FRM Part II · FRM Exam Part II · Governance
A bank redesigns trader compensation after a review finds bonuses were paid fully in cash on annual revenue, with no adjustment for risk. Which redesign best aligns pay with the long-term risk profile of the bank?
Deferring a substantial share of bonuses in equity-linked form with malus and clawback, and sizing the pool on risk-adjusted performance, best aligns pay with long-term risk. It lets losses and risk outcomes emerge before pay vests, unlike upfront cash tied to revenue or trade volume.
- ARaise the cash bonus pool percentage to retain talent, since revenue reflects value created
- BDefer a substantial portion of bonuses over several years in equity-linked form, subject to malus and clawback, and base the pool on risk-adjusted performanceCorrect
- CPay the entire bonus upfront but cap it at a multiple of base salary
- DLink bonuses to the number of trades executed to encourage activity within limits
Explanation
Sound practice ties pay to risk-adjusted results, defers part of it so outcomes can emerge, and allows malus/clawback if losses appear. A cap on upfront cash does not adjust for risk or time horizon, and raising cash on revenue or rewarding trade count increases risk-taking incentives.
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