The Evolving Use of Clawback Provisions in Corporate America
According to a recent Wall Street Journal article, “Today, about 90% of the biggest companies write clawback provisions into executive contracts.” A clawback is a contractual provision of a compensation agreement that positions the employer to require from the former employee, repayment of specific types of previously paid compensation. Repayment conditions ensue when a pre-determined trigger event occurs.
Clawback provisions can be found in incentive plans, change-in-control arrangements, other aspects of employment contracts or as standalone agreements. Sometimes clawback amounts include penalties. Because clawback language can be scattered through numerous documents an organization should maintain an updated inventory of the corporate agreements they use or have used in the past, that include a clawback provision.
How Clawbacks are Structured
The concept of a clawback agreement was inspired by the Sarbanes-Oxley Act of 2002, which targeted corporate officers who knowingly certified false financial statements. In his article, “Compensation Clawbacks: Trends and Lessons Learned,” Joshua Agen, Foley & Lardner LLP, defined the parameters of Sarbanes-Oxley, saying it imposed, “a relatively narrow clawback requirement that applies only to the CEO and CFO and is triggered only if a restatement of financial results occurs as a result of misconduct.”
A generalized criterion for triggering the clawback decision could be, “did the executive’s actions or failure to act harm the organization and/or the public’s perception of the organization, and was this harm evidenced in a material way?”
The impact, however, of an executive’s actions may not be evidenced in the short term. And if a clawback is sought, the publicity around the action may further compound negative perception of the company.
When either publicly or privately held organizations elect to pursue a compensation clawback, the action typically is triggered by financial restatement that may or may not have included executive misconduct. But clawbacks may also be triggered by individual actions that are considered to be a misconduct issue, as is the case with McDonald’s Corporation’s former CEO, Steve Easterbrook. McDonald’s is attempting to recover more than $50 million in severance paid to Easterbrook after he stepped down during a misconduct inquiry. Easterbrook is fighting back.
Manage Compensation Subject to Clawback
As the WSJ article, “Clawbacks Are Hard, So Companies Try Postponing Pay Instead,” points out, recouping compensation because of executive misconduct is not—nor should it be—a quick or effortless process. The author of the article, Theo Francis, quoted University of Delaware finance professor, Charles Elson, who said, “the most effective way to recoup it is to never give it out to begin with.”
In an attempt to avoid clawbacks, some companies are requiring executives to hold a large portion of their vested equity grants beyond vesting or beyond it becoming payable to the executive. Deferring compensation, including annual bonuses, could help companies avoid the resource drain and potential publicity associated with a clawback proceeding, while at the same time protecting the best interests of organizations and their stakeholders.
With so many issues effecting equity-based compensation, corporations will want to be re-evaluating executive compensation plans with guidance from their executive benefits consultant.
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