Is your executive pay package contributing to your company’s risk?
Although managing risk has always been an important priority for Boards of Directors, even before it was reportable, most people agreed that there were a number of cracks in the system that at least contributed to, if not drove, the recent financial crisis. Rather than roll the dice, responsible Boards are asking, “Could we have a problem?” To date, there has been limited guidance as to what is meant by “encouraging excessive risk-taking,” and Compensation Committees are struggling to evaluate the relationship between compensation and risk in a credible, clear and consistent way.
Farient’s Point of View
At Farient, we know that companies are in business to take prudent risks to optimize long-term shareholder value. But shareholders and Boards alike need to be vigilant whether executives and other employees are being encouraged by the pay system to take financial risks that are inappropriate for the business. Moreover, Farient believes that a quantitative approach to measuring risk provides better guidance than the qualitative checklists that are most often used.
How Farient Can Help
To help companies evaluate the appropriateness of their risk-taking behavior, Farient developed the Quantitative Risk Assessor™ which evaluates the propensity of the compensation system to cause undue risk-taking relative to a company’s business context. The Risk Assessor™ works by: (1) evaluating the riskiness of our client’s business relative to the broad market, (2) quantifying our client’s total direct compensation package in terms of leverage, upside potential, performance measures, goals, time horizon, and other risk indicators, and (3) comparing business risk to compensation risk to assess the ways in which the compensation system could encourage undue risk-taking. This quantitative approach is significantly more revealing than the checklist method, sets Compensation Committees and Boards up for better discussions pertaining to risk, and provides a stronger platform for meeting SEC requirements.