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FRM Part II · FRM Exam Part II · Integrated Risk Management

A firm's compensation review finds that traders receive large bonuses on one-year profits with no clawback, while losses emerging in later years fall on shareholders. Which change best aligns incentives with sound risk culture?

Deferring part of the bonus, paying part in equity, and applying malus and clawback tied to risk-adjusted results best aligns incentives. It links pay to long-term outcomes so traders bear some consequences of losses that emerge after the bonus year.

  1. AIncrease the share of bonus paid in cash at year-end to retain talent
  2. BDefer part of the bonus, pay it partly in equity, and subject it to malus and clawback based on risk-adjusted outcomesCorrect
  3. CReplace the bonus with a higher fixed salary and remove all risk metrics from performance reviews
  4. DBase the bonus on gross revenue to simplify measurement

Explanation

Deferral, equity payment and malus/clawback tie rewards to long-term, risk-adjusted outcomes, addressing the mismatch between short-term profit and delayed losses. More upfront cash and gross revenue measures worsen it, and removing risk metrics ignores the issue.

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