Following the financial crisis of 2008, the media and regulatory agencies have negatively focused on companies with compensation plans that promote excessive and unnecessary risk-taking. The pending regulation concerning compensation risk disclosures is meant not only to provide information to the public, but also to ensure that compensation committees are able to design and implement compensation plans that will not exacerbate business risks or create new ones.
The Securities and Exchange Commission issued new disclosure rule changes in December 2009, which require a proxy statement disclosure concerning possible incentives created by compensation plans which would create or increase a company’s risks. The disclosure also extends below officers when compensation risks related to other employees have a material effect on the company. It also requires management to discuss the board’s involvement in the risk management process.
These extended risk disclosures are already required of the financial service companies that received government assistance under the Troubled Asset Relief Program (TARP), but all public companies should begin to develop an understanding of these requirements and what they may potentially mean for their companies’ approaches to risk management. This article outlines three action steps that public companies should take in preparation of these new disclosure requirements.
- Educate the compensation committee about these new disclosure requirements to eliminate information gaps.
- Work with the compensation committee to determine the company’s approach to compensation and risk management in advance of regulation.
- Understand the company’s existing risk management process and key business risks.
It is also important that management prepare a compensation risk assessment from both an overall point of view and risks stemming from specific incentive plan features. Using the existing risk management process and key business risks as the foundation, the other main categories include:
- Compensation Program Design
- Performance Metrics and Goal Setting
- Administrative Procedures
- Communication and Disclosure
Compensation risks will vary widely based on individual companies, but the key is to ensure that the level of rewards and the risk that the employees and management are taking are in the long-term interest of the shareholders. Companies that utilize compensation risk assessments in conjunction with overall business risks can effectively design a well-balanced compensation program that drives corporate performance with appropriate levels of risk-taking.