Most big banks not even paying lip service to risk-based pay

    JP Morgan (JPM, Fortune 500): The JP Morgan proxy states that "Incentives are based on risk-adjusted P&L and are calibrated to the underlying risk of the business activity". That sounds right, but when listing the performance criteria for senior level employees, the financial measures cited are "operating earnings; revenue growth; expense management; return on capital; capital and liquidity management; quality of earnings". Including measures such as revenue growth and expense managements can provide mixed signals for individuals in terms of risk and return. Should we goose risky revenue growth? Or eliminate expenses that could help us reduce risk?

    Morgan Stanley (MS, Fortune 500): Although a working group at Morgan Stanley reviewed "applicable performance metrics", according to their proxy, performance metrics were not listed as "among the factors considered in making [the] determination" that the compensation programs do not encourage unnecessary or excessive risk. And, in fact, "the Company's core financial metrics - return on equity and total shareholder return" are used in incentive compensation decision making, according to their proxy. Neither of those measures tie pay to the risk that is being taken on. In fact, as the crisis showed, stock prices rose in the period where risks were building but had not yet been exposed. Return on equity, as a measure, can have the opposite effect from limiting risk taking. That's because one way to increase return on equity is for the bank to hold less equity, thus increasing its leverage and potential risk. "Growth in revenues", another metric cited in the proxy, is one which clearly does not consider the risks of that business and the impact on the organization's safety and soundness.

    While banks have taken some steps, they still have some distance to travel to meet the intent of using metrics which help shape appropriate motivations and behaviors and adjust bank pay based on risk. One suggestion, not provided in the guidance that might assist in executive and director motivation to consider this task more strongly? Tying a healthy portion of pay to getting this right and ensuring that all signals clearly point to effective risk management.

    --Eleanor Bloxham is CEO of The Value Alliance and Corporate Governance Alliance, a board advisory firm.