Skip to content

FRM Part I · FRM Exam Part I · Enterprise Risk Management and Future Trends

A company's management is rewarded solely on annual accounting profit, with no adjustment for the risk taken. Which strategic risk problem is this compensation design most likely to create?

Paying managers only on unadjusted accounting profit encourages excessive risk-taking. Managers share in the upside but are not charged for the capital or tail risk they consume, so incentives diverge from the firm's risk appetite. Risk-adjusted performance measures help realign them.

  1. AExcessive risk-taking because managers capture upside while risk costs are not charged to themCorrect
  2. BExcessive risk aversion because managers fear any variability in profit
  3. CReduced reliance on short-term results in strategic planning
  4. DLower correlation between business units' exposures

Explanation

Rewarding unadjusted profit encourages managers to take on risk that raises expected profit without bearing the cost of the capital at risk. Linking pay to risk-adjusted performance aligns incentives with the firm's risk appetite.

Did you get it right without looking?

One question tells you little. A timed set on Enterprise Risk Management and Future Trends shows your real accuracy, how long you take and where you lose marks.

Practise Enterprise Risk Management and Future TrendsFree diagnostic mock

More Enterprise Risk Management and Future Trends questions