Bankers’ bonus structures (typically calculated by reference to short term individual/peer group/team performance) have been criticised for encouraging “inappropriate” and “excessive” risk taking for short term personal profit without consideration for the longer term interests of a bank’s shareholders and stakeholders.
One key recommendation made by the Turner Review (which considered the causes of the current financial crisis) was that there should be changes in the regulation of governance and risk management arrangements in respect of remuneration policies in the financial services sector, which should be designed to (a) avoid incentivising undue risk and (b) integrate risk management considerations into the incentives process.
Similarly, in its draft code (which it intends to apply to large banks, building societies and broker dealers) the Financial Services Authority (FSA) recommends that “a firm must establish, implement and maintain remuneration policies, procedures and practices that are consistent with and promote effective risk management”.
To this end, one recommendation made is that executives would be more likely to manage risk if short term cash bonuses were wholly or partly deferred into long term share based rewards, ensuring that their interests are aligned with the long term success of the company (the ultimate value of any share award that is made being governed by the company’s market share price), something that happens to a limited degree at the moment.
To implement and maintain remuneration policies which are consistent with the above recommendations may require wholesale amendments to terms and conditions of employment which are not always easy to achieve. Equally, in an environment where the lure of the cash bonus continues, it is going to be down to the skill of HR teams to ensure that remuneration policies, procedures and practices can be implemented without causing employee discontent and adversely affecting recruitment and retention.