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New York Times, June 8, 2008 column

 

The New York Times

 

 

 


June 8, 2008

 

Fair Game

Pay It Back if You Didn’t Earn It

READY for some good news from your humble research assistant? During this proxy season, almost 300 companies adopted provisions allowing them to recover executive pay that they find to have been based on incorrect financial statements. Four years ago, such clawback policies were found at only 14 companies.

Only in executive payland would figures like these qualify as progress. But having boards agree to go after pay that was not in fact earned is, oddly, still something of a battle. Although pay for nonperformance — or even failure — seems an obvious no-no, shareholders have had to push hard in recent years to have companies institute such provisions.

The data on the growing acceptance of clawback provisions emerged in a study by the Corporate Library, an independent research concern specializing in executive pay and corporate governance. It surveyed 2,121 companies and found that 295 of them, or 14 percent, had clawback provisions. The most common — in 131 cases — were those that kick in when fraud is uncovered. But a good number — 115 — are related to performance pay that was later found to have been improperly awarded because it was based on incorrect figures rather than malfeasance.

This is only proper. Corporations go to great lengths to establish benchmarks for financial performance that must be met before incentive pay is received. Why should executives keep that compensation if it is discovered later that the benchmarks went unmet?

“I think the expansion is pretty significant in terms of the coverage of companies who have adopted a clause,” said Paul Hodgson, a senior research associate at the Corporate Library who conducted the study. “Behind-the-scenes work from some of the more activist funds has stimulated this. And it is gratifying to see this happening without legislation.”

THE provisions vary from company to company, of course, and can be found in proxy filings. For example, Waste Management’s policy, instituted in August, applies only to termination payments. Under the terms of the policy, those payments can be recovered if former employees were involved in conduct, uncovered later, that would have resulted in their being fired for cause.

The policy at General Electric is also fairly specific. It requires that its board must determine that an executive has engaged in fraud or intentional misconduct before the company tries to recover performance-based pay. Then the board can take disciplinary measures, including possibly terminating the employee or demanding reimbursement of pay called into question as a result of a financial restatement.

At other companies, money can be recovered even from managers who had nothing to do with errors or misconduct that resulted in earnings restatements. Monsanto’s provision, instituted in 2006, does not require that money be recovered solely from executives responsible for misconduct. Neither does the plan at American Electric Power, put in place last year.

International Paper’s policy specifies that it will move to recover long-term stock awards if the company’s financial statements are restated as a result of errors, omission or fraud. But the provision doesn’t say that executives reimbursing the company must have been personally involved in the errors or fraud. Under its plan, International Paper said it could ask executives for repayment, reduce the amounts they stood to receive in the future and withhold future equity grants, bonuses or salary increases.

At Citigroup, the policy also states that it will move to recoup pay called into question after a restatement. It can seek reimbursement or cancel previously issued but unvested restricted stock or options that the employee holds, the company’s filings said.

The policy at Qwest Communications International is among the broadest. It states that in the event of a “substantial restatement of previously issued financial statements,” its directors will review all performance pay awarded to executives that was based on the periods during which the results changed.

If the Qwest board concludes that the restatements would have resulted in different executive pay packages and that recovering the compensation is in its interests, it will “pursue all reasonable legal remedies” to get the money back. Qwest added that its board has not had to take such actions since the policy was adopted in January 2005.

“All shareholders suffer from a restatement,” Mr. Hodgson said. “Therefore all executives who benefited from misstated accounts should see their incentives adjusted to reflect actual achievements. This is not the approach taken by the majority of boards, as yet.”

At least one company now subjects its directors to recoupment policies. Arkansas Best, a transportation company, instituted a clawback provision this year requiring cancellation of a director’s unvested stock awards if misconduct by that director resulted in a financial restatement.

Skeptical shareholders may well wonder if these new provisions will ever produce an actual clawback. But Mr. Hodgson made note of one that recently occurred. Warnaco Group">The Warnaco Group, an apparel maker, said in this year’s proxy that its compensation committee had cut the incentive pay for three executives in 2006 by a total of $120,000. The pay cut occurred after the company restated its results for 2005 as a result of accounting errors and irregularities in its menswear division.

Now that shareholders have gained some traction with companies on recovering unearned pay, they should press compensation committees to change policies so that executives who take outsized risks to generate fatter pay packages are forced to return some of that money if the gambles go bad.

Exhibit A for this problem is every investment bank that made huge bets on risky mortgages and other securities in recent years.

During the boom, of course, these wagers made huge money for the firms and their executives. The chief executives of Bear Stearns, Merrill Lynch, Citigroup, Lehman Brothers and Morgan Stanley jointly hauled in almost $60 million in cash compensation in 2006 when mortgage mania was propelling their financial results.

Now those bets have resulted in devastating losses for both the firms and their shareholders. In the last 12 months, these same five firms have lost a combined $330 billion in stock market capitalization. And these unfortunate investors get hammered again as the banks are forced to raise capital to shore up their battered balance sheets.

“The investment houses never think about what might build long-term value for shareholders when they set targets for themselves,” Mr. Hodgson said. “Their response is, ‘We give stock and it vests over the long term, and if it tanks, they lose out.’ But these people typically have so much stock that it enables them to take those risks without the fear that all their stock will disappear. When you get $50 million a year, how bad can losing one of those packages be?”

James E. Cayne, Bear’s former chief executive, can surely say how bad losing all of your stock can be, but the loss he took after his firm’s demise is the exception to the rule — so Mr. Hodgson’s question still resonates.

And maybe it’s a question that directors at the big securities firms should also be asking.

 

 

Copyright 2007 The New York Times Company

 

 

 

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