The Basel Committee recently issued a report examining the alignment of banker pay with risk and performance. The purpose of the report was to clarify some of the misconceptions around risk-based pay: “By providing clarification on the design of risk-adjusted remuneration schemes, the committee aims to promote greater adoption of sound compensation practices in the banking sector.”
The report find that employers often use a one-size-fits-all approach when deferring bonus payout and setting dates for cash-in stock options, rather than tailoring these incentives to the risk each employee is taking. Without adjusting for the risk level, such compensation tools do little to crack down on the most wayward risk takers. The Basel committee noted that “…standardizing the features in ways that do not depend on risk calls into question whether firms are really paying attention to risk-incentive alignment.”
This study was prompted by a trend in regulation requiring EU banks to pay about a quarter of bonuses in cash and defer the rest. The practice of bestowing large bonuses on short-term risk takers has been blamed for fueling the bubble that so recently ended in a global financial meltdown.