Compensation clawback policies started to gain traction in the early 2000s following the fallout of a series of accounting scandals. Remember hearing about Enron and WorldCom? Thanks to the financial misconduct of executives at those and many other companies, Congress passed the Sarbanes-Oxley Act of 2002 (SOX).
One of the provisions in SOX was the requirement that companies must take back some of the compensation given to the CEO or CFO if either executive was responsible for misconduct that required a restatement of financial results.
Then we had the subprime mortgage crisis of 2007-2008. This led to an expansion of how clawback provisions would be used. Specifically, the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) required that clawback policies would apply to all executive officers and could go into effect even if the executive officer was not directly involved with any financial misconduct.
However, despite the Securities and Exchange Commission proposing a rule back in 2015, there is no final rule in effect concerning the enforcement of the clawback requirements under Dodd-Frank. But this hasn’t stopped many companies from implementing their own clawback compensation provisions with their high-level executives.
These clawback provisions have given companies a tool to not just punish executives for wrongful behavior, but have helped motivate executives to act responsibly. This has helped lead to an increase in the confidence of shareholders and the general public that companies will do more to hold executives accountable for their actions and what happens under their watch. There may also be an ancillary benefit of helping victims of workplace discrimination or harassment.
How Do Clawback Provisions Work?
Generally speaking, clawback policies apply to the upper management of a company, usually executive officers. If enforced, they will typically require the executive to pay back any performance-based pay, such as cash bonuses or stock options.
These provisions were originally put into place for financial misconduct. Then came movements like Me Too and Occupy Wall Street. Tack on the growing frustration by the American public and investors with executives getting “rewarded” for poor performance or shameful conduct and the kinds of misconduct that fell under the clawback provisions’ purview began increasing.
Now, the clawback provisions will often not just cover financial misconduct, but also many other actions that could harm the company’s reputation. This includes:
- Unethical practices
- Sexual harassment
- Discriminatory behavior
- Criminal investigations into the executive
- Inappropriate personal relationships
Some companies have gone even further by implementing additional clawback triggers such as:
- Breach of restrictive covenants, like a noncompete agreement
- Failure to identify risks that harm the company
- Inadequate oversight of company operations or subordinates
The expansion of when clawback policies can come into play has the potential to not just improve the conduct of executive officers, but also assist the victims of sexual harassment or discriminatory conduct when seeking compensation.
Why Compensation Clawback Policies May Help Victims of Harassment or Discrimination
One of the original reasons for clawback compensation provisions was to ensure c-level executives do the right thing. This includes being on their best behavior by not discriminating against fellow employees or sexually harassing them.
It also meant taking a more active role in creating a company culture and implementing policies that would prevent those things from happening. Alternatively, offering assistance to those who had to deal with that prohibited behavior.
But another positive consequence is that it has given employees who have become the victim of an executive officer’s harassment or discrimination additional leverage when trying to negotiate a settlement.
Before clawback provisions, if an employee accused an executive of unlawful behavior, the executive knew that he or she could rely on the company or an insurance policy to pay any judgments or settlements that might result from the allegations. In other words, the executive didn’t have to fear losing any money from his or her own pocket when engaged in misdeeds.
Now, because of the potential for compensation clawback, executives know that if they decide to discriminate or harass, not only might they get fired, but they might have to pay back some or all of the stock options or cash bonuses they received.
This means an executive might be more willing to settle allegations as early as possible and for a higher amount. The hope would be to avoid publicity that might force the employer to fire them or enforce the clawback provision.
If the matter can settle quickly and quietly, the company might not need to worry about bad publicity. In turn, this means no need to enforce the clawback provision.
This is an important consideration because companies know that not all executives will give up potentially tens of millions of dollars without a fight. This could lead to lengthy and very public litigation.
And if the employee is in settlement negotiations with the company and not the executive, there’s still an advantage for the employee. Companies may be more willing to settle (or settle for a higher amount) knowing that they can use the clawback provision to recoup some or all of the money they pay to the employee.
The Bottom Line
Compensation clawback policies add extra motivation for executives to do everything they can to prevent unlawful discrimination or harassment. These policies also mean victims of sexual harassment and discrimination may have a better chance of settling their claims sooner, for a higher amount and can avoid having to go through a lengthy lawsuit.