It is good to be able to say that we do not have too many problems with the government’s approach to clawback of executive remuneration.  As noted in the 17 December special alert edition of our newsletter (see HERE),  disclosure will be required of any “reduction, repayment or other alteration” made to KMP remuneration as a result of a material misstatement or omission in the company’s financial statements in any of the previous three financial years. 

 

If no reduction, repayment or alteration has been made, and will not be made, because of the misstatement or omission, the company will have to explain why. An explanation will be required even if the financial misstatement is positive. Perhaps the government should require disclosure in the event of an “adverse material misstatement or omission in the company’s financial statements”. As it is worded now, companies may have to say something like “The company did not clawback remuneration from the executive because we made more money for shareholders than we thought. We did not think this would be fair.”  No disclosure is required in relation to clawback if there is no financial misstatement.

 

We expect a reasonable proportion of companies will volunteer disclosure of clawback policies, and that pretty soon this will be identified as “best practice” by external stakeholders.  We also expect that as more companies voluntarily disclose clawback policy, proxy firms will start requiring this, even though there are less than a handful of instances of ASX300 company financial misstatement in any one year. 

 

From a ‘protection of shareholders’ point of view, it probably makes sense not to differentiate between innocent and at fault executives. And it is hard to argue that incentive awards should not be adjusted if it turns out they have been based on incorrect financial performance.

 

However, in practice, ‘clawback’ is likely to be workable only in relation to deferred pay, given that it is difficult to recover remuneration already paid to executives, and virtually impossible for former executives.  This is particularly the case where the executive is not personally at fault – time-consuming and expensive litigation would likely be required, and would be unlikely to help anyone, including shareholders.  In fact, for other than deferred remuneration, the disclosure made where clawback is triggered would likely be along the lines of “we would have attempted to claw back $X, but had no legal basis for doing so…”.  

 

While the new law is proposed to operate from 1 July 2013, its application to financial misstatements occurring in the previous three years means companies will have had limited opportunity to establish the basis upon which clawback could apply.  However, many companies have already implemented deferral arrangements for STI, in addition to the extended vesting periods that apply for LTI. 

 

Which brings us, again, to a point that nearly everyone except the government agrees on – if the government is serious about encouraging effective clawback arrangements, it must stop taxing unvested equity at termination, so that deferral and LTI performance periods can reasonably be continued beyond termination of employment.

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