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Rivista di DIRITTO SOCIETARIO

Interno, Internazionale Comunitario e Comparato

Niccolò Abriani, Massimo Benedettelli, Vincenzo Carie! lo, Giuseppe Ferri jr, Gianvito Giannelli, Fabrizio Guerrera, Giuseppe Guizzi, Marco Lamandini, Roberto Pennisi, Paolo Piscitello, Duccio Regoli, Giuseppe A. Rescio, Daniele U. Santosuosso, Federico Tassinari, Umberto Tombari

Rivista trimestrale - l/2012

G. Giappichelli Editore - Torino

© Copyright 2012 - La Direzione Registrazione presso il Tribunale di Torino, 30 aprile 2007, n. 53

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Comitato scientifico Pietro Abbadessa, Carlo Angelici, Sergio M. Carbone, Brian Cheffins, Giovanni E. Colombo, Giorgio Costantino, Renzo Costi, Vincenzo Di Cataldo, ]osé M. Embid lrujo, Sabino Fortunato, ]esse Fried, Agostino Cambino, Mathias Habersack, Mario Libertini, Riccardo Luzzatto, Alberto Mazzoni, Paolo Montalenti, Alessandro Nigra, Angel Rojo, Niccolò Salani-tro, Giuliana Scognamiglio, Antonio Serra, Paolo Spada, Antonio Tizzano, Roberto Weigmann, jaap Winter

Redazione di Bari Responsabile: .. Gianvito Giannelli (ordinario di diritto commerciale), via Melo da Bari n. 198, 70121 Bari, tel. 080/523.55.83 - fax 080/524.54.39, email: gianvitogiannelli@studiogiannelli.com Componenti: Francesco Belviso; Monica Bruno; Claudio Burani; Rosella Calderazzi; Stelio Campanale; Eustachio Cardinale; Franco Cassano; Michele Castellano; Daniela Caterina; Vincenzo Chionna; Francesco Costantino; Domenico Dalfino; Gabriele Dell'Atti; Vittorio Dell'atti; Anna De Simone; Massimo Di Rienzo; Barbara Francane; Cira Grippa; Michele Labriola; Eda Lofoco; Giuseppe Losappio; Serenella Luchena; Giuseppe Miccolis; Michele Monteleone; Vito Mormando; Cinzia Motti; Anna Lucia Muserra; Ugo Patroni Griffi; Giuseppina Pellegrino; Francesco Petrera; Emma Sabatelli; Franco Scannicchio, Giuseppe Trisorio Liuzzi; Francesca Vessia

Redazione di Bologna Responsabili: Marco Lamandini (ordinario di diritto commerciale), Strada Maggiore n. 47, 40125 Bologna, tel 051-30.05.03 -fax 051/30.30.04; email: marcolamandini@forschung.it Federico Tassinari (notaio), via Galliera n. 8, 40121 (Bologna), tel 051/6566711 -fax 051/566885, email: ftassina-ri.2@notariato.it Componenti: Tommaso Bonetti; Rosa Castro Bernieri; Fiammetta Costa; Alberto De Prà; Claudia Desogus; Roberto Genco; Marco Maltoni; Emanuela Manzo; Francesco Mocci; Marco Montefameglio; Pierluigi Morara; Federico M. Mucciarelli; Giuseppe Piperata; Alessandro Pomelli; Antonio Preto; Ettore Racchi; Lorenzo Sasso; llan Steiner; Elena Tradii; Carmen Vitale

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Redazione di Messina-Cosenza

Responsabili: Fabrizio Guerrera (ordinario di diritto commerciale), via G. Veneziani n. 23, 98122 Messina, tel. e fax 090/6409536 -email: f.guerrera@tiscali.it Pierpaolo Marano (associato di diritto commerciale), via Guglielmo Tocci n. 2/B, 87100 Cosenza, tel. 0984/492212 fax 0984/492288 email: maranop@unical.it Componenti: Federica Allegritti; Maria Carmela Andricciola; Giuseppe Cava; Cosimo D'Arrigo; Luigi De Santis; Maura Garcea; Giuseppe Giunta; Rocco Guglielmo; Anna Maria Giampaolino; Dario Latella; Beatrice Magarò; Silverio Magno; Filadelfia Mancuso; Giuseppe Minutoli; Gianpiero Monteleone; Manuela Morrone; Roberta Notaro; Antonino Orifici; Amalia Macrì Pellizzeri; Amedeo Valzer

Redazione di Firenze

Responsabile: Umberto Tombari (ordinario di diritto commerciale), via Maggio n. 7, 50125 Firenze, tel. 055/211732 - fax 055/2381313 -email: umberto.tombari@unifi.it Componenti: Francesco Barachini; Emilio Barucci; Serena Bitossi; Riccardo Cambi; Francesco D'Angelo; Anna De Pamphilis; Enrico De Schoenfeld; Ludovico Delle Vergini; Daniele Giovannelli; Fausto Giunta; Domenico laria; Carlo lmò; Philip Laroma jezzi; Paola Lucarelli; Giampietro Malusà; Isabella Mariani; Alberto Marras; Gabriele Mazzotta; Sergio Menchini; Alessandro Nerdi; Ilaria Pagni; Massimo Palazzo; Leonardo Quagliotti; Andrea Simoncini; jacopo Sodi; Lorenzo Stanghellini; Francesco Terrusi

