Compensation clawback provisions are a common aspect of executive compensation packages. However, they have been found to be ineffective in many ways. Here are two ways they don't work and one way to change that, according to a March 22 report published in Harvard Business Review.
A clawback statute allows for incentive-based compensation that has been paid to be taken back if an executive does not complete the term or behaves in a way that is harmful to the company. Compensation clawbacks are to deter executives from making risky decisions for the company and maintain retention.
Yet, applying the provision to get the compensation back from executives is very challenging for two reasons. First, the legal requirement for recovering compensation involves a notion of "cause." If an executive did not commit a crime, they can argue it's theirs to keep.
Second, the burden to recover the compensation is on the company to get it back. If the money is already spent, it can be nearly impossible to recover.
Compensation clawbacks can be effective if the incentive compensation is limited to restricted equity, where the executive cannot sell the shares for six to 12 months after they leave the company. Executives should be allowed to liquidate a portion of their shares with the board's approval, the report said.
Making these changes can allow companies to withhold shares from executives who no longer qualify for their bonuses and allow compensation clawbacks to work more effectively.
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