How Boards Can Turn Clawback Scrutiny To Their Benefit

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While a discussion about clawback policies might be difficult, if handled smartly, it could be used to the board’s advantage. Some tips.

Clawbacks are back on corporate board agendas this year as the Securities Exchange Commission plans to issue updated regulations on the recoupment of executive compensation by the end of October 2022.

The compensation of executives has been a concern of investors in recent years as CEO salaries have continued to rise even as many companies have underperformed during an economic period that has been impacted by worldwide shutdowns because of the Covid 19 pandemic, supply chain disruptions, trade wars, geopolitical unrest, and record inflation.

Now the SEC wants companies to make certain that clawback policies comply with the Dodd-Frank Wall Street Reform and Consumer Protection Act and are posted where investors can see them.

The SEC claims that many company clawback policies do not comply with Dodd-Frank rules. The commission also suggests that clawbacks should be triggered when financial restatements are made due to simple errors – which is not the norm.

Companies should at the very least conduct a review of their clawback policies to make sure that they comply with Dodd-Frank. Such a review might reassure investors that the board is committed to implementing fair compensation practices – even if that means recovering compensation that may have been awarded due to misinformation, financial statement errors or other circumstances when warranted.

While a discussion about clawback policies might be difficult, if handled smartly, it could be used to the board’s advantage:

Create goodwill with shareholders regarding compensation policies.

Alerting shareholders that the board is reviewing clawback policies sends a positive message about the board’s commitment to good governance. Demonstrating that the board is serious about taking money back from executives when warranted will create trust that will strengthen investor relations. The review could extend to discussions with large shareholders about their views on clawbacks and incentive compensation policies. Collecting information about shareholder concerns about compensation will be helpful in crafting future compensation plans that will be approved with shareholder support.

Extend the board review to include incentive-based compensation.

Clawbacks are often a byproduct the type of incentive-based compensation executives are offered. The SEC considers incentive-based compensation “any compensation that is granted, earned, or vested based upon the attainment of a financial reporting measure, including stock price and total shareholder return (TSR).”

It might make sense to eliminate or severely limit the amount of compensation that can be earned, granted, or vested based on measures that can be manipulated or are easily impacted because of financial statement errors. This review could be very helpful because incentive-based compensation that made sense five years ago may not make sense today or in the future. Taking a fresh look at incentive-based compensation may show investors the board is committed to governance.

Announce a review of the financial statement and auditing process.

Announcing a review of how the financial statements are prepared and how the audit process is conducted should prove to shareholders that the company is commitment to complying with Dodd-Frank. Such a review is good governance and should be conducted periodically anyway, so this would be a good time to do it and reap the maximum benefit. If such a review has been done recently, the board could explain how the results of that review have helped its efforts to reduce the possibility of the company needed to clawback compensation from executives.

Review preparedness for clawback lawsuits.

While boards may take steps to prevent clawbacks, no one can predict when a shareholder may file a lawsuit. With increased scrutiny on compensation, there is an expectation that shareholders will be looking to file lawsuits protesting compensation awarded to certain executives – especially if companies report losses during what many expect will be a long and difficult recession. Companies should consider setting aside resources to contest lawsuits and begin developing defense strategies in the event shareholders sue to recoup compensation.

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