Redazione di Milano-Ferrara

Responsabili: Massimo Benedettelli (ordinario di diritto internazionale), via dei Giardini n. 7, 20121 Milano, tel. 02/62.53.01 -fax 02/62.530.800- e-mail: massimo.benedettelli@freshfields.com

Vincenzo Cariello (ordinario di diritto commerciale), via Verdi n. 2, 20123 Milano, tel. 02/72.157.477 - fax 02/72.157.224 - e-mail vincenzo.cariello@chiomenti.net Duccio Regoli (ordinario di diritto commerciale), via Manzoni n. 12, 20121 Milano, tel. 02/760.25.707 - fax 02/760.25.734-38- email: regoli@mazzonieassociati.it Giuseppe A. Rescio (ordinario di diritto commerciale), c.so Italia n. 8, 20122 Milano, tel. 02/72010991 - fax 02/72001562, e-mail: grescio@notariato.it Componenti: Valentina Allatti; Filippo Annunziata; Matteo Bazzani; Enrico Bazzano; PierDanilo Beltrami; Piergiu-seppe Biandrino; Luca Boggio; Michele Centonze; Angelo Cerulo; Antonio Cetra; Alessandro Chieffi; Marco Cian; Filippo Corsini; Eugenio Dalmotto; Filippo Danovi; Giovanni Demarchi; Marco D'Orazi; Francesca Fiecconi; Claudio Frigeni; Manlio Frigo; Luigi Fumagalli; Paolo Giudici; Gianluca Crea; Carlo Marchetti; Fabio Marelli; Massimo Marinelli; Lucio Menestrina, Michele Mengoni; Elena Merlin; Paolo Mondini; Michele Monti; Chiara Mosca; Michele Mozzarelli; Guido Mucciarelli; Francesco Munari; Anna Pellegrino; Gian Giacomo Peruzzo; Alberto Picciau; Giusy Pizzolante; Alberto Ronco; Rinaldo Sali; Armando Santus; Paolo Sfameni; Serenella Rossi; Valeria Salamina; Marco Speranzin; Andrea Tina; Andrea Tucci; Amedeo Valzer; Silvia Vanoni; Marco Ventoruzzo; Andrea Vicari; Gabriele Villa; Filippo Zabban

Redazione di Napoli-Campobasso

Responsabile: Paolo Piscitello (ordinario di diritto commerciale), via Petrarca n. 83; 80122 Napoli, tel. 081/667499 - fax 081/663389 - email: paolopiscitello@virgilio.it Componenti: Federico Briolini; Grazia Maria Buta; Mario Campobasso; Stanislao De Matteis; Oreste De Nicola; Emanuela Fusco; Paolo Chianni; Marcello lacobellis; Gabriella lermano; Gianpaolo La Sala; Ubalda Macrì; Gianmaria Palmieri; Luca Pisani; Fabio Rastrelli; Massimo Rubino De Ritis; Renato Santagata De Castro; Giuseppe Satriano

Redazione di Roma

Responsabile: Daniele U. Santosuosso (ordinario di diritto commerciale), via G.G. Porro n. 15, 00197 Roma, tel. 06/80.693.749-fax 06/80.88.655 - d.santosuosso@studiosantosuosso.it

Componenti: Simone Alvaro; Gianluca Bertolotti; Margherita Bianchini; Fabio Bonomo; Vincenzo Caridi; Ignazio Cerasa; Fabrizio Clemente; Francesca Crivellari; Emilio De Lilla; Agostino Di Febo; Emanuela Di Lazzaro; Alessandro di Majo; Fabrizio Di Marzio; Giovanni Figà Talamanca; Francesco Gerbo; Carlo Giampaolino; Mauro Gigante; Andrea Guaccero; Gennaro jannarone; Enrico Laghi; Donatella La Licata; Antonio Leozappa; Francesco Lione; Antonio Lollo; Marco Maugeri; Francesco Meloncelli; Loredana Nazzicone; Andrea Niutta; Marcella Panucci; Luciano Panzani; Federico Pernazza; Andrea Petteruti, Salvatore Providenti; Nicola Riccardelli; Luigi Salamone; Luciano Antonio Sarcina; Maurizio Sciuto; Laura Schiuma; Daniele Stanzione; Marco Tofanelli; Patrizia Tolomei; Valeria Vallefuoco; Marco Vannucci; Daniele Vattermoli; Sandra Venarubea; Cristiano Verzaro

Redazione di Torino

Responsabili: Niccolò Abriani (ordinario di diritto commerciale), via De Sonnaz n. 11, 10121 Torino, tel. 011/51.65.111 - fax 011/56.26.238, e-mail: niccolo.abriani@unifi.it Mario Barbuto (presidente della Corte d'Appello di Torino), c. so Vittorio Emanuele n. 138, 10138 Torino, tel. 011/43.27.111, e-mail: mario.barbuto@giustizia.it Componenti: Eugenio Barcellona; Gaia Benessia; Pietro Boero; Claudia Burlando; Antonio D'Addario; Roberta Dotta; Andrea Grosso; Andrea Lanciani; Massimo Macchia; Davide Maero; Marino Perassi; Paolo Rainelli; Paolo Revigliono; Alessandra Rossi; Roberto Russo; Riccardo Ventura; Raffaele Zucca

la pubblicazione di ogni scritto è subordinata alla valutazione positiva di blind referees la Rivista si cita RDS

Direttore responsabile: Daniele U. Santosuosso, via G.G. Porro, 15- 00197 Roma, e-mail: d.santosuosso@studiosantosuosso.it Responsabile del sistema di blind referees: Giuseppe Rescio, c.so Italia n. 8 - 20122 Milano, email: grescio@notariato.it Segreteria di redazione: aw. Luciano Santone, via G.G. Porro, 15 - 00197 Roma, e-mail: l.santone@studiosantosuosso.it;

aw. Daniele Stanzione, via G.G. Porro, 15- 00197 Roma, e-mail: d.stanzione@studiosantosuosso.it Responsabile de/sito web: aw. Cristiano Verzaro, via della Pedica, 96-00046 Grottaferrata (RM), e-mail: cristiano@verzaro.com Amministrazione: presso la casa editrice G. Giappichelli, via Po 21 - 10124 Torino

Indice

Parte l Saggi

p a g.

