A clawback or clawback provision is a special contractual clause typically included in employment contracts by financial firms, by which money already paid must be paid back under certain conditions. The term also is in use in bankruptcy matters where insiders may have raided assets prior to a filing,and in Medicaid, when a state recovers costs of long-term care or covered medical expenses from the estates of deceased Medicaid patients. The aim of the clause is to secure an option for an employer or trustee to limit bonuses, compensation or other remuneration in case of catastrophic shifts in business, bankruptcy, and national crisis as the financial crisis of 2007–2008, and for states to recoup the cost of administering Medicaid services.
Bankruptcy is a legal status of a person or other entity who cannot repay debts to creditors. In most jurisdictions, bankruptcy is imposed by a court order, often initiated by the debtor.
The financial crisis of 2007–2008, also known as the global financial crisis and the 2008 financial crisis, is considered by many economists to have been the most serious financial crisis since the Great Depression of the 1930s.
The term clawbacks or claw backs can also be used to refer to any money or benefits that have been given out but need to be returned due to special circumstances or events, which are mentioned in a contract.
The employees' bonuses are, in a clawback scheme, tied specifically to the performance (or lack thereof) of the financial product(s) the individual(s) may have created and/or sold as part of his or her job expecting a high profit. If the product does indeed do well over a long period of time, and permanently improves the nature of the firm, the bonuses paid to the individual are allowed to be retained by the individual. However, if the product fails, and damages the nature of the firm—even years down the line from the product's inception—then the firm has the inherent right to revoke, reclaim, or otherwise repossess some or all of the bonus amount(s).However, research shows managers who are subject to clawback provisions that are newly in place in a company often try to offset their increased risk of bonus clawback by demanding an increase in base salary that is not subject to being clawed back.
The prevalence of clawback provisions among Fortune 100 companies increased from lower than 3% prior to 2005 to 82% in 2010.The growing popularity of clawback provisions is likely, at least in part, due to the Sarbanes-Oxley Act of 2002, which requires the U.S. Securities and Exchange Commission (SEC) to pursue the repayment of incentive compensation from senior executives that are involved in a fraud. In practice, the Securities and Exchange commission has enforced its clawback powers in only a small number of cases.
The U.S. Securities and Exchange Commission (SEC) is an independent agency of the United States federal government. The SEC holds primary responsibility for enforcing the federal securities laws, proposing securities rules, and regulating the securities industry, the nation's stock and options exchanges, and other activities and organizations, including the electronic securities markets in the United States.
The Dodd-Frank Act of 2010 mandates the SEC to require that U.S. public companies include a clawback provision in their executive compensation contracts that is triggered by any accounting restatement, regardless of fault (whereas the clawback provisions per the Sarbanes-Oxley Act only applied to intentional fraud). As of mid 2015, this portion of the Dodd-Frank Act has yet to be implemented.
The usual objective of a clawback provision is to deter managers from publishing incorrect accounting information. Academic research finds that voluntarily adopted clawback provisions appear to be effective at reducing both intentional and unintentional accounting errors.The same study also finds that investors have greater confidence in a firm's financial statements after clawback adoption, and that boards of directors place greater weight on accounting numbers in executive bonuses after a clawback is in place (i.e., pay for performance sensitivity increases).
According to a December 2010 New Yorker magazine article,the clawback phenomenon pursued by banks and other financial groups directly and/or indirectly responsible for the financial crisis has been used by the chief administrators of those institutions in order to make the case that they are presently taking tangible self-corrective action to both prevent another crisis (by supposedly dis-incentivizing the sorts of shady investment-product behavior displayed by their people in the recent past) and to appropriately punish any potential future activity of a similar or identical sort. However, the case is made in The New Yorker article (which cites several professional economists who agree with its perspective) that it is probably unlikely that either result will become the case, and The New Yorker article also alleges that the people making this argument may not even truly believe it, but are instead promoting it as a sort of public relations tactic until such time as the impact of the financial crisis fades and similar (perhaps near-identical) abuses of the financial system can slowly and quietly resume, with minimal or no detection by outside forces.
In the past, clawback phenomena have been used primarily in securing tax incentives, abatements, refunds and grants. Clawbacks are distinguished from repayments or refunds as they involve a penalty in addition to a repayment.
The use of tax incentives for attracting jobs and capital investment has grown over the past twenty odd years to include performance measures from which to gauge a company's growth. Typical measures are:
More unusual measures are retaining a headquarters at a specific site for a period of time, amount of production increase or production cost decrease per unit or the requirement to bring a given technology to a commercial market. The recipient will be required to return the monetary value of the incentive plus a penalty and/or interest to the grantor of the incentive, usually a local or state taxing authority. As the use of incentives mature over time, it is sometimes alleged [ who? ] that the triggering of clawbacks for non performance will likely become more ubiquitous.
