As Compliance Week reports, this study from PwC showed that many companies are adopting clawbacks related to their executive compensation arrangements, even before the SEC acts to implement the Dodd-Frank clawback provisions. The PwC study looked at 100 large public companies and found that 40% had made “some type of change to their compensation plans to modify clawback provisions in the past year.”
According to the study, the policies used a wide range of triggers – e.g., some pharma companies would trigger clawbacks based on failures to follow company policies or protocols – but the most common triggers remained restatements or misconduct. Slightly over 60% applied clawbacks only to executives and senior management, while 9% applied only to NEOs, and 28% applied to a broad-based employee population. Only 42% had a look-back period, the most common being three years; however, 10% of companies had no limitation on the duration of the look-back period.
Some of the bells and whistles associated with the clawbacks could have a significant impact on the accounting treatment. For example, adding performance metrics that affect vesting or retention (e.g., requiring an employee to return an award if a trigger event occurs) could, depending on structure, be considered performance conditions of the awards and not clawbacks at all, with potentially weighty accounting consequences. The study also found that, of the clawback provisions examined, over 80% had “discretionary features, or features where judgment is involved in determining whether they are triggered,” which can add complexity to the accounting. According to the article, again, depending on their structure, clawbacks that involve the use of judgment “can lead to a requirement under GAAP to measure them at fair value, reporting them on a mark-to-market basis each reporting period.” According to a PwC partner, “to get the good accounting that companies like, which is to measure the value upfront and lock it in over time, you need to have all the key terms of the arrangement locked and loaded when you give it to the employee….When we have discretionary features to any arrangement, that gives us pause.” However, there is apparently little guidance on this issue, with the result that determining the proper accounting can require significant judgment.
Interestingly, however, in a prime illustration of the law of unintended consequences, companies’ proactive behavior in adopting clawbacks may not have entirely positive effects. According to CFO.com, adoption of clawbacks can be linked to earnings manipulation. A new study from the Hong Kong University of Science and Technology found that voluntary adoption of clawback policies is “correlated with an increase in ‘real transactions management,’ a way to artificially boost earnings.” More specifically, the research showed clawback adoption “reduced the incidence of one kind of earnings manipulation known as ‘accruals management,’” but increased the incidence of “real-transactions management,” another kind of earnings manipulation that “involves altering actual expenditures to achieve a temporary earnings boost, such as by cutting research and development or by slashing prices or easing credit terms to accelerate sales.”
According to the article, real-transactions management can be even more adverse to investors: while real-transactions management temporarily gooses short-term profits and stock price, “this trend reverses after three years.” The study co-author contends that Dodd-Frank’s mandatory clawback could be “of dubious value and may actually be counterproductive in its encouragement of management practices, like reduced R&D, that can compromise the long-term competitiveness of a firm.” Or, perhaps, directors, directors, analysts and others need to be vigilant in identifying, monitoring and, where possible, preventing, those types of manipulation.