FRM Part II · FRM Exam Part II · Risk Governance
A trading desk head's bonus is paid fully in cash each year and is based solely on that year's trading revenue, with no adjustment for risk taken. Which change would best align incentives with the bank's long-term risk appetite?
Deferring a substantial part of the bonus, paying some in equity, adding clawback and adjusting revenue for risk or capital used best aligns incentives. This lengthens the time horizon so later losses reduce pay and discourages taking excess risk to inflate current-year revenue.
- AIncrease the cash bonus percentage to retain top traders
- BDefer a significant portion of bonus, pay part in equity, and allow clawback, with revenue adjusted for risk or capital usedCorrect
- CBase the bonus on gross revenue only to keep measurement simple
- DReplace the bonus with a higher fixed salary for all trading staff with no variable pay
Explanation
Deferral, equity-based payment and clawback extend the horizon of the payoff so losses emerging later affect compensation, and risk-adjusting revenue discourages excess risk-taking. A larger cash bonus or gross revenue measure worsens the short-term bias. Eliminating variable pay entirely is not the standard alignment approach and may hurt performance culture.
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