The Federal Reserve has just released its official guidance on incentive comp. We’ve embedded the 45 page guidelines, as well as an FAQ. We’ll highlight anything that stands out.
For starters, this is intelligent:
Aligning the interests of shareholders and employees, however, is not always
sufficient to protect the safety and soundness of a banking organisation. Because of the
protections offered by the federal safety net, shareholders of a banking organisation in
some cases may be willing to tolerate a degree of risk that is inconsistent with the
organisation’s safety and soundness. Thus, a review of incentive compensation
arrangements and related corporate governance practices to ensure that they are effective
from the standpoint of shareholders is not sufficient to ensure they adequately protect the
safety and soundness of the organisation.
Among the strategies employed to reduce risk and monitor compensation wil be the establishment of “horizontal reviews” comparing employee pay across companies:
The horizontal review of LCBOs will be led by Board staff, working with relevant
Reserve Bank supervisors, and will draw on a multidisciplinary group comprised of staff
with expertise in banking supervision, risk management, economics, finance, law,
accounting, and other areas as appropriate. This multidisciplinary team also will have
access to information and analysis developed as part of the reviews of other bankingorganizations, and will serve as a resource for supervisory staff across the System on incentive compensation matters.
The Federal Reserve will work closely with each LCBO to ensure that its plans
are likely to result in the establishment and maintenance of incentive compensation
arrangements that do not encourage excessive risk-taking. The Federal Reserve also will
supervise these organisations to ensure that these plans are fully implemented in a timely
This is interesting from the FAQ (the second document):
3. Why is the Federal Reserve not suggesting a pay cap or outlawing particular
As noted in the Principles for Sound Compensation Practices issued by the Financial
Stability Board in April 2009, “one size does not fit all” firms or employees. Best practices for
balancing risk and rewards in incentive compensation programs continue to develop and are
likely to evolve significantly in the coming years.
For most banking organisations, the use of a single, formulaic approach to making employee
incentive compensation arrangements appropriately risk-sensitive is likely to provide at least
some employees with incentives to take excessive risks. For example, spreading payouts of
incentive compensation awards over a three-year period may not be sufficient by itself to balance
the compensation arrangements of employees who may expose the organisation to substantial
longer-term risks. Further experience may reveal specific compensation practices that may
appropriately be required or prohibited. In the Federal Register notice proposing the guidance,
the Federal Reserve has asked for comment on this point.
Anyway, it looks to us like a lot of guidelines that will not have a ton of teeth.
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