An unusual feature of top executive pay at Krispy Kreme Doughnuts, Inc., is its compensation recovery policy. The policy allows Krispy Kreme to take back annual or long-term incentive compensation paid to executive officers and certain other management team members in the event they are later found to have engaged in conduct “detrimental” to the company. Three types of misconduct are specified: (a) financial accounting or reporting violations, whether from gross negligence or willful misconduct, that trigger a restatement of previously issued financial statements; (b) business actions that result in a material negative revision of a financial or operating measure that was the basis for incentive awards already paid; and (c) fraud, theft, and similar acts. What is the penalty for detrimental conduct? The executive may be required to reimburse the company for all, or a portion of, any incentive compensation (including equity-based awards) paid out during the previous 36 months as well as any profits realized from the sale of Krispy Kreme stock during that same period.

Required:
1. Briefly explain how a typical annual and long-term management compensation plan tied to financial accounting numbers may contribute to agency problems within the firm.
2. Provide examples of the accounting abuses that Krispy Kreme’s pay recovery policy is intended to discourage.
3. Explain why you do (or do not) believe the pay recovery policy will be effective in discouraging those accounting abuses.