So, banks have finally come around to looking at compensation through the lens of risk management.
Not to be too cynical, but even this has its limitations.
For example, though it might make sense to introduce risk-weighted pay scales — so that employees who take big risks in pursuit of those big bonuses face tougher performance hurdles than those who take less risk — this approach would have done little to rein in pay before the financial crisis because most banks' models were so grossly underestimating the risks being taken.
Given the tremendous mismatch between high pay and bad results, it is not too radical to suggest that compensation structures need a top-to-bottom overhaul that would encompass much more than the involvement of risk managers in the creation of incentive plans.
Though the good risk managers will ensure that their banks give them a voice in designing compensation structures, the really good risk managers will ensure that their banks do not stop there.
Risk management "is not a silver bullet," said Chris Thompson, who heads the financial services industry risk management practice at the consulting firm Accenture. "It's one input into the performance management process."
But this one input, at the moment, appears to be serving as the primary wellspring of reform ideas.
This was perhaps inevitable given all the different kinds of risk that compensation entails. There is liquidity risk in paying bankers because it forces banks to part with precious capital. There is credit risk in rewarding people for originating loans. Market risk has become a growing factor thanks to the rising popularity of equity-based incentive plans. Compensation also involves an element of compliance risk and an increasingly large reputational risk.
The close relationship between institutional risks and employee rewards has helped give traction to ideas such as deferring larger portions of pay and measuring employees over longer periods to more fully reflect the consequences of their work.
Bank supervisors no doubt are resting easier knowing that more banks these days are thinking about pay in the context of safety-and-soundness considerations. But they need not worry that their evangelizing on the issue will make banks so risk-conscious that regulation becomes redundant.
For one thing, according to Thompson, adoption of risk-based approaches to pay is still happening unevenly across the industry. For another, the federal safety net underpinning the financial system skews the risk appetite for a crucial bank constituency: investors.
"Shareholders may at times be willing to tolerate a degree of risk in a firm's activities that does not fully reflect the costs of that risk to society as a whole," Fed Gov. Daniel Tarullo said in November at a University of Maryland roundtable discussion on executive pay. "Thus, even if banking organizations were able to achieve full harmonization of employee and shareholder interests in their incentive compensation arrangements, supervisory oversight would still be warranted."
Another reason why the government might not leave banks to their own devices in devising pay formulas: It is hard.
There may be no better authority on the challenge of setting pay policies than Kenneth Feinberg, the Treasury Department's special master for compensation. His attempts at guiding the biggest federal bailout beneficiaries on pay issues have been criticized by bankers who resent what they perceive as public retribution.
"In our society, money is a surrogate for self-worth, and it gets very emotional," Feinberg said March 19 in a keynote speech at a business journalism conference in Phoenix. "You see, I'm not arguing with someone who needs $2 million, $3 million, $4 million to survive. It's when people say, 'I'm worth this much, and if you deduct compensation from me, you're denigrating my worth.' It gets a little existentialist."
Accenture's Thompson said the task gets even harder when determining the risk profile of different job functions below the senior executive level.
"It's quite easy at the top of the bank to do that because you've got good measures for risk, but once you start to go down into the divisions and into the product lines, it becomes very muddy," he said.
Pearl Meyer, a compensation consultant at Steven Hall & Partners, agreed, saying she is all for benchmarking different businesses within a bank and installing different performance hurdles depending on the benchmarks. But banks need to strike a balance between promoting performance and discouraging outsize risk-taking.
"If you make [the hurdles] too aggressive, then you're inducing risk" for employees stretching to meet their targets, she warned. "So you should have at least a two-thirds probability of hitting your threshold, and maybe a 10% probability of hitting your maximum" bonus.
But banks cannot rely on risk managers alone to fix the problems embedded in their pay structures.
Meyer said she spends much more time now talking to "the risk people" during the course of her work day. And banking companies have ample opportunity to show off the contribution their risk people make to pay decisions. Fifth Third Bancorp, for example, specified in its recently filed proxy that its chief risk officer "initiated a review of all compensation plans" to determine whether the plans for senior executives encouraged excessive risk-taking and that all employee incentive plans were evaluated by senior risk officers.
"Today there's a greater voice" for risk managers, said William Githens, the president and chief executive of the Risk Management Association. "But I think the perspective most have is that it all starts at the top. It starts with the board of directors. They have to set the culture and the tone for the organization because, really, this is a corporate governance issue."
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