The Advisors' Blog

After giving commenters two new bites at the apple – and releasing a DERA memo to analyze costs & benefits – the SEC is aiming to (finally) adopt clawback rules this fall. The end result of the rules will be that listed companies will need to adopt & disclose policies for recovery of incentive compensation that exceeds what would have been paid in the absence of an accounting restatement. It sounds like a simple concept, but it’s very, very complicated. And the topic hasn’t gotten any more straightforward since 2010, when it was first mandated by the Dodd-Frank Act.

I blogged earlier this year about notable comment letters that pointed out these challenges. New research from two accounting professors reinforces that notion (although I’m not sure that’s entirely the point they set out to prove).

The professors started out by measuring the “severity” of voluntarily adopted clawbacks, as disclosed in 821 SEC filings for non-financial companies from fiscal years 2007 to 2010. I was struck by the fact that the data set is a dozen years old, but apparently that’s because they wanted to leave a cushion of time to detect a subsequent restatement announcement. Their measurement is based on 27 attributes across these 8 categories:

1. Span of employees covered (e.g., current and/or former CEOs, CFOs, key executives);

2. Retrospective number of years the clawback applies to (i.e., the look-back period);

3. Trigger events (e.g., financial restatement);

4. Absence of hurdles inhibiting a clawback (e.g., absence of proof of materiality);

5. Compensation subject to recovery (e.g., short-term, long-term);

6. Reach of compensation subject to recovery (e.g., excess compensation, full compensation);

7. Board’s enforcement authority; and

8. Additional punitive actions (e.g., dismissal, legal action).

Here’s where things get interesting. The professors not only found a wide variation in the strength of clawback policies, but that the more stringent policies tended to exist at companies where directors were paid in cash & stock awards, rather than stock options. They suggested that directors who receive stock options are more motivated to focus on short-term performance and implement weaker clawbacks.

They also looked at unintended consequences: specifically, R&D spend. They conclude that clawbacks can be a “double-edged sword” because management may decrease R&D spend to overcome an earnings decrease due to financial misreporting. Other unintended consequences that weren’t part of the study could include the delay of bad news or ineffective changes to compensation structures.

Lastly, the analysis suggests that some boards are “giving the illusion of good governance to placate stakeholders, as their window-dressed clawbacks lack teeth.” In other words, all clawbacks are not created equal – and that may not come through in the DERA analysis.

Reading this research paper reminded me of a conversation I had with a benefits lawyer when these rules were first proposed. She told me she didn’t even want to think about all the complications here and that she hoped she would be retired by the time they went into effect (it does not appear her wish will come true). While we do have a “Clawbacks” Practice Area for members and guidance in the “CD&A” chapter of Lynn & Borges’ Executive Compensation Disclosure Treatise about how to disclose policies & related forfeitures, I think a lot of folks have shared that sentiment and have understandably been sticking their heads in the sand on this issue, while we all “wait & see” what happens with the rules.

Now that SEC action appears to be imminent, it’s time to get up to speed. If you want the crash course, register for our “Proxy Disclosure & 19th Annual Executive Compensation Conferences” – we have a session on “Clawbacks: Preparing for Final SEC Rules” with Davis Polk’s Kyoko Takahashi Lin, Gibson Dunn’s Ron Mueller, Hogan Lovells’ Martha Steinman, and our very own Mike Melbinger. Plus, 17 other panels, including an interview with Corp Fin Director Renee Jones. The Conference is being held virtually over 3 days – October 12th – 14th. Sign up online (via the conference drop-down), email sales@ccrcorp.com, or call 1-800-737-1271.

– Liz Dunshee