Expert Perspective by Grahall’s OmniMedia Editorial Board
Stephen Gandel says in his January 27, 2009 article in Time Magazine (Can Financial Firms Get Executives to Give Back Pay?): “In the past few months, a number of financial firms have instituted or beefed up rules that would allow them to force employees to return year-end bonuses. So-called clawbacks would be triggered by subsequently discovered misconduct and some firms say they may even apply in cases where employees made trades that looked profitable at first, but go sour… While companies have always had the right to sue employees for ill-gotten gains, more firms are adding provisions to reclaim pay not just for illegal behavior, but poor decisions.”
While this sounds good, clawbacks are difficult to implement for several reasons not least among them, an unwillingness to return money already received (and possibly already spent). Establishing clawbacks on deferred compensation—money that has yet to be paid out—is one way of addressing this issue, but it is possible that deferred compensation might not be adequate to recover the bonus paid for what, in hindsight, proved to be a poor decision.
Another question to what do about employees and executives who are no longer with the firm. As Eric Dash explained in his September 2009 article for the New York Times (“What’s Really Wrong with Wall Street”) clawbacks face the “ ‘I.B.G.-Y.B.G.’ issue — as in ‘I’ll Be Gone and You’ll Be Gone’ if the trade [or a decision] goes south.” Lengthy and costly litigation may be the only way to recover bonus payouts from individuals no longer with the firm.
Further, the poor decisions made by some executives might have financial impacts far greater than a simple recovery of a bonus could cure (think AIG). So although American taxpayers would certainly be happy to see executives and traders forced to repay six and seven figure bonuses for bad decisions, they would probably be happier that these decision were never made. Clawbacks are no replacement for comprehensive risk management, rather, all they are is look in the rear view mirror often when the proverbial “cliff” is straight ahead.
Essentially clawbacks are practically toothless as a tool to punish employees and executives for bad decisions. Shareholders might be better off hoping that the tooth fairy will be bringing dividends and stock appreciation than to bet that clawbacks alone will change behavior on Wall Street.
A better solution would be to pay bonuses for decisions and trades at the time that they are shown to be sound. That is, stop paying in the short term for decisions with long term horizons, and match the performance period and payout with the time horizon of the event.
Because we are not naïve, we know that most companies won’t embrace this radical (but logical) approach. The excuse will be that unless every company takes this approach, top talent will head to greener pastures at the companies who pay in the short term for decisions regales of the event horizon. (Better known at Grahall as the “employee extortion hypothesis” or EEH.)
Because we are optimistic, we believe that fresh and effective rewards strategies can help to reward the right behaviors while limiting the situations where poor decisions are made. Clawbacks may be part of the strategy but they aren’t the only or the best approach. Call us and we will share with you our creative thinking around effective compensation strategy.
Contact Grahall’s Omnimedia Editorial Board at email@example.com