Events such as the corporate accounting scandals of the early 2000s and the financial crisis of 2008-09 have placed executive compensation under the spotlight. One prominent area of focus is the relationship between incentive-based executive pay and the overall ethics and compliance performance of the organization. Now more than ever, CEOs and other top management personnel are required to justify from a compliance perspective the bonuses and other ancillary payments they receive. Failure to do so could result in the forfeiture of certain types of financial incentives.

Sarbanes-Oxley and the rise of “clawback” provisions

The Sarbanes-Oxley Act of 2002 included a so-called “clawback” provision, which mandates that public companies must disclose their policies for the issuance of incentive-based compensation. Additionally, the companies must have policies in place for the recovery, or “clawing back,” of bonuses and similar incentives in certain instances. Specifically, CEOs and CFOs are required to return incentive-based compensation when a financial restatement is the result of their own misconduct.

Broadening of the clawback provisions under Dodd-Frank

In the wake of the financial meltdown of the late 2000s, the U.S. Congress implemented the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010. Among its many provisions, Dodd-Frank proposed giving additional clawback enforcement powers to the Securities and Exchange Commission in an effort to prevent the excessive risk taking by executives that played a major role in the onset of the financial crisis.

Under Dodd-Frank, instead of being limited to instances of CEO or CFO misconduct, compensation can be “clawed back” from current and former executives and officers if an accounting restatement is caused by a material noncompliance with financial reporting requirements under securities laws. For instance, companies that produce financial statements containing significant errors would be required to claw back incentive-based compensation, even if the mistakes were unintentional. The Dodd-Frank clawback rules are still awaiting finalization as of June 2015.

The impact of clawback policies on corporate compliance efforts

Many companies are not waiting for implementation of SEC rules to institute clawback policies. The trend toward developing and instituting these policies has actually been growing over the past decade. According to the Equilar 2013 Clawback Policy Report, 89 percent of Fortune 100 companies had some form of clawback policy or procedure in place, compared to only 18 percent in 2006.

An important benefit of implementing clawback policies is that they increase the level of accountability at the executive level and throughout the organization as a whole. Executives who do not wish to be forced to return incentive-based compensation are more likely to bolster their organization’s financial reporting and compliance functions in an effort to reduce errors that could result in clawbacks. Factors to consider when developing and instituting effective clawback policies include:

• Ensuring the policy is in line with the goals of the organization and its executives, shareholders, stakeholders, and board of directors
• Identifying which employees (and former employees) should be covered under the policy
• Accurately determining the risks that could prompt the need for actual policy implementation
• Determining which types of incentive-based compensation are applicable under the policy

There are also certain best practices that organizations should adhere to from a risk management and clawback policy management perspective. These include the linking of incentives to the achievement of specific compliance objectives, and regular reporting to the audit committee and board of directors with regard to attaining these objectives.

Compliance and compensation from an FCPA perspective

Increased enforcement of the Foreign Corrupt Practices Act in recent years has also forced many companies to examine the link between executive compensation and compliance. A classic example can be found in the case of retail giant Wal-Mart. A 2012 New York Times story alleged that Wal-Mart company officials paid bribes to facilitate the opening of new stores in Mexico.

The following year, the retailer announced that, in addition to basing executive incentive payments on factors such as sales, operating income, and return on investment, there would also be a compliance component included in the compensation program beginning in the 2014 fiscal year. Specific measures taken by the company can be found in its Global Compliance Program Report for 2014. A notable highlight includes the tying of 20 percent of executive compensation to the achievement of specific compliance goals.

Whether a company’s business is domestic or global in scope, it’s clear that linking executive incentives with corporate compliance efforts has become a necessity for virtually every public organization.