Risk vs Reward

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Expert Perspective from Grahall’s OmnniMedia Editorial Board

expert perspective telescopeA Reuters article published on November 6, 2009 titled Pay cuts should not be limited to Wall St  quotes Elizabeth Warren stating: “In my view, it’s not just lower pay on Wall Street, there’s a larger corporate governance issue at stake here.”  She is further quoted as saying “regulators should not be singling out one industry or even one set of companies.”

Certainly good corporate governance is (or should be) a universal goal of boards regardless of industry.  Based on our collective experience over the past 18 months, it is clear that some of the banks, insurance companies and businesses in the financial services sector missed the mark when it came to sound corporate governance and risk management about setting executive compensation.   Is it possible that other industries also suffer from ineffective risk management oversight and inadequate governance around executive compensation?  Perhaps, but we do not think the prescription for better executive compensation decisions is for the government to become a watchdog for all companies.  Frankly, the government’s efforts to manage pay for a small number of people at a small number of TARP companies have been difficult, time-consuming, disruptive, and controversial.   Regulators seem barely able to manage this, let alone expanding this effort beyond a single industry or set of companies.

Moreover, the “moral authority” which exists so that the government can intervene in TARP recipient decisions does not exist in the non-TARP arena, as there is no government ownership or funding upon which its involvement can be justified.  The financial crisis aside, we doubt broad support exists for the elimination of capitalism, and if it did, higher tax rates would be a simpler solution.  
So what might be a better approach than more government agencies?  We suggest that Boards begin with a fresh perspective.  In our view, the Board must set a tone “at the top” using a vision, mission and most importantly values that cascades throughout the organization driving behaviors, helping to establish expectations and contributing to risk management.

In our recent blog Vision, Mission and Values: More than Just Words on a Plaque   we outline the importance of connecting executive rewards strategies – and the philosophies behind them – to the organization’s vision, mission and values (VMV).  “These edicts provide significant directional guidance for decision makers in the organization when the decisions get tough.  We also believe that good VMV statements – assuming that executives buy into them – promote good decisions.   Especially important are the values that are integral to a company.  These are the deeply held beliefs that that should be demonstrated through day to day behaviors of every employee at every level of the organization.  They are, quite simply, an open proclamation of how an organization expects everyone to behave.  These are, in fact, the ethics of the company.”

Coupling refreshed values with a new approach to executive compensation could be a remedy for corporate governance concerns.  In our recent blog Could it be Cainotophobia?  we address an approach to helping boards manage executive pay and risk saying: “there are ways to structure pay to address the executive’s current contributions while managing risk through delayed payment for long term decisions.  Structuring executive compensation to include base pay, coupled with short-, medium-, long, and CAREER-term incentives is a mechanism to appropriately deliver compensation while managing risk.  

Last but not least, the article goes on to say that “Congressman Barney Frank … would like Warren to head a new agency to protect consumers from risky financial products.” 

Wait, WHAT?  One of the most basic aspects of investing is the risk vs. reward formula.  It is essentially a fundamental truth like e=MC squared that the only way to maximize returns is to take on risk.  What would Barney Frank have Ms. Warren do, save us from making money?

That being said, it’s clear that the world seems to have decided that financial instruments became too complicated and the resulting risk caused the meltdown, so I suppose we should not be surprised to see regulation proposed in this area. We do hope that any efforts to regulate “risky financial products” are very well thought out as the inherent difficulties of doing this are significant and the necessity of creating appropriate regulating it correctly is indisputable.  Done wrong, we could suffer the draconian consequences of possibly choking off investments, and that would not be in the best interest of consumers, the country or the world economy. 

Maybe we would be better off with someone protecting us from the politicians.  

Contact Grahall’s OmniMedia Editorial Board at edie.kingston@grahall.com

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