Lessons From the Financial Crisis

Short Term Compensation for long tailed risks – encouraged more and more risk taking. Did not hold anyone responsible for the ultimate losses. Solution is longer term compensation. Some insurers have started to make underwriter compensation payout over multiple years.

In some cases, some people were paid with short term compensation while others were paid with long term incentives. Those being paid short term maximized their comp, blew up the company after cashing their check, leaving those with long term incentives with nothing to show for years and years of incentive comp.

This has become a common conclusion from the crisis. But it does not seem to have seeped into the boardroom.
http://www.nytimes.com/2009/08/16/business/16gret.html?_r=1&ref=business This article tells how executive comp is moving in the opposite direction.

But why is long term better than short term? The main reason is because accounting is unreliable in the short term. In the long term, everything is cash, so accounting is not as troublesome. But short term incentive income invites managers to figure out the flaws in the accounting rules that give the best immediate results regardless of the underlying economics (read long term cash).

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Explore posts in the same categories: Compensation, Enterprise Risk Management, ERM, Risk, Risk Management

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