In 2011, almost two-thirds of global banking organizations had clawback provisions in place, but only 17% resorted to using those measures to reclaim compensation paid to employees, according to research from a recent financial services executive compensation survey.
Earlier this summer, we learned from another survey that the majority of financial services companies had decreased annual cash bonuses, and instead increased base salaries along with the use of deferred compensation. These changes are in line with regulatory guidance addressing concerns that short-term bonus cultures encourage excessive risk taking and contributed to the recent financial crisis.
Although a relatively new phenomenon in compensation programs, emerging after the financial crisis of 2008, a clawback, where paid-out compensation is reclaimed as a result of a financial restatement, malfeasance or gross negligence has become a commonly accepted redress for companies in managing risk, encouraged by regulators. However, the relatively low use of the clawback rules can in part be attributed to the reaction by senior executives to forgo bonuses in response to public anger over pay. In addition, it appears the introduction of the so-called "malus clause" on deferred rewards is having its desired impact.
The vast majority—as many as 80%—of banks have introduced “malus clauses" on deferred compensation. It allows companies to revise or refuse payments if performance results over an extended multi-year period are below the target when the original award was determined. The result can be a reduced or eliminated payout of deferred monies.
And evidence seems to show their success.
As many have noted, the relatively low usage of the clawback demonstrates the importance of clearly defined ‘Malus’ or which is Latin for bad conditions with regard to deferred compensation. When constructed properly, Malus arrangements strike a balance between risk management and the appropriate incentive is maintained.
However, while banking institutions are trying to balance practicality with added complexity in the process, the majority still base their mandatory deferrals on corporate performance, not the performance of the individual or the business unit.
Impact on risk
Critics contend that these rules have limited impact on individual risk-taking behavior. Almost two-thirds of companies have a mandatory bonus deferral program; however, only about 40 percent have taken the step to link bonus deferral payouts to subsequent performance.
It appears that financial institutions have become the real thought leaders in corporate America on issues such as pay for performance and mitigation of risks created by incentive compensation programs.