Moral Hazard – Part Two: Risk Assessment and Incentives

The immediately preceding post introduced the concept of “moral hazard” to the blog.  In today’s post and others to follow we examine how C&E programs can address moral-hazard C&E-related risks.

The principal way to deal with such risks is, of course, through attention to compensation approaches. There are, in turn, two dimensions to this.

The first is to assess how current  (or planned) compensation approaches can create or exacerbate risks.  This can be done by building into the risk-assessment process questions addressed to all forms of compensation, meaning not only salary and annual bonuses but also such matters as business unit and project plans.   For example, a project plan that creates incentives for finishing the project by a certain time but does not sufficiently dis-incent unduly risky conduct (which, depending on the project, could involve a wide range of compliance issues) could be seen as creating moral hazard.

The second general approach focuses on the other side of the compensation coin, and specifically, mitigating risks through creating “positive”  (from a C&E perspective) compensation approaches.  Among the obvious possibilities here are including C&E-related criteria in decisions about promotions, salaries and bonuses, and also having tangible awards for truly exemplary ethical service.

A less obvious measure that can be taken in this regard is to give the chief ethics and compliance officer formal input into promotion and succession planning decisions, at least for senior positions.  Relatively few companies currently do this, but it can be a powerful way to correct for moral hazard and other risks.

Additionally, non-monetary forms of recognition for highly commendable ethical conduct can be helpful.   This can occur either centrally (such as mention in a company newsletter, as appropriate) or on a local basis. To facilitate the latter, companies should consider training managers on means to recognize (meaning here both identify and acknowledge) exemplary ethical conduct.

The third posting in this series will examine non-economic moral hazard issues and also board oversight as a control for moral hazard risks at the senior manager level.