Have you owned a stock that declined in value significantly because the CEO or CFO of the company committed a misdeed, financial or otherwise? And then to add insult to injury, the Securities and Exchange Commission imposed a substantial fine on the company. You say to yourself, why penalize the company — and therefore me? Why not go after the CEO’s compensation?
CEOs and senior managers have engaged in activities where if the outcome was positive, they would reap a huge gain. But if negative, stock owners and often society were left holding the bag. It’s a classic example of a “heads I win, tails you lose” game.
To prevent such activities, companies have introduced clawback provisions in senior management employment contracts. It is a provision whereby money already paid to an employee must be returned to the employer, often with a penalty. The first federal statute to allow for clawbacks of executive pay was the Sarbanes-Oxley Act of 2002. It provides for clawback of bonuses and other incentive-based compensation paid to CEOs and CFOs in the event that misconduct on the part of senior management leads it to restate financial performance.
Following the financial crisis of 2008, clawback clauses became more common and were used primarily in the financial industry, but can also be found in government contracts, and for pensions and Medicaid. About 93 percent of companies in the S&P 500 index state that they have such provisions covering cash bonuses, equity awards or both, according to ISS, a proxy-advisory firm.
As these provisions have grown in popularity, two things have happened. First, the list of misdeeds covered has lengthened. What initially applied solely to criminal financial conduct now extends to almost anything that might damage a company’s reputation, including creating a toxic corporate culture, sexual harassment and inappropriate personal relationships.
Wells Fargo clawed back $28 million from its CEO on top of the $41 million he forfeited when he resigned from the bank, after a probe concluded he had engendered a culture that encouraged employees to open bogus accounts to increase sales. Goldman Sachs made a dozen current and former executives return $175 million because of the investment bank’s role in an embezzlement scandal. McDonald’s is trying to recoup $57 million of severance pay from its former CEO who was fired over sexual relationships with underlings.
Purdue Pharma, then owned by the Sackler family, produced the opioid OxyContin, which earned the family $13 billion. It and other opioids were and are responsible for tens of thousands of deaths each year. Legal efforts to clawback some of this loot have not succeeded as of yet.
Investment fund managers BlackRock and CalPERS now support shareholder resolutions calling for clawbacks of senior executive pay where behavior caused direct financial harm to shareholders, reputational risk to the company or resulted in a criminal investigation, even if these actions did not result in a material restatement of past results. This includes, but is not limited to, settlement agreements arising from such behavior and paid for directly by the company.
Should clawback provisions extend to any and all actions that can cause significant harm? For example, suppose a prosecutor intentionally withholds material exculpatory evidence from a defendant’s attorneys in a criminal case, resulting in a guilty verdict and a long jail sentence or death. When such information comes to light, the innocent defendant is released from jail and settles a lawsuit for millions of dollars, a burden borne by local taxpayers.
So, should the prosecutor’s and police officers’ past income and pension be subject to clawbacks? Should other personal assets be subject to confiscation? The very threat of such actions should prevent such transgressions from occurring. That is the purpose of clawback provisions. They should be required whenever a person has the power to willfully and wrongfully destroy another person’s life.
Murad Antia teaches finance at the Muma College of Business, University of South Florida (USF), Tampa.