FRM Part II · FRM Exam Part II · Risk Governance
A trading desk head receives a large annual bonus paid entirely in cash immediately, based on that year's profits. Losses from the positions may emerge over several years. Which change would BEST reduce the incentive for excessive short-term risk-taking?
Deferring a significant share of the bonus, paying part in equity and adding clawback provisions best curbs short-term risk-taking. These features tie pay to long-term outcomes, so losses emerging later reduce compensation, aligning the trader's incentives with the firm's longer horizon.
- ADefer a significant part of the bonus, pay part in equity, and allow clawback if losses or misconduct later emergeCorrect
- BIncrease the cash bonus percentage to compensate for the risk
- CBase the bonus on gross revenue instead of profit
- DShorten the performance measurement period to one quarter
Explanation
Deferral, equity-based pay and clawback make compensation sensitive to the long-term outcomes of risk taken, aligning staff with the firm's horizon. Higher cash, revenue-based measures or shorter periods reward short-term risk and worsen the misalignment.
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