IQMS Global: Balancing Risk and Reward

Balancing Risk and Reward

5:03 AM Posted by IQMS Global

Companies today should consider myriad corporate strategic concerns as well as increased federal regulation and public scrutiny over executive compensation and disclosure practices. The right balance between pay and risk—while retaining people long-term—can help with CEO succession.

Compensation plans should consider the impact of diverse company operations on the performance of any measured business unit and should include the contributions of those personnel responsible for these operations. It may be necessary, for compensation purposes, to adjust reported financial results, winnowing out the impact of corporate-wide transactions and actions, such as write-downs, that employees' activities cannot affect. Compensation plans should avoid rigid performance metrics and allow the committee ample discretion to adjust compensation to prevent manipulation of the system. Evaluate each provision of the compensation plan in the context of other risk-control strategies the company has adopted, such as the audit committee's financial risk controls.

A bottom-up strategy should be used, whereby business intelligence percolates from staff at ground level and informs the creation of realistic targets, rather than having top management impose arbitrary targets that might encourage imprudent risk-taking. Plans with steep performance curves or ratcheted award plateaus also create incentives for risky behavior to make the next higher level; there is need for discretion to discount (or augment) performance results that seem out of keeping with the company's risk-reward tolerances. One means to adjust performance criteria could be, for example, to weigh profits against return on assets; another would discount easily achieved targets and weigh difficult ones more heavily.