Board remuneration committees may prefer deferral to clawback for governance and risk management
21/09/2010
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Even though the Productivity Commission report on executive remuneration made no recommendations on clawback, the Australian government’s 16 April 2010 response to the Productivity Commission’s recommendations included a commitment to release a discussion paper exploring the ‘clawback’ of bonuses paid to directors and executives where the company’s financial statements are materially misstated.  According to the government, clawback has the potential to assist shareholders recover overpaid bonuses from directors and executives, to simplify the process for shareholders to pursue bonus overpayment and to “… hold directors and executives more directly accountable to the determination of their own remuneration.”

The 21 August federal election has at least delayed the release of the discussion paper, but clawback will remain a topical issue.

The inclusion in the US Dodd-Frank bill in July of mandatory clawback provisions for any US-listed company that materially restates its financial statements provides further impetus in favour of clawback. Under the US Dodd-Frank bill, clawback will apply to incentive-based compensation (including stock options) paid during the three-year period preceding the restatement, and the recovery would be the amount in excess of what otherwise would have been paid to the officer.  This expands the clawback provision contained in the US Sarbanes-Oxley Act of 2002, which applies only to compensation received by the CEO and CFO and then only during the 12-month period following the first issuance of the restatement and only if the restatement resulted from misconduct.

Notable but not necessarily model aspects of the US clawback provisions are that they are mandatory, they apply automatically irrespective of fault and with no board discretion in the event of a re-statement of financial statements for any reason, they apply for 3 years prior to the restatement, and they define the amount to be recovered.

Even if clawback in the event of restatement of financial accounts is legislated, companies may want to consider the voluntary introduction of broader arrangements that will allow the board to exercise its discretion to protect shareholders in a range of circumstances.  These will need to be built in to executive contracts as well as the terms and conditions of incentive plans, with provision for arbitration to resolve disputes.

At best, clawback offers a remedy once a problem exists; preventing problems is a preferable and more effective approach.  This requires the development of remuneration policies and practices that are specifically tailored for the circumstances of each company and that support a high performance and high integrity culture.  The basic elements that need to be considered include:

        The right mix of fixed and at-risk remuneration

        An appropriate balance between short and long-term incentives

        Performance measures that reflect the drivers of company success and shareholder value

       Risk management through deferral of incentive payments after the initial performance testing so that if the performance on which they are based is validated after a reasonable time

        Long term incentives with timeframes and performance measures that ensure rewards are based on relevant performance.

 

This framework for good pay structures is not new, but has received greater attention in the wake of the GFC.  The government stated that its clawback proposal is consistent with APRA’s Prudential Practice Guide PPG 511 recommendations in favour of deferral of rewards with adjustment for subsequent performance, but has ignored APRA’s and the Productivity Commission’s preference for the removal of cessation of employment as a tax trigger under employee share plans, which would greatly facilitate effective risk management. 

© Guerdon Associates 2021
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