On September 27, 2016, Wells Fargo Bank announced that its CEO John Stumpf would forfeit $41 million in long-term incentive compensation because of his failure to prevent wide-spread employee misconduct. Employees were encouraged to create multiple customer accounts to qualify for special bonuses and keep their jobs, all under Mr. Stumpf’s leadership. Mr. Stumpf’s penalty or ‘clawback’ was the largest in U.S. business history and amounted to 25% of the CEO’s total career earnings with Wells Fargo (he was employed by Wells Fargo 19 years) The head of the consumer unit also forfeited $19M in long term incentives.
This case illustrates how powerful Long Term Incentive Plans or LTIPs have become as a tool of executive compensation. Ideally LTIP plans enforce accountability on executives to produce specific business results in exchange for significant compensation. It reduces the reliance on base salary to attract and retain the best executive talent. LTIPs align organizational and shareholder interests with rewards for specific executive outcomes, usually over a 3-5 year period. This discourages executives from sacrificing long-term goals for short-term profits.
“Clawback” provisions are used more often now to recover incentive money due to accounting mistakes or executive fraud or other malfeasance. The use of “clawbacks” gained more popularity after the 2008 financial collapse since it was learned that many executives, particularly in the financial services industry,
were richly rewarded for fraudulent business practices but the bonuses paid could not be legally recovered.
In theory “clawbacks” safeguard organizations from over payments made to executives who have not earned their LTIP fairly or legally. But because “clawbacks” introduce some uncertainty in payments, many executives today are negotiating for more fixed pay (base salary, fixed bonuses, etc.), actually increasing total compensation paid.
The use of Long-Term Incentive Plans or LTIP’s has become very popular in the U.S. A recent study showed that 98% of public companies and 63% of private companies use these plans, which average about 33% of a an executive’s total compensation. Public companies can use stock options or restricted stock to fund these plans while private companies typically use cash.
The most common measures for Long-Term Incentive Plan performance are: FINANCIAL
Total Shareholder Return (dividends + stock price appreciation)
Operating Income (EBIT/EBITDA)
Earnings Per Share
Return on Invested Capital
Return on Assets
Free Cash Flow
Diversity Advancements (increase in the number of women and minorities in management)
As with any performance incentive plan, it’s very important to create a design that is simple and clear to understand from management and the employee’s perspective. It’s also critical to establish what ‘desired outcomes’ are expected from the plan – for instance, diversity or talent retention and engagement goals should be clearly defined and measurable. Other items such as vesting, changes in financial results due to unexpected events or accounting errors and payment schedules must be very clear.
It’s good business practice to establish clear business goals and specific rewards for these outcomes over a 3~5 year period to ensure executives are performing in the best interests of the organization.