July 4, 2012

Executive Compensation: Rewards for success not failure

All company directors should be forced to repay bonuses if they underperform. Executive Compensation: Reward for success not failure advocates introducing “clawbacks” to all bonus contracts as the best way to end rewards for failure in the boardroom. Clawback would also be an effective way of ensuring shareholders are able to reduce the outgoing pay of a poor performing director who had decided to resign.

Remuneration committees should set downside conditions to director contracts which, if breached, would trigger clawbacks. Clear targets such as underperformance in terms of total shareholder return, a fall in the absolute share price beyond a certain level or a rise in the credit spread of the company’s debt beyond a certain level would enable shareholders to see whether the company and its managements had failed in some way.

To build up a clawback fund, half of all bonuses and long term incentive payments would be put in an escrow account and paid out evenly over five years. The company could withdraw the funds if directors underperformed.

The report, published to coincide with the government’s consultation into executive pay and shareholder rights, says that clawback would be a much more effective mechanism to end rewards for failure than the Government’s current proposals. This still allows companies to agree termination payments with under-performing employees. While exit payments are still likely under these proposals, a properly drawn up clawback scheme could easily overwhelm these in the case of failure. Indeed, clawback is structured to ensure that the greater the underperformance the more the executive would have to pay back.


James Barty

Senior Consultant to Policy Exchange, Financial Policy, 2011-2013

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