Climbing Out of the Credit Crunch

Remuneration and Incentives

We believe that executive remuneration arrangements should promote organisational performance. Existing incentive and career structures of banks meant enormous rewards but have reinforced short term thinking, which has been one of the major causes of the credit crunch.

If not addressed, remuneration issues will continue to frustrate other attempts for reform. This is a human behaviour challenge. Risk management and remuneration and incentive systems must be linked. Executive payments should be deferred (eg held in an escrow account) until profits have been realised, cash received and accounting transactions cannot be reversed. Instead of paying out on paper profits, there must be a much stronger link to genuine operational cashflows. These measures would make the risk management function more important in organisations – risk managers should be regarded as having a status equal to those in the ‘front office’ and should be remunerated accordingly.

We question whether the relative share of bank income paid as remuneration compared with dividends has been in the best interests of long–term shareholders. Investors and shareholders have limited ability to influence companies they own. Not all shareholders invest for the long–term and not all of them have an interest in holding boards to account for their stewardship. This is a fundamental governance challenge in capital markets where shares are widely held, and is not confined to the banking sector. The emergence of new strategies (eg using derivatives) for participating in corporate profitability and new types of shareholder, such as sovereign wealth funds, compounds the challenge.

One way to help address both challenges is to ensure that boards and shareholders receive appropriate, clear, timely and reliable information on risk and financial results.

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