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Steven Bank and George S. Georgiev teach executive compensation and corporate governance at the University of California, Los Angeles School of Law and are affiliated with UCLA's Lowell Milken Institute for Business Law and Policy.

To the casual observer in the United States, the 2008 financial crisis may be starting to feel like the distant past. The broad index of the U.S. stock market has doubled over the past five years, unemployment is down and interest rates are set to rise in the near future, signalling a strong economy. Yet, the U.S. regulatory hangover from the financial crisis is still very much with us and it frequently affects companies based in Toronto, Vancouver or Hong Kong just as much as it does those based in New York or Los Angeles.

The primary U.S. market regulator, the Securities and Exchange Commission, served up a powerful new example earlier this month. The Washington-based agency proposed far-reaching rules on bonuses and other incentive-based compensation for all firms listed on U.S. stock exchanges, which include about 300 of Canada's best-known multinational companies as well as more than 600 other international companies. This was a curious choice since the United States has traditionally allowed non-U.S. companies to follow their home-country rules on executive compensation and corporate governance instead of the SEC's rules.

Even worse than the geographic overreach, however, is the fact the SEC's new rules are likely to prove expensive, counterproductive and easy to manipulate.

The SEC's rules came five years after the passage of the Dodd-Frank Act, the landmark financial legislation adopted after the financial crisis. The act tried to link incentive-based pay with company performance, out of concern that chief executives were being rewarded for failure (via so-called "golden parachutes") and that even mediocre performance yielded high bonuses.

Unfortunately, the link between pay and performance remains as elusive as ever. A recent study found that firms headed by CEOs whose pay is in the top 10 per cent in a given year, then suffered an approximate 8-per-cent drop in stock value over the following three years.

Upping the ante, the new SEC rules call for the mandatory repayment (or "clawback") of incentive pay already awarded to executives. Both U.S. and non-U.S. companies listed in the United States will now be required to adopt policies for the clawback of certain executive compensation following a mistake in the company's financial statements. The rules cover payments to a large class of current and former executives going back three years. Even more startling, the clawbacks are completely automatic, regardless of whether fraud occurred or who was at fault. Executives are subject to clawbacks as long as they received incentive compensation tied in some way to the erroneous financial statements.

The SEC's far-reaching clawback requirements will certainly make executives worldwide stand up and pay attention. But this attention is unlikely to be devoted to better company management. Instead, it will be wasted on developing strategies to make executive compensation clawback-proof and on technical compliance with the complex rules. One easy way to game the rules would be to receive less in incentive compensation and more in fixed salary.

Even if this turns out to be unattractive for tax reasons, executives could avoid clawbacks if their incentive pay is completely discretionary or tied to metrics not found in the company's financial statements. Instead of strengthening the link between pay and performance by limiting manipulation designed to achieve performance goals, the clawback rules – however well-intentioned – might actually serve to sever the link altogether.

Unlike U.S. companies, Canadian and other international companies have an even easier way out. They can simply choose to delist from U.S. exchanges and rely solely on their home-market listing. In fact, many non-U.S. companies did just that when they were faced with complex new corporate governance rules under the Sarbanes-Oxley Act in the wake of the Enron and WorldCom scandals of the early 2000s. Studies show that a U.S. listing confers advantages on non-U.S. companies, but the burden from the new rules may well outweigh these advantages, especially at a time when international markets are becoming increasingly competitive.

Of course, a good corporate governance rule may be worth it to investors, even if it drives some non-U.S. companies away. Unfortunately, the available evidence suggests that the SEC's new rules are unlikely to improve firms' performance and investor returns.

For example, one study of firms that had voluntarily adopted clawbacks found that the provisions induced companies to make opportunistic operational changes and focus on the short term at the expense of research and development. Furthermore, any spike in profitability from such measures was reversed within three years, suggesting that the changes were just a big suboptimal shell game designed to evade the clawbacks. Moreover, there is little evidence that these clawback plans did much to align pay with performance or stem the tide of rising executive compensation.

When all is said and done, the SEC's initiative may well turn out to be an expensive experiment with an outcome that is largely predetermined. It isn't clear why Canadian and international companies are being forced to participate.

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