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“Clawbacks” of Executive Compensation

By Harvard Law School Program on Corporate Governance

(Editor’s note: This post is by Amy L. Goodman of Gibson, Dunn & Crutcher LLP.)

My colleagues and I recently published our thoughts on issues to be considered by boards of directors in deciding whether, and how, to implement provisions addressing the “clawback” of executive compensation. Clawback provisions have become increasingly common in the past few years, and we expect that they will remain a focal point for boards of directors, both because of the ongoing spotlight on executive compensation and because of the attention that institutional shareholders and governance activists have focused on clawbacks as a significant corporate governance and executive compensation issue.

Clawback provisions vary by company, but they share a common goal of enabling companies to recover performance-based compensation to the extent they later determine that performance goals were not actually achieved, whether due to a restatement of financial results or for other reasons.

For boards of directors, the threshold question to consider is whether to address clawbacks in the first place. Doing so sends a message to shareholders that the board is committed to sound executive compensation practices and effective corporate governance, and voluntary implementation of clawback provisions will reduce the likelihood that a company will receive a shareholder proposal. On the other hand, companies need to consider whether the adoption of a clawback will adversely affect their ability to attract and retain executives.

Once a board decides to adopt a clawback provision, there are a number of issues to be addressed in formulating the provision. The memo below goes into more detail about these issues, but they include the following:

1. the individuals to whom the clawback provision should apply (the CEO and CFO, all executive officers or all employees)

2. the types of awards to which the clawback provision should apply (short-term or long-term, or both)

3. the circumstances that should trigger the clawback provision (a material restatement, restatements generally, or any error in financial information)

4. the type of conduct that triggers application of the clawback provision (misconduct by the particular individual from whom the company seeks to claw back compensation, misconduct by any employee, or any conduct that results in incorrect financial information)

5. whether the clawback provision should grant discretion to the board in determining whether misconduct occurred and whether to claw back compensation

6. the extent to which the clawback provision should modify existing employment agreements, compensation plans and award agreements

7. how far back the clawback provision should reach

We welcome comments on this subject, including views of readers as to which approaches make the most sense in various situations. Also, we would be glad to have any examples of cases where a board of directors has actually enforced a clawback policy or contractual provision. The memo is available here.

Full post as published by The Harvard Law School Corporate Governance Blog on July 30, 2008 (boomark / email).