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Will claw back clauses improve performance?

What will be interesting will be the degree to which claw backs are used in the future

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When Lloyds TSB became the first British bank to claw back bonuses from its executives, some observers suggested it signalled a watershed for unchecked spiralling executive pay.

A total of 13 of Lloyds directors had their 2010 payouts 'adjusted' down by £2 million because of the mis-selling of payment protection insurance, which cost the bank up to £3.2 billion in compensation.

Clawbacks originated in the US but have been slowly crossing the Atlantic as a central tool in curbing payouts for poor company performance. Chris Roebuck, professor of transformational leadership at the Cass Business School, says: "Clawback goes back to sales within the insurance industry, where people were paid on a commission basis and their employer would claw the commission back if policies sold, ceased before they had paid their front-end loads back to the company.

"Clawback is the principle for money coming back to companies for things that have gone wrong".

In the wake of the credit crisis, in 2009 the Financial Services Authority a claw back provision in its code of practice, also requiring financial institutions to pay part of executives' bonuses in deferred shares therefore easing the ability to claw back the bonus.

The regulator's reasoning was based on the fact that it felt remuneration structures in banks may have encouraged some employees to ignore long-term risks in favour of returning short-term gains.

The 2010 revision of the UK corporate governance code also said "consideration should be given" to including provisions that allow for variable components of remuneration to be reclaimed in exceptional circumstances of misstatement or misconduct.

To legislate or not

Last September business secretary Vince Cable began consulting on the possibility of requiring all publicly quoted companies include a claw back clause in remuneration agreements as part of a wider consultation on executive pay.

Business lobby groups have also broadly welcomed the increasing use of claw backs and the push to make them compulsory.

"There is a body of remuneration committee members who disagree with claw back, especially those with previous experience of working outside the UK, but they are a diminishing body of opinion," says Nicki Demby, Deloitte partner in executive compensation.

To date, most companies that introduced clawback arrangements have applied them to deferred incentive awards only, as they are easier for the employer to adjust.

Any company considering clawback has to be very sure of its legal footing before attempting to force its employees to return shares acquired under employee share options (or other share incentive awards), or to pay over the proceeds of the sale of such shares, or to pay back cash bonuses. Such action can jeopardise the future incentive effect of share options and bonus schemes and even the entire employment relationship.

Effective clawback is difficult for several reasons - and perhaps explains why so few examples have been executed or come to light.

"When clawbacks first began they were relatively simple. There was a specific clawback of a specific amount against a specific payment - definite amounts and times, which were easily identifiable and not arguable," Roebuck says.

"The problem now is that they have become fuzzy. Different elements such as quality levels have been introduced, which are harder to measure. Every time a new element is introduced, they create more problems for the company as there is a greater risk of vague objectives," he adds.

"The best advice for CFOs is get good advice and make sure of tight drafting changes, so that clawbacks only apply in specific situations," says Demby.



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