Executive misconduct and the recovery of compensation

Impact case of the month

October 19 2023

Clawback clauses stipulate that an employee must repay (part of) his variable remuneration if it turns out in retrospect that it should not have been paid out. Prof Dr Michael Erkens is Professor of Corporate Reporting at Nyenrode Business University and examined what these clauses must meet to be effective. He also looked at what the consequences were of effective versus ineffective clawbacks. The outcome of the study resulted in the mandatory implementation of effective clawback clauses in the United States.

Generally, clawbacks are designed to protect the interests of all parties involved and ensure that fairness is maintained even if unforeseen circumstances or problems arise afterwards. For example, if a company pays bonuses to employees based on financial performance and it later turns out that the results were incorrect, or were achieved by improper means. Clawbacks can also be used to ensure the integrity of transactions.

Practical tools

The research by Erkens and his co-authors provides organizations with practical tools in designing and implementing effective clawback clauses. For instance, they show that the choice of wording in these clauses is essential and that only strongly worded clauses lead to better quality reporting and a better reward system for CEOs. CEO turnover is also lower at these companies. "A strongly worded clawback means that compensation can be recovered regardless of whether fraudulent intentions need to be proven. It is also essential to cover all incentive-based remuneration paid for at least three years prior to the adjustment. So it is not just about bonuses paid in the year of the adjustment," Erkens explains.

Measure for investors

Thanks to the survey results, investors are enabled to distinguish companies that are committed to improving reporting quality and the remuneration system from those that are not. Moreover, the power of clawback is a visible measure among many other invisible corporate governance measures. The Clawback Strength Index has also proved to be a useful tool for researchers to conduct further research on recoveries.

Law change

The main outcome of the research is the implications for regulators in the US and other jurisdictions. In the US, the research served as input for a legislative change in SEC regulations in 2022. As a result, listed US companies will have to implement and enforce strong clawback clauses from the end of 2023. "Our research has a major impact on how thousands of companies have to design executive compensation contracts. It also impacts how executives behave, how investors can select 'well' managed companies, how researchers can identify unobservable corporate incentives, and how new legislation is designed," Erkens said. 

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