What Is a Clawback?
A clawback is a contractual provision whereby money already paid to an employee must be returned to an employer or benefactor, sometimes with a penalty.
Many companies use clawback policies in employee contracts for incentive-based pay like bonuses. They are most often used in the financial industry. Most clawback provisions are non-negotiable. Clawbacks are typically used in response to misconduct, scandals, poor performance, or a drop in company profits.
The term clawback also refers to the fall in a stock's price after it increased.
Clawbacks are usually written into employee contracts so employers can control bonuses and other incentive-based payments. It acts as a form of insurance in case the company needs to respond to a crisis such as fraud or misconduct, or if the company sees a drop in profits. The employee must also pay back monies if the employer feels his or her performance has been poor.
They are different from other refunds or repayments because they often come with a penalty. So an employee must pay additional funds to the employer in case the clawback is put into effect.
Clawback provisions prevent people from using incorrect information and are used to put a balance between economic/community development and corporate welfare. For example, they usually avoid the misuse of accounting information by employees in the financial industry.
Clawbacks are considered an important part of the business model because they may restore the confidence and faith of investors and the public into a company and/or industry. For example, many banks characterized their clawback provisions following the financial crisis as a way to correct any future mistakes by their executives.
An interesting point to note is that clawback provisions for Fortune 100 companies were less than 3% before 2005. By 2010, they rose to about 82%.
Examples of Clawback Provisions
Several proposed and enacted federal laws allow clawbacks of executive compensation based on fraud or accounting errors. Companies may also write clawback provisions into employee contracts, whether such provisions are required by law or not, so that they can take back bonuses that have already been paid out.
Here are some of the most common clawback provisions put into place today:
- Executive compensation: Clawbacks can be used if an executive breaches an agreement, misuses information, or goes to work for a competitor.
- Life insurance: A provision could dictate that the policy is canceled and payments will need to be returned.
- Dividends: These can be clawed back under certain circumstances.
- Government contracts: Contractors may be subject to clawbacks if some requirements of the contract are not met.
- Medicaid: Medicaid can recover any monies paid to care for a Medicaid recipient after he or she has died.
- Pensions: Companies can claw back pensions if there is any evidence of fraud or misuse of information by the pensioner.
Clawbacks and Executive Compensation
The first federal statute to allow for clawbacks of executive pay was the Sarbanes-Oxley Act of 2002. It provides for clawbacks of bonuses and other incentive-based compensation paid to CEOs and CFOs in the event that misconduct on the part of the company—not necessarily the executives themselves—leads it to restate financial performance.
The Emergency Economic Stabilization Act of 2008, which was amended the following year, allows for clawbacks of bonuses and incentive-based compensation paid to an executive or the next 20 highest-paid employees. It applies in cases where financial results are found to have been inaccurate, regardless of whether there was any misconduct. The law only applies to companies that received Troubled Asset Relief Program (TARP) funds.
In July 2015, a proposed Securities and Exchange Commission (SEC) rule associated with the Dodd-Frank Act of 2010 would allow companies to claw back incentive-based compensation paid to executives in the event of an accounting restatement. The clawback is limited to the excess of what would have been paid under the restated results. The rule would require stock exchanges to prohibit companies that do not have such clawback provisions written into their contracts from listing. This rule has yet to be approved.
- A clawback is a contractual provision that requires an employee return money already paid by an employer, sometimes with a penalty.
- Clawbacks act as insurance policies in the event of fraud or misconduct, a drop in company profits, or for poor employee performance.
- Provisions typically only involve incentive pay like bonuses or other benefits.
- Clawbacks are used primarily in the financial industry, but can also be found in government contracts, and for pensions and Medicaid.
Clawbacks in Private Equity
The term clawback can also be found in some other settings. In private equity, it refers to the limited partners' right to reclaim part of the general partners' carried interest, in cases where subsequent losses mean the general partners received excess compensation.
Clawbacks are calculated when a fund is liquidated. Medicaid can claw back the costs of care from deceased patients' estates. In some cases, clawbacks may not even refer to money—lawyers can claw back privileged documents accidentally turned over during electronic discovery.