Incentive Compensation as a Risk Factor

footnoted.org has a post highlighting a Risk Factor from the 10Q of Anworth, a company that invests in agency backed mortgage securities. Here’s how it reads

In the risk factors section of its first quarter 10-Q filed Friday, Anworth gives this warning: “In an effort to earn greater amounts of incentive compensation under their Employment Agreement[s], as our executive officers evaluate different mortgage-related assets for our investment, there is a risk that they will cause us to assume more risk than is prudent.” (Anworth has included a version of this disclosure in its filings for the past couple of years, but the latest Q throws in some new language about the structure of a certain bonus pool.)

Now its all great that Anworth is making full disclosure on what it thinks are truly its risk factors. But really, calling compensation policy a risk factor is like saying “Our management practices are deficient. And now you’ve been warned.” This begs the question – why don’t they fix the incentive compensation?

On the other hand, one can rightfully ask, why aren’t other companies giving “uncontrollable executive greed” as a risk factor? Its not like everyone else but Anworth has found the answer. The problem is far too deep set. It is a difficult problem to solve. I have written about this before as well here and here.

One of the topmost problems that the Capital Markets will have to solve as it digs itself out of the hole it is in is executive compensation. Disclosing it as a risk factor isn’t enough.

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4 Responses to Incentive Compensation as a Risk Factor

  1. Vivek says:

    Is this issue really limited to capital markets? I believe that “uncontrollable executive greed” is a serious business issue across industries, and a much bigger social issue almost everywhere. It may have started in certain industries and regions but now it is a deep malaise almost everywhere.

    There was a suggestion by Indian Prime Minister (Dr. Manmohan Singh) some months ago to limit rising executive compensation to keep India competitive. The furore that it raised from business leadership in India made it very clear that it would not be easy to talk about this, let alone resolve it… we humans may have developed too many bad habits, such as this, and may not be able to change till there is much more trouble. Habits and culture change very slowly, if at all, or under extreme pressure conditions.

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  2. Suvendu says:

    This reminds me the testimony given by ivy league US executives, past and present, before the “Committee on Oversight and Government Reform” on high executive compensation. I especially hooked on to the comments of Charles Prince, former CEO of Citigroup(http://www.ethicsworld.org/corporategovernance/PDF%20links/Prince%20CEO%20pay.pdf).

    He has been forthright in his errors on mortgage positions, risks involved and at the same time he has been vocal on some of the success stories of Citi during his tenure and also the policy of Citi executive compensation structure. All fine till we have the subprime avalanche. What went wrong then? So, does that mean executive compensations are sky-rocketing during market driven economic growth and they are falling flat or executive lay offs during time of market trough. This brings to the question- “Are we concerned about the risk of executive compensation or are we concerned about organizational impotence to address emanating enterprise risk?” I am still thinking!!

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  3. Satya says:

    Basab,

    It has been a long silence!

    Are you alright? I mean your health.

    Satya

    Like

  4. Basab says:

    Satya,

    Just writer’s block. I’m back now!

    thanks for asking.

    Like

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