FRM Part I · FRM Exam Part I · The Governance of Risk Management
Which compensation design is most consistent with sound risk governance for senior risk takers at a financial institution?
Deferring part of variable pay over several years and subjecting it to clawback if risk outcomes deteriorate best fits sound governance. It aligns incentives with long-term risk results. Upfront revenue-based bonuses or short-term share price targets reward excessive risk-taking because the costs appear only later.
- ALarge annual cash bonuses based on current-year revenue, paid entirely upfront
- BA portion of variable pay deferred over several years and subject to clawback if risk outcomes prove poorCorrect
- CFixed salary only, with no link to firm performance
- DBonuses tied exclusively to short-term share price increases
Explanation
Deferral and clawback align pay with the longer-term realization of risk, reducing incentives to take hidden tail risks for short-term gains. Upfront revenue-based bonuses and short-term share-price links reward risk-taking without penalty. Fixed-only pay is not the recognized best-practice design, since variable pay adjusted for risk is expected.
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