58 Business The Economist February 20th 2021
Red in tooth and clawback
I
f business hada Moses, “Thou shalt link pay to performance”
would be on his tablet. Compensation committees have, how-
ever, tended to stick to a narrow reading of the commandment.
Whereas they reward good behaviour, deterring the bad is an after-
thought. Worried that this may lead bosses to adopt a mentality of
“heads we win, tails shareholders lose”, boards are rethinking
their priorities—partly in response to pressure from regulators
and investors, but also to shifting social winds. Perfectly balanced
incentives remain as elusive as the promised land. Still, measures
designed to ensure that misconduct does not pay are becoming
central to the debate about how to craft bosses’ salary plans.
The most striking change of recent years has been the rise of
the “clawback”. This is a provision in pay plans that gives the board
the right (or, less commonly, an obligation) to yank bonuses or
stock awards given but later found to be unjustly earned. A proto-
type, contained in America’s Sarbanes-Oxley reforms of 2002, re-
quired retrieving pay from chief executives and chief financial of-
ficers whose sins caused accounting restatements. The idea
gained traction after the global financial crisis. The European
Union mandated recouping money from wayward bankers. In
America Congress told regulators to craft a new clawback rule.
While they mulled this, big firms got the message and began to
draw up such policies voluntarily. Some 93% of those in the s&p
500 index now say they have one covering cash bonuses, equity
awards or both, according to iss, a proxy-advisory firm, up from a
small minority before Sarbanes-Oxley.
As such 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 ex-
tends to almost anything that might damage a firm’s reputation.
That includes creating a toxic corporate culture, sexual harass-
ment and “inappropriate” personal relationships; cupping back-
sides is taken as seriously as cooking books.
The second development is that more firms—albeit still a mi-
nority—are plucking up the courage to invoke the provisions.
Wells Fargo clawed back $28m from John Stumpf on top of the
$41m he forfeited when he resigned as ceoof the lender in 2016,
after a probe concluded he had engendered a culture that encour-aged employees to open fake accounts to lift sales. Goldman Sachs
tapped a dozen current and former executives for $175m last year
to help ease the pain of whopping fines over the investment bank’s
role in the 1mdbembezzlement scandal. McDonald’s is trying to
recoup $57m of severance pay from its ex-boss, Steve Easterbrook,
who was fired over sexual relationships with underlings.
The Goldman Sachs case encapsulates the pros and cons of
clawbacks. The firm won plaudits for its stance; here was a Wall
Street giant willing to make top brass pick up some of the tab for
wrongdoing. But what initially seemed a bold move became an
embarrassment when Gary Cohn, its former second-in-com-
mand, who had cashed in his pay awards on joining the Trump ad-
ministration in 2016, demurred. The stand-off ended when Mr
Cohn agreed to pay a sum, reportedly $10m, to charity. Much as the
bank tried to spin this as fair, it was made to look impotent.
The episode underlines that, when it comes to compensation,
he who has already paid the piper finds it harder to call the tune.
Goldman Sachs’s board could have shown more spine and seen Mr
Cohn in court, if only to signal it was serious about holding gran-
dees to account. That, though, would have been costly and risky.
Lawyers’ fees might have exceeded what Mr Cohn owed as they
wrangled over what is “excessive” pay, “inappropriate” behaviour
or “inadequate” oversight in a scandal that involved decisions at
many levels. The court might have sided with Mr Cohn, who was
never personally accused of wrongdoing. Boards must also con-
sider potential bad publicity. McDonald’s was put on the back foot
when Mr Easterbrook claimed it already had information about
his liaisons, including sexually explicit emails, when it approved
his severance package.
Unsurprisingly, then, some firms try to just put the mess be-
hind them. gedecided last month not to claw back pay from an ex-
boss, Jeff Immelt, after a huge write-off and a probe into disclo-
sure policies led to a $200m fine for the industrial conglomerate.
(He denies wrongdoing.) Drugmakers accused of stoking the
opioid epidemic have also eschewed clawbacks. Such clauses may
deter some executives from reporting misconduct. And broaden-
ing what is considered wrongdoing creates ambiguity. Some firms
include behaviour “embarrassing” to them. Might a ceoexpress-
ing exotic political views count?Fire, brimstone and bonuses
Still, deterrence efforts are proliferating. One popular policy is to
lengthen deferral periods for pay, by a year or more for cash bonus-
es, and a similar period beyond the vesting date for equity grants—
in some cases until after the executive leaves the firm. Though less
dramatic than clawbacks, this has the advantage of reducing the
chance that the money has left the company before alleged misbe-
haviour emerges. Last month cvsHealth, other pharmacy chains
and even a few drugmakers (like Bristol Myers Squibb), agreed on a
set of extended-deferral principles with a group of investors who
had threatened to agitate over the firms’ role in the opioid crisis.
Clawbacks, too, will spread. For one thing, the pandemic reces-
sion has stoked anger over excessive executive pay—particularly
perceived pay-for-failure such as Boeing’s $62m payoff to Dennis
Muilenburg, who presided over the bungled response to two
crashes of its 737 maxpassenger jets. And big investors like such
provisions. In just a few years BlackRock, the world’s biggest asset
manager, has gone from tepid to wholehearted support for them.
What better way to focus executives’ minds than to make it clear
that what the board giveth, the board can take away? Schumpeter
How to design ceopay to punish iniquity, not just reward virtue