US executives are this week familiarising themselves with new rules that mean some of their pay could be clawed back, should their companies have to restate accounts.
The clawback rule was passed last week and caps a 20-year journey since it was floated as part of the initial 2002 Sarbanes-Oxley Act, the tsunami of new measures that responded to the collapse of Enron and WorldCom.
Clawbacks were revived in 2015—only to be shelved again. Then, last year, president Joe Biden’s financial regulator in chief, Gary Gensler, head of the Securities and Exchange Commission, dusted off the project and finally gave the rules the all clear at the end of last week.
Gensler described the new rules as a “common-sense issue” that would “strengthen the transparency and quality of financial statements, investor confidence in those statements, and the accountability of corporate executives to investors”.
No doubt alarming for hardened capitalists, the rules—though tough—are less stringent than they might first appear. The policy means companies must recover incentive-based pay given to executives for the three years running up to an accounting restatement. Stock markets must include clawbacks as part of their listing rules.
Clawbacks apply when restatements are made to correct “material” errors in previous statements, or when a correction for the past would cause a “material misstatement” in a “current” period.
All companies will also now have to publish their clawback policies in their annual reports.
Many see the rules as a long time coming. Richard Leblanc, a professor at Toronto’s York University and a close observer of US governance, says: “This rule is long overdue,” and that it “is good for governance”. He adds: “If executives want to have comfort that their board is not going to chase gains, then they should take proper risks and behave ethically, as the vast majority of executives do.
“So, if you are an ethical executive, this rule should have no impact on you.” The clawback, he says, should promote ethical conduct.
Malus aforethought
However, incentives to behave better could be strengthened with a so-called “malus” provision: the ability for boards to assess risk and ethics before awarding cash and vesting equity.
“With a clawback you have to chase money and equity that has been given,” says Leblanc. “With malus, you perform the analysis first, not after.”
The UK is not without the prospect of seeing some change to clawback and malus provisions in the corporate governance code.
Both had been considered as part of the ongoing reform to audit and governance that has run since the collapse in January 2018 of Carillion, the UK’s largest construction company. Progress has been slow. When a parliamentary committee probed the collapse of travel company Thomas Cook, it complained that bonuses could not be recovered because clawback provisions were too narrowly defined.
After considering proposals for “minimum conditions” for malus and clawback, the government met with opposition, mostly from listed companies who claimed that current measures in the governance code were enough.
However, the code’s watchdog—the Financial Reporting Council—was, in any case, asked in May to consider changes that would “deliver greater transparency” and broaden the range of conditions for which malus and clawback could be applied.
Currently, the code only asks companies to include malus and clawback policies in their remuneration schemes and to describe how they apply. As any reader might observe, such a provision could include a multitude of policy options, while the code also applies only on a “comply or explain” basis.
Executive pay attracts attention, not least in the form of public concern that company managers are paid excessively and sometimes receive rewards for failure. Clawbacks are one way to address the problem. They also demonstrate that politicians and rule makers are willing to act. US executives are coming to terms with that; UK directors can expect to see a toughening of policies in the not-too-distant future.