Category Archives: Risk

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August 9, 2013

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Executive Reward, HR, Pay Regulation, Reward, Reward Strategy, Risk

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A time travelled reward strategy; Who?

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Introduction

I was listening to the excellent “Dr Who at the Proms” on the radio.  The music was evocative of different times and alien terrains.   A thought struck me; what would the reward landscape look like in ten years’ time? Two alternative possibilities collided in my mind: a sort of Matrix like choice of different futures, a red pill or a blue pill? These were:

  • A continuation of what had gone before with ever increasing inequality between high and low paid
  • A more equal, transparent approach with some convergence between the levels.

This article will be looking at the outcomes of these two scenarios and the different pressures that may lead to one or the other becoming the new reward reality.

Continuation of the status quo

A troika of forces support the status quo.

  • The self-interest and power of those who benefit from the current system
  • A lack of political will to make changes; perhaps connected to first point.
  • As the economy improves the supply and demand equation will reassert itself.

There is a large amount of vested interest in the status quo.  This is not only from the direct beneficiaries of high pay; but also from those who benefit indirectly.  The barrier between board rooms and politicians together with senior public servants has always been porous.   Politicians and public servants often move in to corporate board rooms following retirement from “public service”.  It may be argued that waiting for those who currently hold the levers of power to reduce their future earnings potential in the private sector is like turkeys voting for Christmas; unlikely to happen.

Although outside the parameters of this article there is some interesting research to be undertaken on the issues of power and ideology as they relate to the economics of reward.

Even when the global economy is in recession it is difficult to attract the right calibre of staff in to executive management positions.  Or, if we look at the highest paying sector (putting aside football players and those in the entertainment industry), in to investment banking.   Getting the right people in role can make a great difference to organisational and financial success. When Stephen Hester was unexpectedly removed as CEO of RBS, its share price fell by about 7%.   At the top levels it is a seller’s market, with, arguably, an increasing international dimension.  There is anecdotal evidence that top mangers’ prefer moving in to private equity where rewards are higher but less transparent.  Likewise the increasing, and in my view, mistaken, prescriptive approach by the USA, EU and regulators on financial services pay, has the potential to lead to a flight of talent to less regulated shores; much the same as we have seen in the past with corporate tax planning.  This means a race to the top for the best talent with organisations worried about falling behind their competitors; the stairway is to heaven for the high paid.

There are considerable forces of inertia to be overcome before we can travel to a more progressive pay landscape.

What will the status quo pay landscape look like?  I used some data from the excellent MM&K survey of executive pay to develop a model.  The current position in the UK FTSE 100 (the UK top 100 companies by capitalisation) is:

  • Average FTSE 100 CEO remuneration:       £4,516,474
  • Average FTSE employee pay:                       £        33,957
  • Ratio of employee to CEO pay                                    133

If we look at the last ten years, the average increase in CEO remuneration has been 5.8% and 3.9% for employees.  I build a Monte Carlo simulation (with a heroic assumption that the increases were normally distributed and appreciating that ten data points is not a good sample) that showed there was a 50% probability that the following would occur;

  • In 2022 average FTSE 100 CEO remuneration:        £7,972,054
  • In 2022 average FRSE employee pay:                       £      49,668
  • 2022 ratio of employee to CED    pay                                       161

So inequality between those at the top of the pay scale and those on the average wage would get progressively worse.  A “Hunger Games” scenario with a large population of lower paid supporting a small population of very high paid.

There is a counter argument to this approach.  As the Institute of Fiscal Studies reports:

“Income inequality in the UK fell sharply in 2010–11. The widely-used Gini coefficient fell from 0.36

to 0.34. This is the largest one-year fall since at least 1962, returning the Gini coefficient to below

its level in 1997–98. Although this reverses the increase in this measure of income inequality that

occurred under the previous Labour government, it still leaves it much higher than before the

substantial increases that occurred during the 1980s”.

Thus, income inequality is a moveable feast with volatility making it difficult to confirm a consistent trend given the constant transformations of the tax and social security structures.

A more equal, transparent approach with some convergence between the levels.

There are a number of important pressures that indicate that this is the more likely outcome; albeit occurring over a long period.  As Jon Terry of PwC, a globally recognised FS reward expert, notes they can be broken down in to three broad areas:

  • External pressures
    • Pressure from shareholders
    • Pressure from the regulators
    • Economics
    • Cultural pressures

External pressures

I had a very interesting conversation with Cliff Weight, another internationally recognised reward expert, from MM&K.  This was on the subject of the balance of power between shareholders and executive management.  It is my view that in the past shareholders were more relaxed about the quantum of pay. This is because they were making a good return on their equity.  That situation has now changed.  Return on equity has, in many sectors, reduced considerably.  At the same time the percentage being spent on executive remuneration has risen.  Shareholders are now taking a much more detailed interest in the balance between what they earn and what the “talent” gets paid as a percentage of revenue.

