RISK MANAGEMENT-CASE (SHRM)

The head of credit sales at a mid-sized bank has proposed a new compensation system for his commercial sales team. The system would emphasize a bonus linked to the number of new clients the team acquires. Given his mandate from the board to aggressively increase revenue and market share, the CEO has expressed his preliminary approval for the plan.

The head of HR is not comfortable with the proposed system. Under the plan, if salespeople do not achieve their targets, they will still earn their full regular salary. She feels that while the bonus system is aligned with the goals of the business, it is not balanced in terms of risk taking. The downside risk of acquiring clients who are unable to pay their debts is being borne by the bank, while the bonus will incentivize the sales agents to acquire any new client regardless of ability to pay off the debts and without any impact to the agents’ basic pay should they be unsuccessful.

The head of HR requests a private meeting with the CEO. During this meeting, she explains that one of the potential consequences of the bonus plan is that the bank will acquire clients whose creditworthiness is questionable. She uses the historical example of what happened just prior to the financial crisis of 2008, when credit default swaps were being used to misallocate the risks associated with mortgages, which, in turn, resulted in the risk-reward balance between the lender and the borrower being broken.

The CEO is somewhat surprised to see that his head of HR understands the business of banking and risk management so well. After more thoughtful consideration, the CEO ultimately approves a bonus system but one in which the salespeople can still opt to remain on their regular salaries. If, however, a salesperson does opt to participate in the bonus plan, guaranteed salary will be reduced by 50%, there will be a six-month lag in the payment of the bonus, and, if any client defaults, any remaining bonus payment will be forfeited.

The head of HR has demonstrated Business Acumen by understanding the organization’s business model and its implications in terms of human behavior. She has also demonstrated familiarity with the risk management concept of moral hazard—that alignment and balance (not just alignment) between an organization’s goals and associated risks is a necessary requirement for a sustainable business model.

Source: SHRM