Jesse M Fried-Nitzan Shilon, Recouping Excess Pay via the Dodd-Frank Clawback 2

Andrea Lolli, Le clausole generali della True and Fiar View e del Going Concern: una chiave di lettura ed una ipotesi applicativa 11

Nicola de Luca, Premi di fedeltà ed eguaglianza tra azionisti: riflessioni sull'art. 127-quater t.u.f. 23

Paolo Butturini, Diritto di informazione del socio e interessi pubblici nella s.r.l. e nelle Limited Liability Companies statunitensi 44

Parte Il Giurisprudenza

Antonio Leandro, Trasferimento di sede e determinazione del COMI (nota a Corte di Giustizia, I Sezione, 20 ottobre 2011, causa C-396/09) 72

Claudio D 'A/onzo, La disponibilità della riserva da sovrapprezzo nelle società per azioni (nota a Cass. civ., I Sezione, 20 gennaio 2011, n. 1361) 84

Giulia Rugolo, Azione sociale di responsabilità e società in accomandita semplice (nota a Lodo arbitrale, 10 marzo 2010) 92

Parte Il/ Osservatot·i

Sez. l- Osservatorio sulla corporate governance

Carmine di Noia-Emilia Pucci, Il nuovo Codice di autodisciplina delle società quotate: motivazioni e principali novità 114

VII

p a g.

Paolo Guaragnella, Voto di lista e sostituzione di un amministratore di minoranza 126

Sez. Il - Osservatorio sulla crisi dei mercati finanziari Marco Lamandini, La riforma dell'ordinamento finanziario europeo: quali cure per i fal-limenti di mercato, i fallimenti istituzionali e i fallimenti 137

Sez. Il/- Osservatorio sulla giurisprudenza del Tribunale di Milano, a cura di Matteo Bazzani, Paolo Flavio Mondini, Michele Mozzarelli e Amedeo Valzer 146

Sez. IV- Osservatorio sulla giurisprudenza del Tribunale di Roma, a cura di Ignazio Cerasa, Luciano Santone e Daniele Stanzione 151

Sez. V - Osservatorio sulla giurisprudenza del Delaware e sugli orientamenti delle autorità amministrative federali statunitensi, a cura Francesco Lione 155

Parte IV Materiali

Francesco Donato-Seminara, "Associazione di soci" di banca popolare cooperativa quo-tata: tratti distintivi di un "soggetto qualificato" 162 Statuto di "Associazione di soci" di società cooperativa quotata 166

VIli

Parte l

l o }esse M. Fried-Nitzan Shilon, Recouping Excess Pay via the Dodd-Frank Clawback e Andrea Lo/li, Le clausole generali della True and Fair View e del Coing Concern: una

chiave di lettura ed una ipotesi applicativa o Nicola de Luca, Premi di fedeltà ed eguaglianza tra azionisti: riflessioni sull'art. 127-

quater t.u.f. e Paolo Butturini, Diritto di informazione del socio e interessi pubblici nella s.r.l. e nelle

Limited Liability Companies statunitensi

Recouping Excess Pay via the Dodd-Frank Clawback }esse M. Fried-Nitzan Shilon

SOMMARIO: 1. Excess Pay and lts Costs to lnvestors. - 1.1. The inevitability of excess pay. - 1.2. Excess pay's costs to investors. - 2. The lnadequacy of the SOX Clawback. - 2.1. Firms are failing to adopt robust ex-cess-pay clawback policies. - 2.2. Board discretion in more than 90 percent of S&P 500 firms.- 2.3. The costs of giving directors discretion.- 2.4. ls there a benefit to board discretion?- 2.5. No misconduct, no clawback. - 3. Benefits of the Dodd-Frank Clawback Requirement. - 4. Beyond Dodd-Frank: Minimizing Excess Pay from Stock Sales.- 5. Conclusion

The Dodd-Frank Act requires firms to adopt clawback policies for recovering certain types of excess pay- overpayments resulting from errors in performance measures (such as reported eamings). W e discuss the costs of excess pay to investors, explain why most firms' existing ar-rangements fall far short of what the Dodd-Frank Act is likely to require, and offer guidance to boards seeking to eliminate the types of excess pay not reached by the Dodd-Frank Act.

The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) requires publicly traded firms to adopt policies that compel the recovery of certain types of overpay-ments made to executives o n the basis of financial results that tum out to be false an d require a restatement. The Securities and Exchange Commission (SEC) is currently developing regula-tions to implement this new clawback policy requirement.