It is also worth mentioning the role, particularly in the US but increasingly in other countries, of the activities of shareholder advocacy groups such as Institutional Shareholder Services (ISS).  I am not a fan of their somewhat tick box approach; but I fully appreciate that they do an important job in highlighting what may be seen by some, as poor pay practice.  Institutional shareholders are increasingly (although perhaps wrongly) relying on the advice given by these organisations.  The pressure on pay is always downwards.

A similar downward pressure is beginning to be exerted by the regulators; albeit often accompanied by prescriptive, counterintuitive and sometimes downright stupid regulations. There is a good summary of the latest UK regime on remuneration reporting here.  A downward pressure on remuneration by regulators is a clear and present danger to the maintenance of the status quo.  Linked to this are the regulatory requirements, initially in financial services, but likely to move to other industries, to hold sufficient risk based capital to support operations in the event of black swans, unlikely but catastrophic events.   This reduces the risk capital that can be invested in higher risk; higher return activities, so, picking up the issue in the paragraph above, reducing the potential returns to shareholders.

Economics

There are two opposing economic pressures affecting this debate.  Shareholder returns are dropping, as discussed above.  There are structural changes taking place that indicate that we may never see a return to the fifteen per cent plus returns before the financial crisis.  If that is the case there is going to be considerable downward pressure on remuneration in order to ensure a more “equitable” division of return between capital providers and employees.  The counter argument is that if there is a return to high inflation (and that has a high possibility in my view) and good economic growth, there is the likelihood of higher relative returns, while the scramble for labour intensifies and earnings at the top of the ladder explode.

Currently the balance appears to be in favour of the economic constraints on equity return leading to downward pressure.  But, as previous booms and busts have shown little is impossible, even if very improbable.

Cultural pressures

This is the most interesting of the downward pressures on pay.  I discussed this issue extensively with Cliff and Jon.  There is a clear consensus between the three of us that there are strong undercurrents of social pressure to increase transparency and have a more equitable distribution of pay.

These pressures are coming from all levels and in some cases some unexpected directions.  We are currently seeing the senior executives of some large organisations preaching pay restraint and greater responsibility.  Although, as the recent CIPD report on “Rebuilding trust in the City” (of London) shows there is a long way to go and some leaders still work on the basis of do not do what I do, do as I say.  But, this apparent change by the changing leadership of some large organisations is an interesting trend.

It can also be argued that those currently coming in to the system or beginning the climb up the greasy pole of corporate life have a different approach to reward, work and life balance.  Perhaps there is something less of a drive for personal gain and more a realisation of the importance of social contribution; we can but hope.

I am unsure that issues of high pay have yet entered the popular consciousness; a bit like the zombies in “World War Z”; we know they are bad but we are not going to come across one in real life.  Very few people have even indirect experience of high pay either in an absolute or relative sense.  Thus, while there is a broad sense of moral outrage driven by an often misinformed media; there is a limited popular demand for restraint on high pay and even less of an understanding of labour market economics or the complex nature of senior reward.

Having said that, social pressures are leading to what Jon Terry described as a “noticeable shift” in attitude by those both at the top of the tree and those who are working their way up the branches.  It is not yet revolution but is most certainly evolution.

What is clear is that social pressure is building up a head of steam and will have, perhaps, a defining effect on the reward landscape a decade hence.

Conclusion

My travel in to the future of reward is complete.  The evidence supports the scenario that in ten years’ time we will have a more transparent, more equal, reward landscape.  It is also likely to be an extremely regulated environment, particularly for high pay.  The issue is that state intervention starts to look like pay policy and pay policy, as history has shown, seldom works and discourages an open market in reward with frequent unintended consequences.

Executive Directors, consultants, remuneration committees, regulators and last but not least, reward professionals must start to prepare themselves for the changes that are beginning to appear on the horizon of the reward landscape.  It must be acknowledged that the future seldom turns out the way we expect; but there are sufficient broad trends emerging to at least give a probability of a more equal approach on pay.  In some ways this becomes a self-fulfilling prophecy.  If we start to think and prepare for a more transparent and equal pay environment it is more likely to happen.

Acknowledgements

I would like to thank two globally recognised reward experts, Jon Terry of PwC and Cliff Weight of MM&K for sharing their insights on the subject with me.  However, all the views expressed in this article are mine alone.

