Bonus Claw-Backs and Restrictions in Action

At the end of last year it was reported that HSBC would be deferring top executives’ bonuses for the next five years, as part of an agreement reached with the US Department of Justice following the money laundering scandal which engulfed the bank. In the insurance market, the pressure from shareholders over business performance prompted new CEO, Mark Wilson to announce that there would be no bonuses for directors and no pay rise for many of its senior managers.

HSBC and Aviva join the many companies facing pressure from shareholders, government and the public alike. It’s no longer just a boardroom matter. Businesses are facing a backlash on big bonuses and remuneration packages meaning they are no longer able to ‘reward failure’ for senior level employees.

Most recently, the European Union Council has endorsed a proposed cap on variable remuneration for those employed by financial institutions that will limit bonuses to the amount of an individual’s fixed salary – or, if approved by shareholders, twice that amount. Whether shareholders will be persuaded to do is an interesting question.

The causes of the revolt over what is seen as excessive pay have already been dissected. However, no institution aims to reward failure from the outset. A new chief executive, or chief investment officer, joins a company in possession of skills and experience which are sought after by many businesses – they have been chosen in the expectation of success, not failure.

Prospective leaders in their fields generally already have secure and well paid jobs. Persuading them to move may require attractive remuneration packages. However, what looks sensible when a company is doing well and wants a big-hitter CEO can look very different after a period of poor performance.

For such reasons, contracts for senior executives need to be drafted carefully from the outset. Once a contract is agreed, it can only be varied by consent, so organisations need to agree the right terms to begin with and be careful to avoid ones that are overly generous. Not surprisingly, it is rare indeed, usually only after intense public pressure, for a departing senior executive to accept less than their contractual entitlement.

Just taking some basic precautions may help prevent damaging coverage aimed at exposing alleged “reward for failure”.

Generally, notice periods should be set at one year or less. It is not unusual for the contract to provide for payment in lieu of notice by instalments which stop when the executive has found another role. The contract should oblige the executive to look for alternative employment and to inform the company as soon as new employment is found.

Bonuses should also be designed appropriately so they don’t provide a “heads I win, tails you lose” payout for the executive. Payment should be subject to robust company, business unit and individual performance conditions. Contracts should include the right to defer payment over a number of years so that bonuses are forfeit if company performance in the longer term is lower than expected. Companies should also consider including a right to claw back bonuses already paid if, for example, the company’s value has been misstated.

It’s also important to have a balance between fixed remuneration (salary) and variable remuneration (bonus). Paying part of the bonus in shares (perhaps with a requirement that the shares must be held for a significant period of time before they can be sold) will ensure that if company performance dips, so does the value of the bonus.

Executives reluctant to move from an existing well-paid and secure job might be persuaded by the offer of an initial longer notice period, but this should be reduced to one year (or less) after a bedding-in period. Guaranteed bonuses can still be used to lure new recruits, but should only be offered for the first year of service. As with other bonuses, payment should be deferred (meaning that part or all of the bonus is paid in tranches, normally over three years, and not all at once) and not payable if company performance proves to be less than expected.

While the cases of HSBC and Aviva were different, the message stays the same. Businesses cannot pay huge sums of money without revolt, unless it is justified by stellar performance. Nevertheless, Moss was perfectly within his rights to collect on what had been originally agreed when he took the reins. HSBC on the other hand, was required to take strong action against its senior staff to make sure they faced consequences (hitting them where it hurt).

The world of executive pay is extremely complex. On the one hand, what often seems like a reasonable amount of pay for senior executives at one time can soon look over-generous when things take a turn for the worse.

Directors should be careful not to bow down to tall orders from high-flying execs. This might cause much more than embarrassment at a later date. Contracts should be written with continuity in mind, and ensure that it meets long-term business goals – not just short-term gain.

Jessica Corsi is Partner at UK’s largest specialist employment law firm, Doyle Clayton Solicitors.