Risk and performance are integrally linked to how company executives should be rewarded

Historically, risk management in an organisation has operated and been viewed in isolation. The association between risk, its management and the overall performance of a business has not been considered thoroughly. This siloed approach to risk management has more times than not, failed to have a meaningful impact on an organisation's overall performance. This in turn has affected how executives have been rewarded in the past – and many times, inappropriately so.

“The connection between risk management and remuneration has not been a close one at all,” says Anton van Wyk, PricewaterhouseCoopers’ Risk Advisory Services leader. “The financial crisis saw over $50 trillion of wealth being wiped out and several banks collapsing – and for this, executive reward particularly in the financial services sector has come under scrutiny. Following on from the crisis, company boards and management are now, more than ever, under pressure to reform how risk is assessed and then to monitor the effect of such risk on an organisation's performance and related executive reward determination effectively. Leading on from this, would be to link this new approach into how executives are more suitably rewarded in the future.”

Van Wyk says that one benefit of a more appropriate relationship between risk and performance is giving an organisation and its management the confidence and incentive to take ‘smart’ risks, rather than completely suppressing risk appetite and making executives overly risk averse.

A correlation between risk and performance, and now reward, means change is required in several areas of a business. Performance measurement tools and techniques may require redesign, and this would include a far greater inclusion of non-financial measures than is presently seen. The operation of remuneration and risk committees and how they monitor and measure performance may also require an overhaul.

An important part of this reform means looking at the composition, role and operation of the remuneration committee of a company. A remuneration committee should have at least one member who is experienced in remuneration, something which has historically been lacking. The use of expert remuneration consultants needs to be appropriately managed because sometimes conflicts may arise as these specialists serve both the remuneration committee and the senior management team.

A remuneration practice code on executive remuneration is needed for businesses to comply with. Van Wyk emphasises that incentives need to be more closely aligned with sustainable longer-term company growth and shareholder interests. “King III acknowledges that strategy, risk, performance and sustainability are inseparable – as such we need to take these interrelationships even further and link them to remuneration.”

Strategic risk has, by its nature, predominantly long-term realisation, which is aligned to organisational sustainability. On the contrary, performance and reward tend to be short-term based. “Achieving the alignment to organisational sustainability lies at the core of addressing the reward debate,” says Van Wyk.

The remuneration committee is not the only committee which should be involved in rewards. Van Wyk asserts that risk committees should inform performance assessment and hence what is appropriate remuneration for directors. “There should be interaction between the risk and the remuneration committees, as the issues they oversee are related.”

It is imperative that the performance related degree of risk undertaken by executives should be considered in an executive’s financial and non financial performance metrics. van Wyk says “Remuneration committees need to address the questions of risk and sustainability in measurement of performance. There needs to be greater application of discretion by remuneration committees in setting targets and measuring achievement. This places trust in the board and assists in including the intangible aspects of non financial metrics in executive performance measurement. The risks undertaken in delivering financial results should be accounted for when assessing performance.”

King III does consider the issues of risk, performance and remuneration, but Van Wyk cautions against applying the various chapters in isolation. “There are interconnected themes that pervade King III. Effective implementation of its guidelines means identifying this interconnectivity and translating it into the way a company is governed.”

Van Wyk concludes that a narrow, compliance-focussed approach to risk management carries the risk of creating dangerous blind spots for organisations. “It can threaten growth and impact sustainability negatively – and executives should certainly not be rewarded for this type of management style.”