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July 27, 2013

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Demographics, HR, Pensions, Reward, Risk

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The pessimistic person’s pension problems Pandora’s package

Introduction

I had a letter recently from the Trustees of one of my defined contribution occupational schemes.  They told me they were going to change all of my carefully balanced investments in to funds of their choosing.  They said they were doing it in the best interests of all members; a reason that gives little room for argument.  It did set me thinking of the many pension risks we face; often not of our making.

Here is a list from the Pandora’s package of a pessimistic person’s pension problems.

Security risk

There is an assumption that our pensions are safe but what about:

  • The strength of the sponsor; as pensioners in Detroit have found – nothing is guaranteed
  • Investment manager – more on this later; but what happens if our investment manager fails?
  • Spouse risk; we assume that our spouse has made appropriate pension arrangements in the event of their death, but have they?  What about divorce?
  • State risk: some people rely on the state to provide a pension.  Research has shown that there are a lot of European countries who will not (and in some cases currently cannot) be able to afford the state pension burden.  If, it is going to be paid followed by when is it going to be paid followed by how much is going to be paid?

Political Risks

  • What tax regime are we going to face on our future savings and on pensions in payment?  In the US have we made use of the Roth rollover?  In Europe, what are marginal rates of tax going to look like in the future given the deficits are likely to last for another twenty years?
  • What limitations and regulations are going to be put in place now and in the future?  In the UK the limits on pension savings change every few months.  Are we going to face a savings limit; or like Australia a reduction in our state pension because we were prudent enough to save for our old age?  We know this is on the agenda of the UK and other European governments.
  • Are our pension’s savings going to be confiscated by the state at some stage, as we saw proposals to take savings from bank accounts in Greece recently? Do not think because it has not happened it will not happen in the future.
  • For those countries that allow income drawdown; will those rights be curtained or removed thus driving the proverbial coach and horses through our pension planning.
  • Regulatory risk; in order to protect pensions will regulators have to put such high hurdles in place that pension provision becomes impossibility expensive.

Economic risks

  • What happens to our savings when QE ends and the bond bubble bursts?
  • What happens if inflation takes off, as I consider very likely?  Are our savings and our pension payments protected against massive price rises?
  • Our country goes bankrupt!  Not at all impossible in these volatile times.
  • Annuity risks: are annuity risks going to crash even further (yes, probably).  Meaning we have to save vastly more for the same level of pension.

Sufficiency risk

  • Research by Fidelity and others have shown that very few people are saving enough to meet a basic standard of living let alone meet their retirement aspirations
  • Economic shocks for individuals such as unemployment, depression in the real level of wages, rising costs taking larger proportions of income are becoming the norm rather than the exception
  • Annuity rates are falling and there is little sign on the horizon of increases.  Forecasts based on old or historic annuity averages will underperform against the market reality
  • Life expectancy; this is the good news bad news story.  It is great that people are living longer.  But, that also pushes annuity rates down even further.  Someone (that is you) has to pay for all those extra years of pension

Investment risk

Where does one start?

  • Do we invest conservatively to reduce volatility; but with a greatly reduced investment return or do we invest more aggressively and risk losing it all?
  • Market timings – when do we buy and when do we sell; is our “lifestyle planning” going to mean our fund manager exists equities at exactly the wrong time?
  • Hidden costs eroding our pension savings.  De we actually know how much we are paying for all these advisors, fund managers, intermediaries, actuaries, professional trustees, pension lawyers, pension administrators and other assorted hangers on who seem to make a very good living out of our pension savings?
  • Investment advice; should we be in bonds or equities, infrastructure or emerging markets debt?  Even if we avoid the perils of active management do we know where we should be invested?
  • Diversification risk, everything seems to be correlated with everything else when we look at investments.  Are we over diversified or under diversified; should we be diversified?  Are our fund managers over or under diversified
  • Active vs. passive fund management?  Should we hope that “our” fund manager can do better than the market over the long term (statistically very unlikely) or should we invest in the market indexes and perhaps lose out on juicy “one-off” investment opportunities?
  • Vanilla or exotic investments.  Should we invest just in main index stocks, or should we use derivatives to help hedge our exposure?  Are Credit Default Swaps a good or a bad place to be; or both?

Operational risk

  • Have we got good fund administrators?
  • Are our pension records with our advisors correct and up to date?  Does someone still hold the record for the pension I took out in 1984?
  • Are our pension administrators undertaking the correct highly complex calculations correctly to ensure the correct final pension payment?  Some years are indexed against one figure (In the UK, for example, against RPI) and in other years against another index (again, for example in the UK, CPI).  Has inflation indexing, if we are that lucky, being calculated correctly.
  • Would we ever know if any of the above does contain errors?
  • Are the auditors of our pension scheme doing a good job for us?
  • Are the pension lawyers looking after our best interests
  • Have the pension trustees made the right investment and administrative decisions?
  • Have the regulators got sufficient resources and expertise to ensure that pension scheme members are being treated fairly?
  • Are the pension scheme communications easy enough to understand so we know the risks we are taking?