In a recent study, we found that most firms lack a robust "excess-pay" clawback policy-one that requires firms to recover extra pay received by executives as a result of errors in per-formance measures [ 1]. The absence of such a policy is likely to reduce finn value by leading to the systemàtic overpayment of executives and, more importantly, by weakening and dis-torting executives'incentives. Dodd-Frank's clawback-policy requirement can thus be expected to improve compensation arrangements at public firms. However, in our view, Dodd-Frank's clawback requirement does not go far enough. In particular, it does not appear to require firms to recoup excess pay arising from executives' sale of company stock at prices inflated by errors in eamings or other metrics. Permitting executives to keep these forms of excess pay is likely to be detrimental to firms and their shareholders. W e recommend that boards seeking to im-prove executives' incentives implement arrangements beyond those required by Dodd-Frank to address this limitation .

. i]'jJ_

[1] FRIED-SHILON, "Excess-Pay Clawbacks", }o urna/ of Corporation Law, 36, 2011, 722-7 51.

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1. fxcess Pay and lts Costs to lnvestors

1.1. The inevitability of excess pay. - Executives receive a substantial amount of their pay in the form of incentive compensation - equity and bonuses. Much of this incentive compensa-tion is directly or indirectly tied to quantifiable performance measures. For example, bonuses are often directly linked to a company's annual eamings. In addition, the payoff from execu-tives' sale of equity is indirectly tied to current eamings to the extent that these eamings affect the stock price.

The mismeasurement of these performance metrics can lead to erroneously high payouts, or "excess pay." In many cases, excess pay results from misconduct, such as when executives de-liberately inflate eamings or other metrics to boost their own payouts. For example, Gary Winnick, the CEO of Global Crossing, sold more than $700 million worth of stock in the year before the firm filed for bankruptcy, while the company was allegedly inflating sales revenues [2]. Similarly, Qwest insiders sold more than $2 billion of stock while they were overstating revenues, as the firm's stock price dropped by over 90% from its peak [3 ]. Unfortunately, these are not isolated cases. Empirica! studies consistently report a systematic link between inflated eamings and executive stock sales [4].

It is not difficult to find examples of executives who have misreported financial results to boost their bonuses. During the period 2001-2004, Fannie Mae executives received millions of extra dollars in eamings-based bonuses and option grants while overstating firm eamings by at least $10 billion [5]. Similarly, during the years 2000-2004, Nortel Networks executives en-gaged in accounting manipulation that triggered tens of millions of dollars in "return to profit-ability" bonus payments [6]. The secret backdating of executive option grants and nonexecu-tive employee option grants also boosted reported eamings in affected firms by billions of dol-lars, thereby increasing executives' bonus payouts [7].

Excess pay can also arise in the absence ofmisconduct. For example, a number offirms ap-peared to engage openly in the backdating of employees' option grants because of an innocent misunderstanding ofthe relevant accounting rules [8]. Such option-grant backdating erroneous-ly boosted reported eamings and thereby inflated any bonuses based on these eamings. To the extent that the higher reported eamings inflated the stock price, executives were also able to sell their own shares for a higher price. Even executives in these firms who were acting in good faith may well have received substantial amounts of excess pay.

[2] SENDER-BLUMENSTEIN, "Questioning the Books: Clobal Crossing Creditors Review Sales, Swaps", Wa/1 Street }ournal, February 25, 2002, A6.

[3] MARTIN, "The Fundamental Problem with Stock-Based Compensation", Rotman, Winter 2003, 9 (www.rotman. utoronto. ca/rogermartin/fundamental _prob/em .p d().

[4] SUMMERS-SWEENEY, "Fraudulently Misstated Financial Statements and lnsider Trading: An Empirica! Analysis", The Accounting Review, 73, 131, 144, 1998; BURNS-KEDIA, "The lmpact of Performance-Based Compensation on Misreporting", The }ournal of Financial Economics, 79, 2006, 35, 63.

[5] BEBCHUK-FRIED, "Executive Compensation at Fannie Mae: A Case Study of Perverse lncentives, Nonperformance Pay, and Camouflage", The }ournal of Corporation Law, 30, 807, 2005; DASH, "Fannie Mae to Restate Results by $6.3 Billion Because of Accounting", New York Times, December 7, 2006 (www.nytimes.com/2006/12/07/business/07 fannie.html? _r= 1 &em&ex= 1165726800&en=ce14eaf69685179d&ei=5087%0A).

[6] SEC Press Release, "SEC Charges Four Former Senior Executives of Nortel Networks Corporation in Wide-Ranging Financial Fraud Scheme", March 12, 2007 (www.sec.gov/news/press/2007/2007-39.htm).

[7] FRIED, "Option Backdating and lts lmplications", Washington and Lee Law Review, 65, 2008, 853, 858-874. [8] FLEISCHER, "Options Backdating, Tax Shelters, an d Corpo rate Culture", Virginia Tax Review, 26, 2007, 1031, 1038.

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1.2. fxcess pay's costs to investors. - Excess pay imposes three types of costs on investors. First, whether or not executives' receipt of excess pay results from misconduct, excess pay re-duces the amount ofvalue available to shareholders. For example, an executive who is paid $1 million based on misstated eamings, but who should have been paid $500,000 based on actual eamings, receives $500,000 that otherwise could have been distributed to shareholders or in-vested in the firm on their behalf.

Second, the possibility of overpayment can hurt shareholders by undermining the desirable effects of incentive-based compensation arrangements. Lafge incentive payments are justified as necessary to motivate managers to generate firm value. Permitting executives to keep pay that is not merited by actual performance reduces the payoff differential between good and poor performance, thereby weakening pay-performance sensitivity and executives' incentives to increase firm value. Again, this problem arises whether or not the excess pay is the result of misconduct.