Clawbacks can be understood to be the contractual elements that stand between the drive for economic development and community development and the slippery slope of corporate welfare. They are highly controversial and are utilized as community based guarantees for some expectation of performance. The site location industry normally tries to eliminate or reduce any such promises as part of their negotiations.
Clawbacks are also used by most banks and lenders to recover money from "unprofitable" home loans. This is usually done when the borrower pays back the loan in a short period of time, usually within 24 months of the loan advancement.
In Australia this fee is usually 0.77% of the total loan amount for loans paid back within the first 12 months after the settlement and 0.385% within 24 months. If a borrower is using a mortgage broker for their home loan, then the broker will usually charge them this amount.
See Medicaid#Clawback controversy.
Creative accounting is a euphemism referring to accounting practices that may follow the letter of the rules of standard accounting practices, but deviate from the spirit of those rules. They are characterized by excessive complication and the use of novel ways of characterizing income, assets, or liabilities and the intent to influence readers towards the interpretations desired by the authors. The terms "innovative" or "aggressive" are also sometimes used. Other synonyms include "cooking the books" and "Enronomics."
The Sarbanes-Oxley Act of 2002, also known as the "Public Company Accounting Reform and Investor Protection Act" and "Corporate and Auditing Accountability, Responsibility, and Transparency Act" and more commonly called Sarbanes–Oxley, Sarbox or SOX, is a United States federal law that set new or expanded requirements for all U.S. public company boards, management and public accounting firms. A number of provisions of the Act also apply to privately held companies, such as the willful destruction of evidence to impede a federal investigation.
An investment bank is a financial services company or corporate division that engages in advisory-based financial transactions on behalf of individuals, corporations, and governments. Traditionally associated with corporate finance, such a bank might assist in raising financial capital by underwriting or acting as the client's agent in the issuance of securities. An investment bank may also assist companies involved in mergers and acquisitions (M&A) and provide ancillary services such as market making, trading of derivatives and equity securities, and FICC services. Most investment banks maintain prime brokerage and asset management departments in conjunction with their investment research businesses. As an industry, it is broken up into the Bulge Bracket, Middle Market, and boutique market.
A financial transaction is an agreement, or communication, carried out between a buyer and a seller to exchange an asset for payment.
The principal–agent problem, in political science and economics, occurs when one person or entity is able to make decisions and/or take actions on behalf of, or that impact, another person or entity: the "principal". This dilemma exists in circumstances where agents are motivated to act in their own best interests, which are contrary to those of their principals, and is an example of moral hazard.
The Public Company Accounting Oversight Board (PCAOB) is a private-sector, nonprofit corporation created by the Sarbanes–Oxley Act of 2002 to oversee the audits of public companies and other issuers in order to protect the interests of investors and further the public interest in the preparation of informative, accurate and independent audit reports. The PCAOB also oversees the audits of broker-dealers, including compliance reports filed pursuant to federal securities laws, to promote investor protection. All PCAOB rules and standards must be approved by the U.S. Securities and Exchange Commission (SEC).
Restricted stock, also known as letter stock or restricted securities, is stock of a company that is not fully transferable until certain conditions (restrictions) have been met. Upon satisfaction of those conditions, the stock is no longer restricted, and becomes transferable to the person holding the award. Restricted stock is often used as a form of employee compensation, in which case it typically becomes transferrable ("vests") upon the satisfaction of certain conditions, such as continued employment for a period of time or the achievement of particular product-development milestones, earnings per share goals or other financial targets. Restricted stock is a popular alternative to stock options, particularly for executives, due to favorable accounting rules and income tax treatment.
A financial adviser or financial advisor, is a professional who suggests and renders financial services to clients based on their financial situation. In many countries financial advisors have to complete specific training and hold a license to provide advice. In the United States for example a financial adviser carries a Series 65 or 66 license and according to the U.S. Financial Industry Regulatory Authority (FINRA), license designations and compliance issues must be reported for public view. FINRA describes the main groups of investment professionals who may use the term financial advisor to be: brokers, investment advisers, accountants, lawyers, insurance agents and financial planners.
Payment protection insurance (PPI), also known as credit insurance, credit protection insurance, or loan repayment insurance, is an insurance product that enables consumers to ensure repayment of credit if the borrower dies, becomes ill or disabled, loses a job, or faces other circumstances that may prevent them from earning income to service the debt. It is not to be confused with income protection insurance, which is not specific to a debt but covers any income. PPI was widely sold by banks and other credit providers as an add-on to the loan or overdraft product.
Sell side is a term used in the financial services industry. The three main markets for this selling are the stock, bond, and foreign exchange market. It is a general term that indicates a firm that sells investment services to asset management firms, typically referred to as the buy side, or corporate entities. One important note, the sell side and the buy side work hand in hand and each side could not exist without the other. These services encompass a broad range of activities, including broking/dealing, investment banking, advisory functions, and investment research.
