http://www.directorship.com/boards-discourage-risk/ Boardroom Intelligence Tue, 07 Feb 2012 09:48:26 +0000 hourly 1 http://wordpress.org/?v=3.0.1 http://www.directorship.com/boards-discourage-risk/comment-page-1/#comment-752 Michael Choniski Thu, 24 Sep 2009 18:09:07 +0000 http://www.directorship.com/?p=10851#comment-752 The appropriate place for risk management within a financial company (or any other for that matter) is mostly within the internal practices and controls surrounding investment and spending decisions. If, within those bounds, decisions can be made that carry widely divergent levels of risk, then it may indeed be a great idea to handicap certain components of incentive compensation associated with taking on higher levels of risk that are still within the bounds of internal practices and controls. For instance, if engineers and salesmen of financial products have an incentive comp system based on the production of fee income, and it falls within the acceptable bounds of internal practices and controls to buy or sell credit default swaps in which neither party has a direct interest in the underlying, then that may be a failure of the internal controls (or of regulation), but as you correctly point out incentives paid out for capturing fee income by entering into these more risky contracts should have been handicapped. Maybe that would have modified decision-making somewhat. But the bulk of risk management of financial institutions should be external via regulation, and what is left should be addressed by the governance of the board. Managers are working there to make money for themselves. They live by the creed "IBG, YBG" when considering risk... (I'll be gone, and you'll be gone...if the risk doesn't work out). The appropriate place for risk management within a financial company (or any other for that matter) is mostly within the internal practices and controls surrounding investment and spending decisions. If, within those bounds, decisions can be made that carry widely divergent levels of risk, then it may indeed be a great idea to handicap certain components of incentive compensation associated with taking on higher levels of risk that are still within the bounds of internal practices and controls. For instance, if engineers and salesmen of financial products have an incentive comp system based on the production of fee income, and it falls within the acceptable bounds of internal practices and controls to buy or sell credit default swaps in which neither party has a direct interest in the underlying, then that may be a failure of the internal controls (or of regulation), but as you correctly point out incentives paid out for capturing fee income by entering into these more risky contracts should have been handicapped. Maybe that would have modified decision-making somewhat. But the bulk of risk management of financial institutions should be external via regulation, and what is left should be addressed by the governance of the board. Managers are working there to make money for themselves. They live by the creed “IBG, YBG” when considering risk… (I’ll be gone, and you’ll be gone…if the risk doesn’t work out).

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