Third, the ability to reap excess pay via manipulation can lead executives to take steps that impose direct costs on the firm. For example, Enron executives' manipulation of eamings de-stroyed a business with an estimated $30 billion offirm value [91. Even ifa firm is not substan-tially weakened or destroyed by financial reporting manipulation, the out-of-pocket costs of such manipulation can be substantial. F or instance, firms that restated their financial results following SEC allegations of accounting fraud during the period 1996-2002 collectively paid an extra $320 million in taxes while overstating their eamings by $3.36 billion, which may well have enabled managers to sell their shares at higher prices !10]. Fannie Mae alone in-curred more than $1 billion in expenses cleaning up its books when its executives, who had been given high-powered incentives to boost eamings, overstated eamings by $10 billion [11]. In each of these cases, the amo un t of firm value lost to the govemment an d outside accountants far exceeded the excess pay received by the executives.

2. The /nadequacy of the SOX Clawback

Section 304 of the Sarbanes-Oxley Act (SOX) gives the SEC the ability to recoup certain payments made to executives [12]. It can be applied when a firm is required to prepare an accounting restatement due to material noncompliance, as a result of misconduct, with any fmancial reporting requireme11t. In such a case, Section 304 enables the SEC to require the CEO and CFO of the firm to retum to the firm any bonus or other incentive- or equity-based compensation received within 12 months of the misleading financial statement, as well as any profits realized from the sale of stock during that peri od [ 13].

[9] )ENSEN, "Agency Costs of Overvalued Equity", Financia/ Management, Spring 2005, 5, 10-11. [10] ERICKSON et al., "How Much Will Firms Pay for Earnings That Do Not Exist? Evidence of Taxes Paid on Allegedly

Fraudulent Earnings", Accounting Review, 79, 2004, 387, 406. Some of these taxes may have been subsequently refunded to the firms.

[11] BEBCHUK-FRIED (supra, n. 5), 809-12; GORDON, "Wall St. Applauds Fannie Mae Restatement", Chicago Tribune, December 7, 2006, 3.

[12] Sarbanes-Oxley Act of 2002 § 304, 15 U.S.C. § 7243 (2002). [13] lbid. The provision does not specify whether the misconduct must be that of the officer targeted or the firm.

Recently, however, a court has accepted the SEC's argument that the clawback can be applied as long as there is some misconduct associated with the false financial statement, even if the executive himself did not commit misconduct. See SEC v. }enkins, 718 F. Su pp. 2d 1070, 1074-77 (D. Ariz. 201 0).

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Notably, in the event of a required restatement and a finding of misconduct, the SEC could recover not only excess pay but al! of the incentive pay received in the 12-month period fol-lowing the misleading statement. Relative to a clawback targeted solely at excess pay, the SOX recovery provision appears quite punitive. However, the SOX clawback is very unlikely to be deployed, substantially reducing its deterrence (and recovery) effects. To begin with, the SOX clawback can only be deployed if there has been misconduct. As previously discussed, excess pay can impose substantial costs o n investors even if there is no misconduct by diverting value from investors and undermining pay-performance ·sensitivity. The SOX clawback cannot do anything to mitigate these costs.

Moreover, even if there has been misconduct at a particular firm, significant resource con-straints make it difficult for the SEC to determine that misconduct has occurred and prosecute a Section 304 clawback action. As a result, the likelihood that an executive of any particular firm would be required by the SEC to return pay has been quite small. Indeed, the SEC has de-ployed the SOX clawback very infrequently during the last decade and, in most of the cases, the targeted executives had first been convicted of criminal :fraud (14 J.

2.1. Firms are failing to adopt robust excess-pay c/awback policies. - Our study of S&P 500 firms indicates that, unfortunately, most firms have failed to put in piace clawback policies that require them to recover excess pay resulting from errors in performance measures.

While we found many gaps in the clawback policies of the firms studi ed, we focus on the two defects that most undermine the effectiveness of these policies. First, the overwhelming majority of S&P 500 firms gave directors discretion not to recoup excess pay. Second, most firms with clawback policies barred directors from recouping excess pay unless the executive had engaged in misconduct.

2.2. Board discretion in more than 90 percent of S&P 500 firms. - More than 90 percent of S&P 500 firms gave directors discretion whether to recoup excess pay. To begin, nearly 50 percent of S&P 500 firms did not have any excess-pay clawback policy. Firms that lacked such a clawback policy ranged from companies with market capitalizations in the hundreds of bil-lions of dollars, like Appie and AT &T, to smaller, less well-known firms. Directors of those firms are, of course, free to decide whether to recoup excess pay.

Among the remaining S&P 500 firms that had fully disclosed excess-pay clawback policies, 81 percent gave boards discretion to let an executive keep excess-pay even if the board found that the executive had committed misconduct. Consider, for example, Procter & Gamble's 2010 clawback policy, which states: "The Committee has adopted the Senior Executive Officer Recoupment Policy that permits the Company to recoup or 'claw back' [certain bonus and incentive] payments made to executives in the event of a significant restatement of financial results for any reason" [15]. The policy fails to require the board to seek recovery of excess pay; it merely gives directors the ability to seek recovery, allowing the board to decline to recover all or any excess pay.

