Executive compensation risk management: strategies for an evolving regulatory landscape.

• Author: Dunn, Michael

Risk management oversight at the board level historically has focused on minimizing exposure to potential criminal or civil liability. Companies have developed corporate compliance programs consistent with the seven point framework for an effective compliance program articulated in the U.S. Sentencing Guidelines with an emphasis on prevention, detection and remediation of improper conduct and promotion of full and complete compliance with applicable disclosure laws. Although the audit committee is responsible for risk management policies and procedures under most compliance programs (and NYSE listing standards require the audit committee to have such authority), management retains broad discretion and authority to assess and manage exposure to business risks, including as it relates to incentive compensation for non-executive employees.

As Congress, the Treasury Department and the SEC act to stimulate the economy and address the unprecedented turmoil in the capital markets, executive compensation practices that are deemed to have encouraged excessive or inappropriate risk have been at the center of public debate. Federal regulators and lawmakers have responded by adopting or proposing a series of measures that target the assessment of compensation policies and packages as a significant component of financial risk management.

Five principles

The Treasury Department has identified five broad-based compensation principles that companies should consider to align compensation practices with the interests of shareholders:

* Compensation plans should properly measure and reward performance;

* Compensation should be structured to account for the time horizon of risks;

* Compensation practices should be aligned with sound risk management;

* Companies should re-examine whether golden parachutes and supplemental retirement packages align the interests of executives and shareholders; and

* Companies should promote transparency and accountability in the process of setting compensation.

The principles state that compensation committees should align compensation practices with sound risk management by conducting and publishing risk assessments of pay packages to ensure that they do not encourage imprudent risk taking. A compensation package would be properly structured under the principles if it is determined that the package has been appropriately customized to create an incentive for the employee to achieve a balanced mix of the company's overall...