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Firms Face Challenges ‘Clawing Back’ Compensation
Recouping funds proves difficult; 'malus conditions' reduce deferred comp not yet paid

By Stephen Miller, CEBS  8/27/2012
 

Clawbacks, which reclaim paid-out incentive compensation based on a downward financial restatement or discovery of gross negligence or malfeasance, are an increasingly common feature in compensation structures. Their inclusion has been encouraged by regulators as a means of managing employee risk-taking following the financial crisis of 2008.

A new survey showed that 14 percent of global banking organizations have “clawed back” compensation payments made to employees while a further 3 percent have reclaimed the payments but have yet to receive the pay back. This data comes from Mercer’s Financial Services Executive Compensation Snapshot Survey, which looks at compensation structures in 63 global financial services companies, including banks and insurance firms.

“There are a variety of reasons why actual clawbacks of payments already made are limited—often the concept conflicts with local labor laws so actually recouping the funds can be difficult,” commented Vicki Elliott, Mercer’s global financial services human capital leader. “Clawbacks are a relatively new phenomena in compensation programs so it will take some time for them to bed down. A small number of clawbacks doesn’t signify that the sector is ignoring lessons from the financial crisis but does raise legitimate questions about whether companies will actually seek pay-back of compensation paid.”

Elliott pointed to numerous cases in which top executives have succumbed to political and public pressure and “volunteered” to forego bonus payments awarded to them by their boards as a sign of increased responsiveness in the sector.

'Malus' Reductions: The Anti-Bonus

The term bonus-malus (Latin for good-bad) is used for a number of business arrangements that alternately offer a reward (bonus) or charge a penalty (malus) based on key performance indicators. While clawbacks seek to reclaim compensation already paid, setting malus conditions allows companies to revise the payment amount or not pay out at all if actual realized performance results over a multiyear time frame turn out to be significantly less than the performance assessment when the original award was determined.

Clawback and malus conditions are typically applied to both cash and equity parts of deferred compensation.

“It’s worth also remembering that the majority of banks have introduced ‘malus conditions on deferred compensation,” Elliott noted. “This can result in reduced or no payouts of deferred monies. It will be interesting to see if, at a time when the news is dominated by major banking missteps and scandals in the U.S. and the U.K., levels of clawback and malus increase in 2012.”

If they do not, then it would be fair to ask if the regulatory approach of managing risk through this kind of pay feature is working, Elliott added. “Focusing on the manner in which banks are managing risk, performance measurement and compliance internally may achieve much more in terms of sound risk management than the regulatory requirements on pay structures have achieved thus far.”

Survey Results: Use of Clawbacks and Malus Reductions

In Mercer’s survey, 44 percent of banks had clawback provisions in place prior to 2011, and an additional 18 percent introduced them subsequently. Typically, a clawback is triggered by:

A breach of code of conduct (73 percent).

A breach of authority/ethical violations (63 percent).

The relatively low but growing use of clawbacks underlines the importance of clearly defining the malus conditions that are applied to deferred compensation, Elliott said. Mercer’s survey indicated that 80 percent of banking organizations have malus provisions in place, compared to 60 percent of insurance organizations.

The most prevalent criteria to trigger malus reductions are:

Firm downturns/loss in financial performance (67 percent).

Business unit downturns/loss in financial performance (54 percent).

Individual breach of code of conduct (56 percent). 

Criteria Triggering Clawback or Malus

 

Clawback

Malus

Individual Criteria

Breach of code of conduct

73%

56%

Performance

20

41

Losses on transactions

40

33

Noncompliance or breach of authority level

63

49

Violation of noncompete provisions

57

31

Ethical violations not related to financial restatements

63

51

Termination of employment shortly after the exercise of stock options or vesting of restricted stock

13

15

Business Unit Criteria

Downturns/loss in financial performance

23

54

Failure of risk management

37

41

Firm Criteria

Downturn/loss in financial performance

13

67

Failure of risk management

37

49

Change in capital base

10

33

Financial restatement, regardless of misconduct

40

49

Source: Mercer.

The majority of financial companies still base their mandatory deferral payout on corporate performance rather than business unit or individual performance. The two most prevalent performance metrics used to determine final deferral payouts are net/operating profit or loss (42 percent) and relative or absolute total shareholder return (27 percent).

“It is crucial that malus arrangements are constructed properly so the balance between risk management and appropriate incentive is maintained,” said Dirk Vink, senior associate with Mercer and the survey project manager. “Malus conditions should be aligned with the continued measurement of business performance over a realistic timeframe for assessing likely realized outcomes.”

Stephen Miller, CEBS, is an online editor/manager for SHRM.

Related Articles:

Clawbacks Take Hold Amid Wait for Rules, SHRM Online Compensation Discipline, July 2012

Clawing Back Compensation, HR Magazine, September 2011

10 Executive Comp Issues for Aligning Pay Strategy, SHRM Online Compensation Discipline, July 2010

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