[14] MARKHAM, "Regulating Excessive Executive Compensation-Why Bother?", }ournal of Business & Technology Law, 2, 2007, 277, 299.

[15] Procter & Cambie, Noti ce of Annual Meeting and Proxy Statement, filed August 27, 201 O, 42 (www.sec. gov/Archives/edgar/data/80424/0001 7 93 7 257 07 98880/ddef1 4a.htm (emphasis added)).

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2.3. The costs of giving directors discretion.- Unfortunately, directors seldom use their dis-cretion to recover excess pay from executives. As the New York Times reported in 2005, "[C]ompanies very, very rarely- as in almost never- get that money back" [16].

The reason for this reticence is simple: directors incur significant personal costs when they seek to recover excess pay from current or departed executives. Forcing a current executive to retum excess pay would obviously impose a financial cost on the executive and be embarrassing, especially ifthe executive was responsible for the error that gave rise to the excess pay. If directors feelloyal to the executive or otherwise care about their relationships with the executive, they are likely to find i t awkward to seek to recover excess pay.

The board of Las Vegas Sands Corporation found itself in this position several years ago. Directors accidentally gave chairman and CEO Sheldon Adelson an extra $1 million in 2005 as a result of what the company termed an "improper interpretation" of his employment con-tract [17]. The compensation committee voted 3-1 to allow Adelson to keep the $1 million, even though Sands' stock had declined 18 percent during the year. The committee justified its decision based on the "outstanding performance of the company in 2005". Of the three com-pensation committee members who voted to allow Adelson to keep the excess pay, two were or had been affiliated with another of Adelson's businesses, suggesting that loyalty to Adelson may have influenced their decision.

It may be somewhat less costly for directors to recover excess pay from a departing or de-parted executive, who has much less influence over directors after leaving the firm. However, directors will stili incur substantial personal costs in seeking to recoup excess pay from depart-ed executives. First, an executive will typically litigate rather than tum over the money sought by the board [181. Litigation is not merely unpleasant for directors; it could also reveal poten-tially embarrassing facts about their service on the board. Second, directors seeking recovery will forfeit the value of their relationships with the executive. Directors tend to be interested in maintaining good relationships with departing or departed executives because these executives can perform favors for them in the future. As one corporate lawyer put it, "It's quite normal for a board to want the departing CEO to be a friend, no t an adversary" [l 9]. A departing CEO is more likely to be a friend if directors do not aggressively pursue the recovery of any excess pay that the CEO received.

Given these considerations, directors are likely to let executives departing the firm keep any excess pay. Indeed, this is precisely what happened at Fannie Mae. CEO Franklin Raines de-parted the firm in late 2004 following an eamings-manipulation scandal after he had reaped millions of dollars in excess pay from bonuses based on inflated eamings [20}. Not only did Fannie Mae's directors allow Raines to keep the excess pay, but they also gratuitously boosted his pension on the way out [21].

[16] GLATER, "Sorry, l'm Keeping the Bonus Anyway", New York Times, March 25, 2005 (http://query.nytimes.com/ gst/fu/lpage.html?res=9AOOE4DC143CF930A25750COA9639CBB63); DVORAK-NG, "Check Please: Reclaiming Pay From Executives is Tough to Do", Wa/1 Street }ournal, Nove m ber 20, 2006, A 1.

[17] MORGENSON, "Big Bonuses Stili Flow, Even if Bosses Miss Goal s", New York Times, june 1, 2006, A 1 (www. nytimes.com/2006/06/01 /business/01 bonus.htm/).

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[18] 0VORAK-NG (supra, n. 16), A 1. [19] Kouos1, "Why CEOs are Paid So Much to Beat lt", Fortune, May 29, 2000, 34-35. [20] BEBCHUK-FRIED (supra, n. 5), passim; DASH (supra, n. 5), passim. [21] BEBCHUK-FRIED (supra, n. 5), 814.

2.4. ls there a benefit to board discretion?- Some might argue that giving directors discre-tion not to recoup excess pay could benefit shareholders by allowing boards to forgo recovery in cases where the costs of a clawback are greater than the amount of excess pay. For two rea-sons, we find this argument unpersuasive.

First, giving boards discretion is likely to drive up the cost of recovery. If an executive knows that the firm will pursue him until the excess pay is recovered, he has little incentive to resist recoupment. Thus, the cost of recovery will be lo w. If, on the other hand, the executive knows that directors have discretion over the recovety of excess pay, he has a strong incentive to drive up the cost of the process to deter directors. A policy requiring directors to recoup ex-cess pay could therefore actually lower the cost of recovery.

Second, even if the cost of recovery always exceeds the excess pay recouped, there are like-ly to be desirable deterrence effects associated with a policy requiring recoupment. Suppose, for example, that by manipulating a compensation metric, Executive A will generate excess pay of $5 million. Suppose further that the cost of recovering that excess pay is $1 O million. If Executive A knows that the firm will not seek to recover the $5 million because it will cost the firm $1 O million, Executive A has an incentive to manipulate the compensati o n metri c an d reap an extra $5 million at shareho1ders' expense. If, on the other hand, the firm commits in advance to recover the money ( even though i t will impose a net cost on the firm of $5 million), Executive A has no incentive to manipulate the compensation metric ex ante, and the firm will not incur any recovery costs ex post. The firm's shareholders are thus $5 million better off by having committed to spend $10 million to recover $5 million of excess pay. Requiring boards to recover excess pay, even if it is costly to do so, is thus likely to lower recovery costs by re-ducing both executives' resistance to returning excess pay and the likelihood that sue h excess pay will arise in the first instance.

