This recent data comes from Mercer’s Financial Services Executive Compensation Snapshot Survey which looks at compensation structures in 63 global financial services companies, including banks and insurance firms.
Clawbacks, where paid-out compensation is reclaimed based on financial restatement, gross negligence or other malfeasance, are a common feature in bank compensation structures today. Their inclusion has been encouraged by regulators in Europe and North America as a means of managing employee risk-taking following the financial crisis of 2008.
'There are a variety of reasons why actual clawbacks of payments already made are limited – often the concept conflicts with local labour laws so actually recouping the funds can be difficult', said Vicki Elliott, Global Financial Services Human Capital Leader at Mercer. 'Clawbacks are relatively new phenomena in compensation programs so it will take some time for them to bed down. A small number of clawbacks doesn’t signify that the sector is ignoring lessons from the financial crisis but does raise legitimate questions about whether companies will actually seek pay-back of compensation paid'.
Ms Elliott also pointed to numerous cases where top executives have succumbed to political and public pressure and 'volunteered' to forego bonus payments awarded to them by their Boards as a sign of increased responsiveness in the sector.
'It is worth remembering that the majority of banks have also introduced 'malus conditions' on deferred compensation', she added. 'This can result in reduced, or no payouts, of deferred monies. It will be interesting to see if, at a time when the news is dominated by major banking missteps and scandals in the US and the UK, levels of clawback and malus increase in 2012'.
'If they do not', she concluded, 'then it would be fair to ask if the regulatory approach of managing risk through this kind of pay feature is working. Focusing on the manner in which banks are managing risk, performance measurement and compliance internally may achieve much more in terms of sound risk management than the regulatory requirements on pay structures have achieved thus far'.
In Mercer’s report, 44% of banks have had clawback provisions in place prior to 2011- they were more common in North America prior to 2011 than in EMEA - and an additional 18% of banks on both sides of the Atlantic have introduced them subsequently. Typically, a clawback is triggered by criteria on an individual level with the most prevalent criteria to trigger a clawback being a breach of code of conduct (73%), and individual non-compliance, breach of authority level or ethical violations (63%).
According to Mercer, the relatively low usage of clawback underlines the importance of clearly defining the ‘Malus’ conditions applied to deferrals. Malus conditions allow companies to revise the payment amount or not pay out at all if actual realized performance results over a multi-year timeframe turn out to be significantly less than the performance assessment when the original award was determined. Mercer’s report indicates that 80% of banking organizations have ‘Malus’ provisions in place, compared to 60% of insurance organizations. The most prevalent criteria to trigger Malus reductions are Firm (67%) and Business Unit (54%) downturns/loss in financial performance, and individual breach of Code of Conduct (56%).
'It is crucial that ‘Malus’ arrangements are constructed properly so the balance between risk management and appropriate incentive is maintained', said Dirk Vink, Mercer Senior Associate and Snapshot Survey Project Manager. 'Malus conditions should be aligned with the continued measurement of business performance over a realistic timeframe for assessing likely realized outcomes'.
The majority of financial services organizations (67%) have ‘Bonus Malus’ performance conditions with moderate probability of adjusting the ultimate payout. Thirty-five percent of banking organizations indicate that ‘Bonus Malus’ performance conditions are typically easily achievable. Only a very few banks (4%) have performance conditions that are difficult to meet.
Most organisations have mandatory bonus deferrals (66%) and forward-looking long-term incentive programs (70%). Mandatory deferrals are most prevalent in the banking industry (83% of banks) and a majority (58%) also have forward-looking long-term incentive programs. Almost all insurance organizations (94%) have forward-looking long-term incentive programs, but only one-third have mandatory deferrals.
The majority still base their mandatory deferral payout on corporate performance rather than business unit or individual performance. The two most prevalent performance metrics used to determine final deferral payouts are net/operating profit or loss (42%) and relative or absolute Total Shareholder Return (TSR) (27%).
'It is critical for a firm to maintain a forward-looking long-term incentive program, particularly for top executives, in order to keep them consistently tied to the future success of the company. Deferred annual bonuses do not assure this link when annual performance is weak', said Ms. Elliott.
The question remains whether clawbacks and malus conditions as they are currently structured will effectively help to ensure prudent risk taking. Given that performance conditions for deferral and long-term incentive payouts are often not based on risk-adjusted outcomes and primarily focus on overall company performance, there may be limited impact on individual risk-taking behaviour.