Compensating to Manage Risk: Paying for Prudent Performance

The recent financial crisis has put "pay for performance" under the microscope. Many believe that compensation programs that focus on short-term profits without regard to risk and stock options and that encourage volatility rather than value were partly responsible for the financial crisis. Companies, particularly financial institutions, are reviewing their compensation programs and facing the difficult task of ensuring that their compensation programs reward performance but penalize excessive risk taking.

Genesis of Compensating Risky Behaviour

Compensation programs have been changing in response to increased shareholder focus on pay for performance, quantifiable metrics and discipline in the design of compensation plans. As a result, complex, cash and share-based compensation programs with performance metrics have emerged.