price
reaction of -3.3% to ``Big R'' restatements and -0.3% for ``little
r'' restatements); Thompson, supra note 79 (finding an average stock
price reaction of -1.5% to ``Big R'' restatements and -0.3% for
``little r'' restatements).
    \532\ See supra note 107.
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4. Other Alternatives Considered
    Some commenters suggested that issuers may choose to implement a
nonqualified deferred compensation plan (e.g., a ``holdback plan'') to
aid in the recovery of erroneously awarded incentive-based
compensation.\533\ One commenter suggested that the Commission
specifically require the use of a holdback plan,\534\ and another
commenter noted that such a plan may raise significant tax issues and
recommended that the Commission provide the board of directors with
broad discretion.\535\ A holdback plan would likely reduce the costs of
recovering erroneously awarded incentive-based compensation. On the
other hand, a holdback plan may further augment any increase in
compensation necessary to offset the expected cost to the executive
officer of a recovery policy. This is due to the executive officer not
having access to the funds she has earned and having to delay
consumption that would otherwise be possible. These considerations
suggest that a holdback plan could be efficient at some issuers but
inefficient at others. We note that the rule does not mandate a
holdback plan, but also does not prevent issuers from adopting a
holdback plan if they so choose.
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    \533\ See comment letter from Compensia; NACD; and Bhagat and
Elson. See also Stuart Gillan and Nga Nguyen, Clawbacks, Holdbacks,
and CEO Contracting, 30 J. Appl. Corp. Fin., 53 (2018).
    \534\ See comment letter from Bhagat and Elson.
    \535\ See comment letter from ABA 1.
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    One commenter suggested that the Commission consider also requiring
recovery of proportional incentive compensation, whether or not it is
numerically connected to the restated financial results. This
suggestion would require issuers, in the event of a restatement, to
recover a proportionate amount of the compensation tied to qualitative
variables or board judgment.\536\ Relative to the final amendments,
this alternative implementation would reduce the incentive to alter the
composition of an executive officer's compensation package to more
heavily weight qualitative variables or board judgment, while
increasing the incentive to more heavily weight base salary as well as
performance-based compensation tied to metrics other than financial
reporting measures. To the extent that performance compensation based
on qualitative variables and board judgment allows the board to
compensate the executive officer for performance that is otherwise
difficult to measure, the reduced weight on this form of performance-
based compensation could make it more difficult for the board to align
the executive officer's interests with those of the shareholders. On
the other hand, as suggested by the commenter, we agree that reduced
weight on this form of performance-based compensation could make it
easier for shareholders to understand the incentives of the executive
officer. Because a greater amount of performance-based compensation
would be at risk for recovery, implementing this alternative could also
increase the amount of expected compensation the executive officer
would require in order to voluntarily bear the increased uncertainty.
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    \536\ See comment letter from Public Citizen 1.
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V. Paperwork Reduction Act

A. Summary of the Collection of Information

    Certain provisions of our rules, schedules, and forms that will be
affected by the final rules contain ``collection of information''
requirements within the meaning of the Paperwork Reduction Act. The
Commission published a notice requesting comment on changes to these
collections of information in the Proposing Release and submitted these
requirements to the Office of Management and Budget (``OMB'') for
review in accordance with the PRA.\537\ While a number of commenters
provided comments on the potential costs of the proposed rules, as well
as factors that could affect the scope of entities covered by the
proposal, commenters did not specifically address our PRA
analysis.\538\
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    \537\ 44 U.S.C. 3507(d) and 5 CFR 1320.11.
    \538\ See supra Section II. One commenter contended that the
Reopening Release should have included an updated PRA analysis. See
comment letter from Toomey/Shelby, supra note 14.
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    The hours and costs associated with preparing, filing, and
distributing the schedules and forms constitute reporting and cost
burdens imposed by each collection of information. An agency may not
conduct or sponsor, and a person is not required to comply with, a
collection of information unless it displays a currently valid OMB
control number. Compliance with the information collections is
mandatory. Responses to the information collections are not
confidential and there is no mandatory retention period for the
information disclosed. The titles for the affected collections of
information are:
    ``Form 10-K'' (OMB Control No. 3235-0063);
    ``Form 20-F'' (OMB Control No. 3235-0288);
    ``Form 40-F'' (OMB Control No. 3235-0381); and
    ``Form N-CSR'', Certified Shareholder Report of Registered
Management Investment Companies'' (OMB Control No. 3235-0570).\539\
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    \539\ The amendments also affect the following collections of
information: ``Regulation 14A and Schedule 14A'' (OMB Control No.
3235-0059); ``Regulation 14C and Schedule 14C'' (OMB Control No.
3235-0057); and ``Rule 20a-1 under the Investment Company Act of
1940, Solicitations of Proxies, Consents, and Authorizations'' (OMB
Control No. 3235-0158). Regulations 14A and 14C and the related
schedules require the new disclosure to be included in proxy and
consent solicitations. Rule 20a-1 requires funds to comply with
Regulation 14A, Schedule 14A, and all other rules and regulations
adopted pursuant to Section 14(a) of the Exchange Act that would be
applicable to a proxy solicitation if it were made in respect of a
security registered pursuant to Section 12 of the Exchange Act. As
noted below, for purposes of the PRA and in order to avoid the PRA
inventory reflecting duplicative burdens, we assume the disclosure
will be incorporated by reference into Form 10-K and Form N-CSR from
proxy and information statements and do not include a separate
burden for these collections of information. See notes 543 and 544.

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    The Commission adopted Form 10-K, Form 20-F and Form 40-F under the
Exchange Act. Form N-CSR was adopted under the Exchange Act and
Investment Company Act. The forms set forth the disclosure requirements
to help shareholders make informed voting and investment decisions.

B. Summary of the Final Amendments and Effect of the Final Amendments
on Existing Collections of Information

    To implement the provisions of Section 954 of the Dodd-Frank Act,
which added Section 10D to the Exchange Act we are adopting Rule 10D-1
under the Exchange Act as well as amendments to Items 402, 404, and 601
of Regulation S-K; Rule 405 of Regulation S-T; Schedule 14A; Form 20-F;
Form 40-F; Form 10-K; and Form N-CSR. Rule 10D-1 directs national
securities exchanges and associations to establish listing standards
that require listed issuers to adopt and comply with written policies
for recovery of erroneously awarded incentive-based compensation based
on financial information required to be reported under the securities
laws, applicable to the listed issuers' executive officers, over a
period of three years. As described in more detail above, we are also
adopting new disclosure requirements in Schedule 14A, Form 10-K, Form
20-F, Form 40-F, and Form N-CSR to require issuers listed on an
exchange to file their written compensation recovery policy as an
exhibit to their annual reports. Form 10-K, Form 20-F, Form 40-F
additionally require issuers listed on an exchange to indicate by a
check box on the cover page of their annual reports whether the
financial statements of the registrant included in the filing reflect
correction of an error to previously issued financial statements and
whether any of those error corrections are restatements that required a
recovery analysis; and disclose actions an issuer has taken pursuant to
such recovery policy. These disclosures will also be required to be
provided in tagged data language using Inline XBRL.\540\
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    \540\ While paperwork burdens associated with investment company
interactive data requirements are generally accounted for in the
Information Collection titled ``Registered Investment Company
Interactive Data,'' any burdens associated with interactive data for
investment companies associated with the final rules are estimated
to be negligible. For administrative simplicity, these burdens