Nearly all S&P 500 companies have now implemented a clawback clause of some sort. While initially the clauses sought to recover compensation in the event of fraud, this has expanded to cover misconduct that may not have resulted in a financial restatement but had a negative reputational impact.
However, there has been some skepticism regarding the willingness and ability of companies to actually claw back compensation when necessary. Sanjai Bhagat of the University of Colorado and Charles Elson of University of Delaware recently published an article in the Harvard Business Review entitled “
Why Executive Compensation Clawbacks Don’t Work.”
Looking at recent examples such as Goldman Sachs’ effort to recover $174 million from current and former executives due to a 2012 financial scandal, the authors identify two major reasons they consider clawbacks unsuccessful:
- Legal requirements for recovering compensation already paid to an executive typically involve the notion of “cause” — unless convicted of a crime, the executive can assert that the company does not have a legal right to reclaim the cash.
- Once the money is out the door, it is almost impossible to track it back down. It may have been spent or is functionally unrecoverable.
The authors’ proposed solution is to increase the use of restricted equity and options, requiring executives to hold shares until 6 – 12 months after departing a company. However, this is likely to result in a decrease in the perceived value of executive awards, a point the authors attempt to address by suggesting that boards might moderately increase the level of equity awards to balance the additional holding period and increased concentration and liquidity risks. Further, they note, the compensation committee could develop policies for approving the liquidation of small portions of equity over time.
Like calls for companies to eliminate performance-based equity in favor of restricted shares and salary, this proposal is not likely to win wide-scale adoption, but may be a part of the overall conversation on executive compensation going forward. Some market voices have called for stronger (and longer) equity retention requirements to better link long-term shareholder returns to executive pay, and any perceived difficulty clawing back compensation post-scandal may only increase those calls.