I could have gone on and on looking in my Pandora’s package but I have depressed myself enough already writing this.  I am going to have a little lay down and a cup of tea.

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June 26, 2013

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HR, Metrics, Probability, Reward, Risk, Strong analytics

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Why thinking in averages is below average thinking – Strong analytics II

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Introduction

As a reward specialist I am asked questions like, what is our pay inflation going to be next year?  I used to go away, do research and say 2.4% – having used the historic average.  Of course it was never exactly 2.4% so my boss would turn round and say – “but Ian, you said it was going to be 2.4%, you’re fired”.  If asked the same question now, I respond with an answer; “there is a 50% probability that it will be 2.4%; but there is as 10% probability it could be 4%, so we should factor that in to our budget.”

The problem is that point data estimates, like, pay inflation is going to be 2.4%, have a high possibility of being wrong.  Using a probability approach gives more information about outcomes and new ways of thinking about those low probability, high impact events in our lives – our “Black Swans”.    Dr Sam Savage, a pioneer in work on probability, tells the story of the mathematician who drowned in a river that had an average depth of three inches – that average hid a deep trench right across the centre.

Average forecasts are wrong on average

Taking point averages and using them to forecast is a common fallacy.  House prices have gone up, on average, $20,000 per year, the forecast is that they will go up $20,000 next year – oops, they fell $50,000.  Using a probability approach tells us that there was a less than 40% chance of a $20,000 increase and, a 10% chance of a $50,000 fall.  

Playing with Monte Carlo

So how do we get to the “50% probability that inflation will be 2.4%”?  My favourite method (but not the only one) is to use a Monte Carlo Simulation.   This is a statistical technique that allows me to account for volatility in numeric analysis.  It does this by producing a probability distribution for any factor that has variable outcomes and by producing a large number of random samples.  What does this mean?  Well, I took some UK National Health Service (NHS) quarterly sickness data over five years.  The average percentage absence was 4.2%.  I ran one million random trials (it took about twelve minutes) against the data distribution.  It showed that while there was a 50% chance of absence being 4.2% there was a 10% chance of it being 5%.  That may not seem like a big difference but when you are dealing with the biggest workforce in the UK, 0.8% is a large number of doctors and healthcare workers off ill.    I used a different set of NHS data on the number of sick days lost per employee.  The 50% probability of days lost was 6.1 – but there was a 10% chance of 9 days, a large difference. 

As an HR professional it is better to say that we have a 50% probability of wage inflation at 4.2%, which clearly gives a large range of other probabilities than saying it will be 4.2% with a very high probability of being wrong.

Probable advantages

There are a lot of advantages to using the probability approach.  We can show what might happen and also the probability of each outcome.  One example of this that I have used is to look at the probability of different performance measure outcomes in an organisation if they were normally distributed.  I then compared this with actual outputs and was able to show the CEO which departments were “outliers”; had produced markings that were higher or lower than forecast.  That allowed us to talk to the line mangers to find out why the department was marking higher or lower than was predicted if the performance was normally distributed – which is what you would expect.

Using probability analysis is invaluable for “what if” exercises.  How many times have we been asked to model what would happen if you cut the budget by 3%? Using one number you get one output.  Using the probability approach you can give a range of possibilities.  I have looked at death rates in an organisation against the probability forecast.  On one occasion, using a probability approach, I suggested increasing insurance cover just in time for a sad increase in the number of employees dying. (The increase was, of course, entirely random, but I had forecast that probability). 

Another important use of probability is that of project planning. One statistical quirk in project planning is that if all the tasks are completed, on average, on time, then the project will be delivered late!  (Think about that for a minute….) 

Fooled by Black swans while thinking fast and slow

You may have read “Fooled by randomness” by Taleb or “Thinking fast and slow” by Khaneman.  Both make the same point. As humans we are programed to apply heuristics and biases to problem solving: dismissing or ignoring the unlikely in favour of what we think we know or what happened recently.  Yet unlikely outcomes are more common than most people would guess; also the outlier outcomes tend to be extreme by definition.  Of course, in HR we work with people, who act in quite random ways sometimes……

Bombs and gas masks

When in investment banking I worked with an outstandingly good business continuity manager called Stuart Dunsmore.  He talked about the possibility of a bomb in central London being extremely small; but the effects would be highly disruptive. Sadly, he was proved right, but the upside was we came through the London bombings with our UK business unharmed due to his preparations.