2.5. No misconduct, no c/awback.- A second major problem with firms' clawback policies is that they :frequently bar recoupment in the absence of misconduct. Our study found that more than two-thirds of S&P 500 firms with clawback policies indicate that directors cannot recoup excess pay unless there is a finding of executive misconduct. In other words, an execu-tive cah keep excess pay- no matter how much- unless the company determines that the ex-ecutive has committed misconduct. Consider, for example, IBM's 2010 clawback policy:

T o the extent permitted by goveming law, the Company will seek to recoup any bonus or incentive paid to any executive officer if (i) the amount of such payment was based on the achievement of cer-tain financial results that were subsequently the subject of a restatement, (ii) the Board determines that such officer engaged in misconduct that resulted in the obligation to restate, and (iii) a lower payment would have been made to the officer based upon the restated financial results [22].

The policy commits the company to recoup an inflated bonus :from an executive only if the misstatement giving rise to the excess pay was due to the executive's misconduct. Ifthere is no misconduct, the executive would be free to pocket the excess pay.

The costs of permitting an executive to keep excess pay absent misconduct are substantial. Allowing an executive to pocket excess pay even in the absence of misconduct confers an un-deserved windfall on the executive a t shareholders' expense ex post. It also reduces the per-

--·-llilli

[22] l BM, Notice of Annua/ Meeting and Proxy Statement 201 O, fil ed March 8, 201 O, 36 (wwwsec.gov/Archives/ edgar/data/51143/000110465910012758/a09-363 76 _1 def14a.htm (emphasis added)).

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fonnance sensitivity ofthe executive's compensation ex ante, thereby undennining incentives to increase finn value.

A misconduct hurdle also reduces the likelihood of recovery even if there was, in fact, mis-conduct. Directors may use their dis.cretion to wrongly detennine that there has not been mis-conduct for the same reasons that they are reluctant to recoup excess pay more generally: the personal costs of recouping pay from an executive far exceed the benefits. In other words, a misconduct requirement may give boards an excuse not to demand repayment. Additionally, when misconduct has in fact occurred, even directors acting in good faith may have difficulty detecting it. In either case, the executive will be pennitted to keep excess pay despite having committed misconduct. This, in turn, will systematically transfer additional value :from share-holders to executives and further undennine the deterrent effect ofthe clawback policy.

In short, a "misconduct" requirement enriches undeserving executives, undennines pay-perfonnance sensitivity, and reduces deterrence against misconduct without any significant offsetting benefits. The apparent culpability or innocence of an executive should not affect the executive's ability to keep pay that was uneamed.

3. Benefits of the Dodd-Frank Clawback Requirement

The Dodd-Frank Act instructs the SEC to create a clawback policy requirement. Under the Act, the SEC must direct each national securities exchange to require every listed company to put in place a clawback policy to recover certain incentive compensation paid to executives when the finn is required to prepare an accounting restatement l23]. The clawback policy must provide that ifa finn is required to restate its financial statements due to "materia! noncompli-ance" with fmancial reporting requirements under the securities laws, the company will recov-er from current and fonner "executive officers" any "incentive-based compensation" (includ-ing any stock option award) that is (i) based on "erroneous data," (ii) received during the "three-year period preceding the date on which the company becomes required to prepare an accounting restatement," and (iii) in excess of what would have been paid if calculated under the restatement.

Section 954 of Dodd-Frank differs from the SOX recovery provision in a number of im-portant ways. First, Dodd-Frank requires each finn to recover excess pay; the SOX clawback can only be invoked by the SEC. Second, the SOX clawback can be triggered only if the re-statement is the result of "misconduct," while Dodd-Frank requires recovery of excess pay even absent misconduct. Third, SOX allows the recovery of all incentive pay, while Dodd-Frank requires the clawback of only certain types of excess pay.

The SEC is currently developing regulations for implementing Dodd-Frank's clawback pol-icy requirement. The exact contours of this clawback requirement have not yet been deter-mined. While the devii will be in the details, it nevertheless appears that Dodd-Frank will have significant effects on compensation arrangements. Prior to Dodd-Frank, fewer than 2 percent of S&P 500 finns had policies requiring the clawback of excess pay whether or not there had been misconduct on the part of the targeted executive. After Dodd-Frank, all publicly traded finns must have such a clawback policy, substantially increasing the likelihood that excess pay will be recouped.

[23] Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, § 954, 124 Stat. 1376, 1904 (201 O) (codified at 15 U.S.C. 78j-4).

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Requiring publicly traded firms to put in place robust clawback policies will generate three important benefits for shareholders. First, it will reduce the ex post diversion of value from shareholders to executives via excess pay. Second, it will improve the performance sensitivity of executives' compensation arrangements by more closely tying payouts to actual perfor-mance; this, in turn, will increase executives' incentive to generate value for shareholders. Third, i t will reduce executives' ex ante incentive to manipulate eamings and other compensa-tion-affecting metrics.

4. Beyond Dodd-Frank: Minimizing Excess Pay from Stock Sa/es

Although Dodd-Frank's clawback requirement will substantially improve clawback ar-rangements at public firms, it does have a number of limitations. Most important, Dodd-Frank does not seem to require a policy to claw back the excess proceeds from sales of stock made while the finn was inflating eamings or other metrics.

