Finance

Clawback Provision

Clawback Provision

Questions often arise that what happens if a person fails to pay the amount taken, failed to keep their promise, or maybe even flawed a performance report. The answer to that is the clawback provision which is mentioned in the signed contract. It basically means that the employee has to return back the money that has already been paid, back to the employer sometimes even with a penalty. This type of provision is mostly used for incentives like bonuses. They are non-negotiable and are mostly used in the financial industry. Clawback provisions are a way for the company to act back in case of scandals, misconduct, poor performance, or a drop in company profits.

Get complete CFA Online Course by experts Click Here

How Does It Work?

Let’s take an example to understand the working of a clawback provision. If there is a Chief Executive Officer (CEO) of a certain organization and is doing quite well in the terms of the company making profits. So, the company has decided to reward his efforts and signed a contract with the clawback provision. Also, decided that if the company makes profits of 15% in the next four years the CEO will get a bonus of $350,000. The financial statement showed that there was a profit of 15% after the four years and therefore the CEO was entitled to a bonus.

When the accounts were audited at the end of the financial year the auditor noticed some mistakes. On completion of the audited accounts, it came into view that the profits were not 15% but 12%. So, the CEO won’t be entitled to the bonus since he did not reach the required benchmark set and therefore, he would have to return back the bonus he received. In certain cases, if a penalty is mentioned in the contract then the CEO would have to pay the penalty along with a bonus.

Uses of Clawback Provision

  • Life Insurance could have such a provision that if the policy is canceled the payments made have to be returned.
  • Pensions can be clawed back by the company if they find out that the pensioner has committed some fraud or misused the information.
  • Government Contracts may be clawed back from the contractors in case the requirements of the contract are not met.
  • Dividends can be taken back under special circumstances like bankruptcy.
  • Medicaid can recover back the money paid to a Medicaid recipient who has passed away and does not need the aid anymore.

Get complete FRM Online Course by experts Click Here

Clawback Provisions in the Financial Recovery Act

After the global financial crisis of 2008-2009, the clawback provision received more attention from the regulators and authorities. In July 2015 the Securities and Exchange Commission issued a ruling on the clawback provision as a part of the Dodd-Frank Financial Reform Legislation. The ruling said that the companies should institute clawback provisions against executive compensation that is due to intentional over-reporting. Executives will also be asked to return stock options exercised and bonuses if the profit levels do not match the required figures.

Although giving bonuses and incentives works in the favor of the organization but sometimes, they can backfire but you don’t know when that’s when the clawback provisions will help you.

Author -Sanjana Rau

About the Author- Started my journey of self even when the odds were against me, keen observation, a cool temper, and sports worked the best for me.

Related:

What is Shareholder Activism?

Chinese Wall

Related Posts

Leave a Reply

Your email address will not be published. Required fields are marked *

12 + 18 =