Commissions are a form of variable-pay remuneration for services rendered or products sold. Commissions are a common way to motivate and reward salespeople. Commissions can also be designed to encourage specific sales behaviors. For example, commissions may be reduced when granting large discounts. Or commissions may be increased when selling certain products the organization wants to promote. Commissions are usually implemented within the framework on a sales incentive program, which can include one or multiple commission plans.
Finite risk insurance is the term applied within the insurance industry to describe an alternative risk transfer product that is typically a multi-year insurance contract where the insurer bears limited underwriting, credit, investment and timing risk. The assessment of risk is often conservative. The insurer and the insured share in the net profit of the transaction, including loss experience and investment income. The premium is generally well in excess of the present value of a conservative estimate of loss experience. The policy generally contains retrospective rating provisions such as
Executive compensation or executive pay is composed of the financial compensation and other non-financial awards received by an executive from their firm for their service to the organization. It is typically a mixture of salary, bonuses, shares of or call options on the company stock, benefits, and perquisites, ideally configured to take into account government regulations, tax law, the desires of the organization and the executive, and rewards for performance.
Credit rating agencies (CRAs)—firms which rate debt instruments/securities according to the debtor's ability to pay lenders back—played a significant role at various stages in the American subprime mortgage crisis of 2007–2008 that led to the great recession of 2008–2009. The new, complex securities of "structured finance" used to finance subprime mortgages could not have been sold without ratings by the "Big Three" rating agencies—Moody's Investors Service, Standard & Poor's, and Fitch Ratings. A large section of the debt securities market—many money markets and pension funds—were restricted in their bylaws to holding only the safest securities—i.e. securities the rating agencies designated "triple-A". The pools of debt the agencies gave their highest ratings to included over three trillion dollars of loans to homebuyers with bad credit and undocumented incomes through 2007. Hundreds of billions of dollars' worth of these triple-A securities were downgraded to "junk" status by 2010, and the writedowns and losses came to over half a trillion dollars. This led "to the collapse or disappearance" in 2008–09 of three major investment banks, and the federal governments buying of $700 billion of bad debt from distressed financial institutions.
The Troubled Asset Relief Program (TARP) is a program of the United States government to purchase toxic assets and equity from financial institutions to strengthen its financial sector that was passed by a Democratic Party controlled Congress and signed into law by Republican Party President George W. Bush on October 3, 2008. It was a component of the government's measures in 2008 to address the subprime mortgage crisis.
The Dodd–Frank Wall Street Reform and Consumer Protection Act was signed into United States federal law by US President Barack Obama on July 21, 2010. Passed in response to the 2008 global financial crisis, the Act brought the most significant changes to financial regulation in the nation since the regulatory reform that came following the Great Recession. It made changes in the American financial regulatory environment affecting all federal financial regulatory agencies and almost every part of the nation's financial services industry.
Raffi Indjejikian is the Robert L. Dixon Collegiate Professor of Accounting at the Stephen M. Ross School of Business at the University of Michigan. His research is primarily focused on the development of models and theories illustrating the role of managerial accounting in decision-making through the basis of agency theory.
The Investor Protections and Improvements to the Regulation of Securities is a United States Act of Congress, which forms Title IX, sections 901 to 991 of the much broader and larger Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Its main purpose is to revise the powers and structure of the Securities and Exchange Commission, credit rating organizations, and the relationships between customers and broker-dealers or investment advisers. This title calls for various studies and reports from the SEC and Government Accountability Office (GAO). This title contains nine subtitles.
Utility ratemaking is the formal regulatory process in the United States by which public utilities set the prices they will charge consumers. Ratemaking, typically carried out through "rate cases" before a public utilities commission, serves as one of the primary instruments of government regulation of public utilities.
In the United States, the compensation of company executives is distinguished by the forms it takes and its dramatic rise over the past three decades and wide-ranging criticism leveled against it. In the past three decades in America executive compensation or pay has risen dramatically beyond what can be explained by changes in firm size, performance, and industry classification. It is the highest in the world in both absolute terms and relative to median salary in the US. It has been criticized not only as excessive, but also for "rewarding failure"—including massive drops in stock price, and much of the national growth in income inequality. Observers differ as to how much of the rise in and nature of this compensation is a natural result of competition for scarce business talent benefiting stockholder value, and how much is the work of manipulation and self-dealing by management unrelated to supply, demand, or reward for performance. Federal laws and Securities and Exchange Commission (SEC) regulations have been developed on compensation for top senior executives in the last few decades, including a $1 million limit on the tax deductibility of compensation not "performance-based", and a requirement to include the dollar value of compensation in a standardized form in annual public filings of the corporation.