When in the City of London I carry an emergency gas mask.  Why, well, the chances of needing to use one are small, but I only need to use it once to save my life!  The probability of a biological or chemical attack in London is tiny; but the chance of death is high.  Low probability events with high impact; do not let them take you by surprise. 

The dark side

Now for a public health warning.  First, those of you who have a statistical background (unlike me) will spot holes in my argument.  There are issues with Monte Carlo simulations or even using probability approaches.  But, they are better than point averages for forecasts.  It is a continuum, yes, there is better mathematical or statistical approaches available but even starting to think on the basis of probability is a game changer.  Second, probability often depends on the future being similar to the past – but it will not be!  However, using the probability approach makes us more aware of both that factor and that highly unlikely events do occur with surprising frequency.

Conclusion

Most of us in HR are not statisticians  Using the probability approach does involve some understanding of statistics and how to use the programs that are available, be they Microsoft Excel add-ins or programs designed specifically for this work. However, taking the time to understand probability both as a mind-set and as a set of techniques is a major game changer for HR. 

I would urge you to give it a try; you have little to lose.  The gains are large; greater chance of producing “better” forecasts, certainty of being wrong, on average, less often.  Increased credibility and perhaps a more open mind set to when those outlier events do occur.  Enjoy!

 

 

 

 

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June 12, 2013

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Banking pay, CIPD, HR, Pay Regulation, Reward, Risk

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Rebuilding trust in the City of London

 

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Introduction

I was at a recent meeting in the City of London to launch the document “Focus on rebuilding trust in the City” a Chartered Institute of Personnel and Development (CIPD) survey of staff in financial services in the City of London on trust and their employment relationship.  (I tweeted from the meeting #rebuildtrust )  The keynote speakers to an invited audience of senior City HR people and journalists were:

 

It was an informative meeting presenting both the survey results and material on initiatives taking place to build trust after the calamities, errors, poor judgement and near criminal activity in the City over the last few years, which has badly eroded trust in what was once a gold standard for honesty and integrity.

Both Peter Cheese and Andrea Eccles gave particularly good presentations from different ends of the initiative spectrum.  Peter spoke on the big picture and in particular the role that HR has to play in leading the changes.  Andrea spoke of the very important key initiatives at grass roots level that City HR are taking, working with the Lord Mayor’s City Values forum.

The key themes during the meeting were:

Each of these themes is explored below.

Culture

Culture has been identified by the CIPD in earlier work as being fundamental to the required changes in the City.  The survey indicated clearly that the existing culture is a long way from being what is needed.  45% of the participants said their employer put profit before values.  Only 47% of staff saw customers as their key stakeholder.  As one of the speakers said, “What is required is a return to the core values of caring for customers and caring for employees”. 

One interesting take on the subject was the suggestion that financial services organisations need to focus more on recruiting “ethical” people.  My own experience, backed up by the survey results, is that a lot of people join financial services to make money.  In order to be seen as successful and to make the big bucks you need to be aggressive and egotistical; otherwise how would you make deals worth millions of pounds?  Unfortunately, aggression and egotism are not good indicators of ethical behaviour.  This goes to the heart of the matter; it is very difficult to make lots of money in an ethical and customer focused way.  The demands on one hand, by shareholders and analyst to make shed loads of money on one hand, and on the other, regulators, politicians (especially the European Union) and media on the other trying to stop profitable activity.

The role of HR in leading the changes was highlighted several times.  Again the paradox between this approach and the role of HR in supporting the business to carry out its activities was evident.  A good example was a comment about the morality of HR being involved in compromise agreements in financial services.  It was alleged that these compromise agreements can (as in the case of the NHS) be used to gag whistle blowers.  The reality is that compromise agreements are an essential part of the HR toolkit.  It allows for the amicable separation between employer and employee, normally on a “no fault” basis.  In the fast paced and rapidly changing environment like financial services, there will be differences of opinion, strategy and personality clashes.  Compromise agreements lead to a civilised and low cost way of managing these situations.  The suggestion that HR should stop using them is really throwing the baby out with the bathwater.  HR has far more important tasks in providing the frameworks for culture change than worrying about compromise agreements.  It is getting tied up in the detail rather than working on the big strategic picture that often leads to HR being perceived as a barrier rather than an enabler.

There was some good news.  RBS, the largely state owned bank in the UK, was singled out for praise for its work in introducing a much more ethical and customer centred approach – something of which I have some personal experience. (And would like to have more if Rory Tapner is reading this).  Sadly examples of good practice are few and far between. 

