Avoiding Executive Claw Marks

By: Paul R. Dorf, Ph.D., APD

Upper Saddle River, N.J. - November 21, 2006 - A recent Wall Street Journal article provided a number of examples of companies and shareholders trying to recoup bonuses that were paid out to executives due to erroneous financial data, poor and/or ambiguous plan language, or deals that have gone sour. Referred to as "clawbacks", these provisions, while often incorporated into a plan's language, are difficult to execute and leave the executive with ill-gotten gains at the expense of corporate profits and shareholder interests.

Rather than rehash the problems, we believe it would be best to focus on the solutions, in an effort to avoid the need to trigger the clawback.

Change of Control - Language in the agreement should clearly define what constitutes a change warranting possible payments; the change by itself should not trigger the payment (known as a "Single Trigger"). In addition to the actual event occurring, the executive must have been terminated, or at least have "administratively" lost his/her job. This is referred to as a "Double Trigger" and serves to better justify payment in the event of a Change of Control.

Termination for Cause - It can be a big embarrassment to the company for an executive to walk away with large amounts of compensation in the event he/she is terminated for bona fide reasons (malfeasance, conviction of a felony, irreconcilable differences with the Board, etc.). Therefore, employment agreements should clearly indicate that in the event of termination for Cause, any unpaid incentive awards, unexercised stock options (vested or unvested), restricted stock grants (for which restrictions have not lapsed), and future Supplemental Executive Retirement Payments (SERPs), as well as any other form of incentive compensation, will be withheld and the rights to those payments may be forfeited.

Reclaiming Previously Paid Awards - The plan should contain specific terms for repayment of any awards that an executive received due to errors in the company's financial reporting, whether or not it can be proven that such accounting errors were intentional. The executive has the right to expect that the company will provide them with legal representation to handle such issues; however, the company's obligation should be limited if the executive has contributed to and benefited from the restatement.

Payment of Severance Payments - Often, the terms of employment agreements provide for severance payments conditional on non-solicitation, non-competition and non-pirating by the executive post-termination. These are referred to as "Good Boy Provisions". The language should clearly state the company's rights to demand repayment of severance payments under these and other certain conditions, as well as terms covering repayment of certain awards in which the vesting and/or exercise provisions accelerated in conjunction with the termination. An alternative is to pay the severance out over the restriction period (i.e., two years). Although this may not make it easier to obtain repayment of previous payments, future payments can be cut off if the prohibitions are violated. Similarly, rather than accelerating vesting, it may be frozen and the exercise period could be limited until the end of the prohibition period; this would forestall the need to chase after those awards.

To quote an old cliche, an ounce of prevention is worth a pound of cure. Taking the time to review your compensation plans and agreements and ensuring that they contain appropriate language and protections for the company and its stakeholders is key to avoiding some of the problems that can result when clawbacks are necessary.

About Compensation Resources, Inc. (CRI): CRI provides compensation and human resource consulting services to mid-size and Fortune 500 clients, as well as public, private, not-for-profit, family-owned, and emerging companies, specializing in executive compensation, sales and incentive compensation, performance management, salary administration, and expert witness services.

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