This Week in Leadership
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It would have been unthinkable just a few years ago that a board of directors would consider seizing the compensation of a chief executive officer who wasn’t considered unethical or charged with fraud. But buckle up: pressure to go after CEOs who perform poorly is growing.
Lawyers and other experts in corporate governance say that a small but growing number of firms are reviewing so-called clawback clauses and redefining what events justify seizing the pay of past and present senior management teams. The result may be that the standard criteria—that an individual acted with malevolent intent—could change.
To be sure, any widespread movement is still uncertain, but at least one high-profile case has made headlines. Tonya Mitchem Grindon, a corporate governance expert and Nashville-based director of the law firm Baker Donelson, says that clawbacks in the past generally required a “double trigger”—that is, both an executive’s unethical behavior and a restatement of the firm’s financial filings. “Now, it’s maybe just one of those components, regardless if there was unethical misconduct,” she says.
In this scenario, a catastrophic lapse in executive oversight, which eventually prompts a material financial restatement, could in itself lead to an executive’s pay getting seized. “Companies are starting to realize they have to have a broader net to claw back dollars,” says Korn Ferry’s Irv Becker, vice chairman, executive pay and governance. “The unfolding trend is to give boards more discretion to interpret what is the situation that truly deserves a clawback.”
Activist investors are pushing some of this change, as public concerns over CEOs paid highly for poor performance only grows. Some of this is also part of an evolutionary development from the Enron-related Sarbanes-Oxley Act of 2002. That act launched clawback language focused on the CEO and CFO, making sure such senior executives were held personally liable for any fraudulent financial statements. After the financial crisis, Dodd-Frank reforms expanded some of the situations clawbacks could cover, but the Securities and Exchange Commission has still not signed off on that change. In this vacuum, some companies appear to be moving ahead on their own.
If they do, experts warn that reimagining clawback offenses may come with a host of knock-on ramifications. One example: if a disgruntled CEO sues over the repayment demands, directors could find that their insurance and indemnification bylaws are outdated. “Companies usually set up broad indemnification when the sun is shining and everyone is happy,” notes Kevin Lacroix, an executive vice president at RT ProExec, specialists in management liability and insurance.
But the bigger question may be how much these wider nets will affect the recruitment of top CEOs who oppose them. Grindon suggests that in-demand CEOs might be able to play one company off of another and possibly win broad protections against clawbacks other than for outright fraud. “It’s imperative that companies have protections in place to attract and retain the best qualified chief executives,” Grindon says.
But Lacroix takes a different tack. The boards have a fiduciary responsibility to shareholders, he says, which is why they are starting to demand these broader clawbacks from CEOs in the first place. “A CEO candidate that will refuse any job contract that includes a [broad] clawback might have increasingly limited job prospects,” he says.