According to a press release, Watson Wyatt’s evaluation of the executive compensation architecture at more than 1,000 firms and their correlation to corporate risk-taking revealed findings that contradict widely held beliefs, including the common critique that high incentive levels encourage reckless risk taking.
Similarly, conventional wisdom says higher amounts of annual bonuses, long-term incentives (LTIs) and stock options encourage excessive risk taking; however, the analysis found that these actually encourage executives to take less risk, the release said.
According to the analysis, high levels of stock ownership are associated with reduced risk, and excessively high levels of pay opportunity encourage more risk taking.
To evaluate the potential risk, Watson Wyatt employed in its correlations the Z-score, a widely used measure to assess credit risk.
For more information, go to www.watsonwyatt.com/payriskinsider .
Correlation of Executive Pay Elements With Risk Taking
Excessive pay opportunity
Use of earnings-based metrics in annual incentive plans
High proportion of LTI in total direct compensation
Use of a number of performance metrics in annual incentive (bonus) plans
High levels of nonqualified deferred compensation
Use of market-based metrics in annual incentive plans
Use of return-based metrics in annual incentive plans
Longer vesting terms (years) for LTIs
High annual incentive leverage
Higher proportion of options in LTI mix
Source: Watson Wyatt
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