Values

Part of the discussion on culture must include values.  City HR is leading a lot of work on the development of toolkits to help.  The presentation by Simon Thompson went in to detail on the work of the Institute of Bankers on professional standards and many big employers in the City have signed up to these standards and the educational and training frameworks that support these approaches. 

Professionalism

This was a key theme in the presentations.  Raising the level of professionalism is very important in defeating the current broken culture.  What do I mean by broken culture?  It is the behaviours that allowed the manipulation of LIBOR rates for profit; that mis-sold products including PPI and, perhaps, some derivative products for gain rather than the good of the customer.

The survey showed that only 30% of staff are in professional bodies with standards.

To work in HR in the City you need to be CIPD qualified, yet to work as a banker you need no qualifications at all

That quote summed up for me the entire issue around professionalism.  One can argue about professionalism and its meaning.  It does normally provide a framework of acceptable (and unacceptable) behaviour that can form the basis of reward on one hand and disciplinary action on the other.

There was a comment that there are a vast number of codes of practice, regulations, laws, (domestic and foreign) and guidance – some of which is in direct contradiction.  True, but no one said it was going to be easy.

I must again praise the work of City HR in providing structure and good practice for professionals in the City.  This slow drip drip drip of information, tools and frameworks are, over the long term, likely to prove to be a bigger boost to professionalism than grand culture change initiatives by those embedded in the current City ideology. 

Leadership

One of the more disappointing results from the survey was that 41% of the participants said that there was one rule for senior management and another of other staff.   Given that nearly all the speakers emphasized the key role of senior management and CEO’s in leading the culture change; there is still a big mountain to be climbed.  The fact that only 36% of “other ranks” are aware of their organisations values indicate that organisational leadership has a large communications issue on their hands; and what is leadership if it is not communication of the vision.

Risk Management

A key theme during the presentation and during the Q&A session that followed was risk management.  It is clear that the framework to support culture changes needs good human capital measures and strong analytics.  Why?  Two major reasons were discussed.  First, it is difficult to discuss change if it cannot be properly measured.  Second, in the world of financial services number crunching and risk analysis are part of the bread and butter of daily activity.  To have credibility, the change activity, particularly if led by HR, needs to adopt this approach.  When I worked in investment banking I sat on the Operational Risk committee and that experience led directly to my design and implementation of a reward risk framework.     Exactly the same type of approach can be used when thinking about risk and culture in the financial services environment.  It is this sort of fundamental change in thinking that is going to provide the scaffold for the success of the work in culture change.  HR does, on occasion, shy away from people metrics; yet they are an essential framework for designing interventions and supporting our businesses. 

Role of HR

There was a lot of discussion on the role of HR.  Here I must depart from the gospel according to the panel speakers.  There are two places the pressure for change will come; the first is from senior management.  There is a bit of an issue with this one.  Senior management got where they are by supporting and encouraging the status quo.  Much of this has been made in management literature; the ideology of management has support for the status quo deeply imbedded within it.  Asking senior management to support massive cultural change may be like expecting turkeys to vote for Christmas….  The second place is from the employees within the organisation.    It is possible, as history has shown, for small but articulate groups of people to push for change from within the organisation.  Given the above mentioned ideology that is a possibility but not a strong probability. 

If culture change becomes another HR intervention it has the possibility to be marginalised and not become part of mainstream business thinking.  The survey showed that a number of culture change initiatives have not worked so far.  Only 17% of participants saw the culture change in their organisation as being very effective.

Clearly HR does have a role in providing the toolkits, interventions, training and development necessary to carry out the culture change; but leading it is not, in my view, going to happen and if it does it is more likely to lead to a marginalisation of the change on the business agenda as so often happens with HR led initiatives.

HR does have a key role in modelling and supporting behavioural change as well as ensuring that the new generation of bankers coming through at least start with an ethical mind-set. 

Reward issues

Reward is at the heart both of what is “bad” in the City and what will help drive change.  But,

  • 73% of staff think that some people in financial services are overpaid
  • 67% say there is secrecy around pay for senior mangers
  • Only 36% see reward as being “fair”.

As reward professionals we have to stand up and be counted.  Discussion needs to take place on what is “fair” pay.  Pay systems have to be somewhat more open so there is a greater understanding of what people are being paid for,

Key tasks include:

  • Better advocacy of pay levels and differentials in organisations
  • Development of incentives to encourage professionalism
  • Development of reward and performance management that encourage thinking about how an objective is reached as well as the measure of the objective.
  • Being as open as is appropriate to stakeholders on our reward approaches and outcomes
  • Being an advocate both internally and externally for the reward systems and outcomes.
  • To bring measured, data led, rational debate to politicians, the media and other commentators to prevent or at least moderate the near hysteria around financial services and senior executive pay

Conclusion

The CIPD report is a timely looking glass in to the views of those who work in financial services as to issues of trust and reward.  It is well written and influential; I would recommend it to you. (Disclosure note; I undertook some analysis of the raw data in the report for the CIPD).  Both the CIPD and CityHR are clearly thought leaders in this field and their activities are to be applauded.  The report is an important part and input to the on-going discussion on this subject.

