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Executive remuneration: Pressure mounts to introduce ‘clawback’ provisions

Following recent corporate scandals – PwC report.

In light of South Africa’s significant inequality, there has been growing criticism against the eye-watering remuneration packages paid to some executives of JSE-listed companies.

It is an emotional debate, influenced in large part by the benchmark commentators use as a reference point. On the one side, civil society groups and unions argue that it is grossly excessive and morally wrong to pay a CEO R50 million in total compensation in a country where the National Minimum (Annual) Wage of R42 000 is not considered a living wage. On the other side, remuneration committees contend that these skills are scarce and that the incentives are necessary to attract the best global talent. Moreover, it is not nearly as much as some of the compensation packages awarded to US or UK executives, they add.

There have also been growing calls that investors should have a “say on pay”, but because shareholders have no personal duty or responsibility to a company like its directors, King IV merely compels JSE-listed companies to vote on executive remuneration. The vote is non-binding.

But recent local and international corporate scandals have brought a new dimension to the debate. If there is value destruction due to corporate governance failures or accounting irregularities, what happens to the compensation packages of the executives involved, which often include not only a guaranteed salary, but substantial short- and long-term incentives? In the case of Steinhoff, shareholders lost more than 90% of the value of their investment overnight after accounting irregularities emerged and the fate of the global furniture retailer’s 100 000-odd employees still hangs in the balance.

Speaking at the release of PwC’s 10th report on executive remuneration, Anelisa Keke, managing editor of the report, said there has been a huge push from international regulators – particularly for financial services companies – to start adopting “malus” and “clawback” policies.

“Malus” refers to the reduction of unvested or unpaid variable pay before the date that it vests.

“If there are any trigger events that arise during that vesting period – irrespective of whether the other performance conditions have actually been met – you will either reduce or completely eliminate whatever variable pay award that person is going to get,” Keke said.

These “trigger events” will vary, but will most commonly include material misstatements of financial results, gross misconduct or material failure of risk management in a particular business unit.

“There are very few companies that actually penalise for subsequent underperformance but we have seen it before.”

Clawback creates an obligation for executives to repay amounts to the company that should not rightfully have been paid to them.

Where shareholder value was lost after incentives have already been paid, the argument is that these executives should never have received the variable pay in the first place.

In South Africa, companies have to be mindful of the employment law implications, as these provisions could change material conditions of employment. Moreover, it is not yet clear how the South African Revenue Service would treat clawbacks where executives have already paid employees tax on their short and long-term incentives, Keke said.

“There are very few instances in South Africa and abroad where people have (A) implemented malus or clawback and (B) disclosed the details around it.”

Gerald Seegers, director at PwC, said the problem was enforcement, but test cases were starting to emerge. A UK study looking at about 18 cases suggests that they were successful in about 60% of the cases to claw back lost shareholder value.

A “surprising number” of South African companies have started to adopt such provisions, added Martin Hopkins, director at PwC. All the large banks have malus provisions and most of them have clawback in place. A number of large mining companies now have malus policies and clawback to some extent.

“The big high profile corporate failures are really, really adding impetus to this.”

In the case of Steinhoff, the company did not have a clawback policy, but because one of its main companies was registered in the Netherlands, the legislation introduced a three-year clawback term, Hopkins said.

But even though shareholder votes on executive remuneration are non-binding, (King IV requires that where 25% or more of the voting rights exercised by shareholders are against the remuneration policy or implementation report, the board should engage these parties and address their objections and concerns) institutional shareholders have become more vocal in their opposition over the past few years.

Hopkins said these investors were prepared to pay big money to executives who performed well, but the company had to be doing well – either on a relative basis to the sector or an absolute basis, certain hurdles had to be cleared and headline earnings had to be growing.

“We are now seeing very, very aggressive ‘no’ votes.” 

The Public Investment Corporation in particular has been vocal in its criticism of certain remuneration policies. The table below shows how institutional investors voted on some listed companies’ remuneration policies and implementation reports between September 1, 2017 and May 6, 2018.

Five to ten years ago, almost all the votes were in favour of remuneration policies, Hopkins added. 

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Absolutely nothing wrong with the principle of of clawback or malus. If the argument is that the business pays the executive for the extra that s/he brings to the table and that it is measured by way of company performance, the converse must also hold true. The complexities have to be sorted out and managed, including any tax issues. Clawback can surely be done over a number of years and the clawback amount treated as a tax loss? That way it will not wipe out the whole taxable income in any year and get into the territory where a tax refund would be on the cards – something which I somehow don’t see Treasury/SARS being very enthusiastic about. The mere fact that the possibility of effective clawback exists will go a long way to keep executives from pushing the limits of honesty and propriety when it comes to reporting.

In the case of Steinhoff, all execs and non execs who where present during the periods of “accounting irregularities” should be forced to payback any and all bonuses accrued as well as being declared delinquent so they are disqualified to such positions in the future.

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