Dodd-Frank requires firms to adopt a policy that will recover from an executive "who re-ceived incentive-based compensation" the "excess [over] what would have been paid to the ex-ecutive" in the event that certain conditions are met 124!. Because the proceeds of a stock sale are not "paid" by the finn, the SEC may interpret Dodd-Frank as not requiring firms to adopt a policy to recover the extra proceeds an executive receives by unwinding equity incentives at a stock price inflated by errors in performance metrics.

Such an omission would be problematic even if other elements of an executive's compensa-tion arrangement are subject to recovery under a Dodd-Frank-compliant clawback policy. Ex-ecutives will stili have an incentive to manipulate eamings before they dispose of large amounts of stock. Indeed, eamings manipulation prior to stock sal es has been qui te common.

W e do not suggest trying to remedy this problem by expanding clawbacks to reach excess stock -sale proceeds ( the difference between what the · executive actually received selling stock and the amount that h e would ha ve received absent the metri c errors ). The reason is simple: i t would be complicated for firms to calculate what the stock price would have been absent the errors and thereby determine the amount of excess stock-sale proceeds.

Instead, we suggest structuring executives' equity arrangements to make it difficult for ex-ecutives to profit heavily from selling stock when the price is inflated by erroneous eamings or other metric.s. T o begin with, firms should limit the extent to which the payoff from stock sales depends on a single day's price. Rather, as Lucian Bebchuk and one ofus have argued, an ex-ecutive's equity payoff should be based on the average stock price over a significant period of time [25]. For example, the payoff from the liquidation of equity incentives could be based on the average stock price over the preceding year. If the executive's payoff is not based on the stock price over a short period, the incentive to manipulate the short-term stock price prior to unwinding the equity would be substantially diminished.

One or two additional steps should also be taken. First, executives could be subject to a "hands-off' arrangement that leaves them no discretion over when their equity is cashed outj26J. Under this arrangement, restricted stock and stock options would be cashed out ac-

[24] lbid. [25] BEBCHUK-FRIED, "Paying for Long-Term Performance", University of Pennsylvania Law Review, 158, 201 O, 1915,

1945-47. [26] FRIED, "Hands-Off Options", Vanderbilt Law Review, 61, 2008, 453, 468-70.

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cording to a fixed, graduai, and pre-announced schedule set when the equity is granted. Be-cause each sale would involve only a small amount of stock and the executive would have no control over the timing ofthe sale, the executive would have much less incentive to manipulate the stock price around the sale [27].

Second, as one of us has previously proposed, to the extent that executives ha ve any discre-tion over when they cash out their equity, they should be required to disclose their intended unwinding in advance [28]. Such advance disclosure would notify the market that executives might be manipulating the short-term stock price or be aware ofbad news, thereby intensifying scrutiny of the firm's accounting results and prospects. This would lead to a downward ad-justment in the stock price to the extent that investors be lieve the finn is "hiding something". Coupled with average-price payoffs, advance disclosure would further reduce executives' abil-ity to profit from manipulating a firm's stock price.

In short, Dodd-Frank appears to allow executives to keep windfalls from stock sales made when eamings or other price-affecting metrics are erroneous; even if these deviations result from deliberate manipulation. This deficiency cannot easily be fixed through an excess-pay clawback policy because of the difficulty of determining the extent of excess stock-sale pro-ceeds reaped by an executive. Instead, i t can be mitigated by structuring executives' equity in-centives so as to reduce their motivation and ability to manipulate eamings and other metrics before they unload shares.

5. Conclusion

Executives' receipt of excess pay imposes substantial costs on shareholders. By requiring firms to adopt policies mandating the recovery of certain types of excess pay, the Dodd-Frank Act is likely to improve compensation arrangements at public firms. However, Dodd-Frank does not reach all types of excess pay, and directors should thus take additional steps to mini-mize excess pay and its costs.

About the Authors Jesse M. Fried is a professor at Harvard Law School, where he teaches courses in corporation law, corporate

govetnance, executive compensation, and venture capi tal. H e is the author of more than two dozen arti-cles on executive compensation, insider trading, corporate govemance, and venture capita!. His well-known 2004 book Pay without Performance: the Unfulfilled Promise of Executive Compensation, co-authored with professor Lucian Bebchuk, has been widely acclaimed by both academics and practitioners, and has been translated into Chinese, Japanese, and Italian. He holds an AB. and A.M. in Economics from Harvard University, and a J.D. magna cum laude from Harvard Law School. Before joining the Harvard faculty, h e was a professor of la w and faculty co-director of the Berkeley Center for La w, Busi-ness and the Economy (BCLBE) at the University ofCalifomia, Berkeley.

Nitzan Shilon is an SJD student at Harvard Law School. His research focuses on corporate govemance and executive compensation. He received his L.L.M. from Harvard Law School, and an M.A., LL.B., and B.A. from Tel-Aviv University.

[27] At least one firm, Leve! 3 Communications, has adopted the "hands-off" approach to its option compensation. See Leve! 3 Communications, 2009 Annua! Report & Proxy, p. 28 (http://files.shareholder.com/downfoads/LVLT/ 77 9 76358 7 Ox0x3 63608/2ABB6CC9-B 76E-4529-BFFF-B41 A5F76B3AB/2009 _Annua/_ Report-Proxy.pdD.

[28] FRIED, "Reducing Corporate lnsider Trading Profits with Pretrading Disclosure", Southern California Law Review, 71, 1998, 303, 349-53.

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