The report is also timely.  The results from the Banking Standards Inquiry by the UK’s House of Commons are due to be produced very soon.  Unfortunately it may be argued by some that it has been badly tainted even before release because:

  • The standards of politicians in the UK are at an all-time low and lecturing other people on ethics and standards is at best the pot calling the kettle black and at worst rank hypocrisy.
  • A lack of understanding of the world and work of financial services by MP’s who have seldom operated in the real world and those who have did so via the playing fields of Eaton (an elite fee paying school in England  attended by many of the UK cabinet and their advisors).
  • A large part of the problems with the collapse of trust in financial services is due to inaction by politicians and regulators who believed that light touch and not actually understanding what was going on was a good way to regulate a very complex, risky, global business.
  • A potential perception that there is a lot of band-standing and jealousy going on at Westminster village that does not aid credibility

I hope I am wrong and wait to read the report with interest.  However, the weight of history is against them; since when have politicians made anything better?

Failure is not an option unless we do want the politicians to bring their incredibly costly sledge hammers to smash some nuts that, it turns out on closer inspection, actually have nothing to do with the problem.

It is only by hard work based on sound data such as the CIPD report; and not taking some moral high ground and seeking to apportion blame; that will make the very necessary changes.  HR and reward in particular do have key roles to play.  At the end of the day there must be the drive and will in the Board room to make the required culture change a reality. 

#reward #rebuildtrust #CityHR #RBS #trust #financialservices #cipd #cityoflondon #stronganalytics #rewardmanagement #risk #riskinhr #hrblogs

 

 

 

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March 6, 2013

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More pay regulation – Doh!

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Photo copyright Ian Davidson Police and protesters outside the Bank of England

Introduction

I am spending a lot of time at the moment reviewing the various global approaches on remuneration regulation.  It suddenly struck me, in a Homer Simpson moment, to ask a basic question.  Does more remuneration regulation lead to better reward outcomes?  It turns out not.  In fact, regulation is a poor solution to a low level problem that will throw up more issues than it resolves.  The real reasons behind the regulatory assault appears to be more to do with political expediency and an easy target rather than resolving issues of market failure.

Few would argue that shareholders and remuneration committees are closer to the issues of executive remuneration than regulators and shareholder advocacy groups taking a generic tick box approach could ever be.  The regulations not only fail to discourage the behaviour that they believe, incorrectly, led to the financial crisis   but they are storing up problems for organisations over the next few years just when the focus should be on economic and organisational recovery.

Does regulation solve the problem?

Professor Ian Tonks of Bath University argues persuasively that statistically, pay performance sensitivity in banks is actually no higher than other sectors and overall is quite low.  The relatively small performance-related element of executive pay means that there is little evidence that executive compensation in the banking sector is dependent on short term financial performance.  He notes that as Conhon et at (2010) shows that the role of compensation in promoting excessive risk taking prior to the crisis was dwarfed by the roles of lose monetary policy, social housing policies and financial innovation – which of course falls largely under the very politicians and regulators that now endeavour to regulate on pay.      As Weight (2012) notes the key determinate of levels of executive pay is organisational size. 

So the evidence points to the fact that executive pay in banking had very little to do with market failure and thus regulating it will have a very limited, if any, impact on the probability of further market issues – as if the current LIBOR issues did not prove that fact with greater eloquence that this commentator could hope to achieve.

Does it work?

So does the regulation of pay work?  The answer is not really.  The CIPD submission to the UK Government’s banking inquiry showed that the issue is mostly around culture; a view greatly supported by the actions of the new CEO of Barclays who is attempting a massive transformation of the Bank’s culture in response to its multiple failings.  Reward is but one small part of a much bigger issue.  But the FSA in the UK, the FCIC in the US and the EU capital requirements directive all link remuneration structures to market failure; with surprisingly little robust evidence to support this assumption. 

In general the approach is to defer large parts of the bonus payment in to the future and also that a large part of the deferred portion must be paid in equity or similar instruments. The deferred part of the bonus is subject to malus and claw back.  What is worse is the EU proposal that bonuses be no more than one times base salary.

