Moral hazard: the final compliance frontier?

Moral hazard exists when there is a gap between the interests of those who can create risks and those who bear the consequences of risk taking. Moral hazard is not the same as conflict of interest, but is conflict like. As described in various prior posts,  C&E programs need to take moral hazard into account in identifying and mitigating risk.

This week, the Society of Corporate Compliance & Ethics  published the results of a survey which showed that “despite the importance of compensation in affecting risk compliance [personnel] rarely play[] a role in evaluating incentive programs” at their respective companies.  The report noted: “just 23% report reviewing the plan prior to the plan’s approval. Just 8% do so after it is approved, and 52% report that the compliance team never reviews the plan. The balance did not know whether the incentive plan is reviewed.”

While disappointing, these numbers are not surprising. Indeed, based on what I have seen at many companies, I would have expected that the percentage of those who reviewed an incentive plan prior to its approval to be even lower than the survey results.

But practices in this key area could change, given – as the SCCE survey notes – the recent publication of  the Department of Justice’s compliance program evaluation guidance document which suggests that prosecutors assessing programs ask (among other questions):  How has the company considered the potential negative compliance implications of its incentives and rewards? Of course, the question does not necessarily mean that compliance professionals need to be part of this determination. But surely the consideration would be seen by the government as more serious (and more informed) if they were involved.

As well, involving the compliance staff in this determination can be seen as empowering them. Such involvement – if made known throughout the company, as it should be – enhances Compliance’s “clout,” which has long been viewed by Justice as fundamental to an effective C&E program.

Also,, note that there are many other ways that C&E can be incented – as described in this post from the FCPA Blog. But all companies, in my view, should involve Compliance in reviewing incentive plans.

Finally, I recently suggested that ethical thinking from the business realm can fortify ethics at the societal level. Understanding the pernicious effects of moral hazard in the two  highly consequential areas of climate change and irresponsible fiscal policies may be a way in which such fortification can work. (For a related post on “Two conflicts of the apocalypse” click here.) Indeed, while the notion of moral hazard being a final frontier has one meaning in terms of C&E program practices, it has a more urgent significance when thought of in terms of these risks.