"It’s not yet clear whether clawbacks will be government mandated or a best practice for compensation design," says Irv Becker, national practice leader for the executive compensation practice at Hay Group. "The issue is high up on the institutional shareholder list, and that’s where the pressure will come from."
The clawback provisions in the Sarbanes-Oxley Act of 2002 apply only to the CEO and CFO, and the only trigger is a financial restatement caused by misconduct. But the TARP rules apply clawbacks to senior executives and the 20 next most highly compensated employees and expand the trigger to include not only fraud or misrepresentation but also financial statements that are found to be simply "inaccurate."
In 2008, 64 percent of the Fortune 100 companies had a publicly disclosed clawback policy, up from 42 percent in 2007 and 17 percent in 2006, according to Equilar. Most cover cash bonuses and equity incentive compensation, but most apply only to the top five executives and limit the trigger to unethical behavior. Congress and shareholders are likely to demand broader clawback provisions modeled on TARP.
"Best practices will include inaccurate financial information as a trigger," Becker says. "The TARP language is the model and the claw- back would apply to any employee who received a bonus based on those incorrect numbers."
Morgan Stanley set a particularly severe standard in its December 2008 clawback provision. Its clawback now covers 7,000 employees and holds cash and equity bonuses in reserve for three years, subject to a clawback for any "conduct detrimental to the firm," including actions that cause the need for a restatement of results, a significant financial loss or "other reputational harm."
Some 2009 shareholder proposals for clawbacks at financial services companies include a provision to hold bonuses in escrow accounts for three years, a requirement similar to the bonus bank now in place at UBS, the Swiss banking giant, and a number of other financial firms.
"The concept of a bonus bank has been around for a while," Becker says. At UBS, executives can draw down no more than one-third of their bonus in the year it is earned. Becker believes that shareholder demands for escrow accounts or bonus banks will remain limited to companies in the finance sector.
"The reason companies haven’t gone down this path is that it minimizes the value of bonuses," Becker notes. A Hay Group study found that bonus banks can reduce the focus on maximizing performance and create confusion about goals. Some financial firms that adopted bonus banks have now discontinued them because of the motivational problems they create.
At companies that do not use a bonus bank or escrow account, HR executives will face significant questions about how to administer the clawback. "It’s hard to retrieve the money," Becker notes. "This problem can’t stop companies from adopting clawbacks because the momentum is there. But HR executives can think through the implementation issues."
Workforce Management, April 20, 2009, p. 18 -- Subscribe Now!