Clawbacks are back in the spotlight again and boards should embrace these policies as they can benefit of the companies they oversee. With the right emphasis and oversight, clawbacks can help improve financial reporting, lower some incidences of misconduct and enhance the company’s reputation as a bastion of good governance.
In February, Nasdaq and the New York Stock Exchange submitted proposals that would put them in compliance with the SEC’s Rule 10D-1, which directs the nation’s securities exchanges to require issuers to adopt and implement “clawback” policies. Under the rule, those policies must “provide for the recovery, in the event of a required accounting restatement, of incentive-based compensation received by current or former executive officers where that compensation is based on the erroneously reported financial information” and “require a listed issuer to file the policy as an exhibit to its annual report and include other disclosures in the event a recovery analysis is triggered under the policy.” The Nasdaq and NYSE proposals are in the comment phase.
Clawbacks are not new. Many companies, including Citibank, Wells Fargo and Capital One already have such policies (recently these companies expanded the circumstances in which clawbacks can be used). These NYSE and Nasdaq proposals require all companies listed on the two major stock exchanges to develop clawback policies and disclose the provisions of those policies publicly or risk being delisted. The threat of delisting ensures that corporate boards will take implementing clawbacks seriously. While no company wants to be threatened to comply with a rule, boards should embrace clawbacks for the following reasons:
Clawbacks can increase the level of trust between investors and the board. Boards exist to protect the investors. What better way to protect investors than to reclaim company revenue that was erroneously awarded as executive compensation. Boards have been under heavy scrutiny in recent years about the level of compensation they have approved for CEOs and other executives. Clawbacks provide protection that ensures that if financial restatements prove pay for performance objectives were not met, the company can recover any compensation that was not truly earned. Making sure executives do not profit from mistakes can help investors feel confident that the board is truly committed to awarding compensation fairly.
Clawbacks demonstrate that the company is committed to good governance. Exercising good governance requires that there be systems in place to hold people accountable. Clawbacks can help. Pay for performance has become a governance best practice, and clawbacks can serve to increase the emphasis on making sure individuals are compensated for actual results. Such policies show the company is willing to take the steps necessary to make things right. Showing commitment to good governance builds good will in the marketplace and can improve the company’s reputation with regulators and the public. Admitting mistakes and correcting them on behalf of investors is fundamental to good governance. Those companies that expand the use of clawbacks to include taking back bonuses from executives who cause serious financial or reputational damage to the company can enhance their reputation with investors and the community as a company that is run well and has exceptional governance standards. As employees understand that these accountability measures are in place and enforceable, it may help decrease some misconduct at the company.
Clawbacks can help improve the quality of financial reporting. Knowing that clawbacks can be triggered if financial records are not accurate could serve as motivation to make sure all financials are accurate. Financial restatements hurt the company’s reputation in the marketplace, and reclaiming compensation from current or former executives can become very costly and complicated. Understanding all of the drawbacks of filing inaccurate financial reports can serve as an incentive to double and triple check the numbers at all times.