Potential outcomes

 

It is all downside for the employer

The most interesting and critical part of this analysis is what will the results of these limitations?  First of all the approach to limit bonus payments to one times salary.  At its most simple level it is going to mean large hikes in base salary.  We have already seen this occurring in response to regulators demands for a greater balance between fixed and variable remuneration.  For employers increasing fixed salary has a very large down side.  It massively increases fixed costs at the same time as the same regulators are demanding greater capital holdings – doh!  The benefit of having a flexible bonus system is that you can pay out when times are good and not pay when cash is tight.  In addition salary payments are not performance driven or risk adjusted; so you are undermining the very strategy on which the assumption of market failure is based.

This leads on to a second issue for employers that are closely linked to the first point.  If you defer large parts of the bonus over multiple years you are forcing employers to pay cash out when they may have much better uses for this resource – including building capital reserves or returning cash to shareholders.  Thus the regulations on pay are hampering the very important role of management in managing the cash resources of their business.  Oh, of course shareholder advocacy groups say do not dilute share capital – the regulators say pay bonuses in equity instruments – doh!

It is largely (but not completely) downside for the employee

The regulators seem to be ignoring two very important financial concepts when introducing regulations on pay; as are shareholder advocacy groups such as ISS when making similar demands on executive pay.  These are the time value of money and the fact that the risker the financial vehicle the more return it has to generate. (Although this is a double edged sword as we will see later).  A cash bonus of £500 today is worth more than £500 paid next year or the year after.  To give the equivalent in today’s money of £500 in two years’ time would mean paying out perhaps £535  – and that is using quite a modest discount rate.  You then say to your employee I promise to pay you £535 in two years’ time; BUT if we do not perform well, or if someone in the organisation misbehaves and we lose money we reserve the right to reduce or not to pay the bonus.  An intelligent employee will look at her organisation and what is happening in other organisations and say “well, I think there is a 10% chance each year over the next three years that I will lose my bonus”.  So the deferred bonus is not worth £500 to me in three years’ time; it is worth   £432.  So the employee can either accept a lower value, uncertain payment in the future or look to her employer to increase the bonus to make up the lower future value.  Not an ideal employee engagement scenario.

The double edged sword of equity

Regulators and shareholder advocacy groups are insisting that a large percentage of deferred bonuses are paid in equity or similar instruments such as cocos. (Broadly, conditional bonds).  For the employee this is a double edged sword.  On one side, equity levels can produce very good results.  For example, Goldman Sachs share price has had an annual increase of around 23% over the last three years.  So if your bonus was deferred in to stock it would have doubled over three and a half years with little or no effort by you.  For the regulators and the politicians this means that stock based bonus pay-outs have the possibility of being very much higher than originally forecast.  Not exactly the policy outcome that was hoped for.  The other side of the sword for employees is the uncertainty factor.  Goldman Sachs shares may have increased; but many organisations share prices will not have risen; or given share price volatility have a high probability of being at a lower level at the very point of vesting.  Uncertainty, as noted above, reduces value.  In the eyes of a rational employee a bonus deferred in to stock over say three years must be discounted to a much lower level that the actual value awarded. (Although the concept of “actual value” here is quite nebulous).  Some traders that I know have discounted future equity based deferred bonuses to close to zero due to the risk (and perhaps their own financial time horizons).   Thus the deferred bonus in to equity ceases to be a retention tool unless you have to be one of the lucky Goldman Sachs employees – but then you do not know if you are going to be in a job in three years….doh!

The other arguable point about deferring bonuses in to equity is that it actually increases risky behaviour.     Why?  A deferred bonus in equity cannot drop in value below zero for the employee so there is a limited downside.  However, if taking a business risk increases the probability of equity upside then there is no rational reason for an employee or a director for that matter, not to take that risk.  So, instead of regulators and politicians providing policy that reduces financial risk the current approach appears to increase the risk, reduce flexibility and increase fixed costs; not an ideal policy outcome with no clear winners and the potential for everyone to lose – doh!

Conclusion

The evidence points to the efforts by regulators to provide prescriptive regulation on pay and bonuses; particularly in the banking sector, to be deeply flawed.  They are trying to solve a problem which played only a small part in the near global market failure.   They would be better to focus on the more important issues of lose monetary policy, culture and poor financial regulation of complex financial instruments.  The pay regulations are counterproductive and have a high probability of not delivering the desired policy outcomes but making the situation worse and more risky than it was before – doh!

I believe the time is right for evidence based, principled regulation around high pay.  Not for any reasons to do with market failure but because we must at least start to take heed of the arguments around social justice while appreciating that in a demand driven market economy the concept of “fair pay” is, like Plato’s table, something of an unobtainable but delightful concept. 

 

 

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January 30, 2013

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Emerging Markets, Executive pay in emerging markets, Executive Reward, HR, Reward, Risk

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Executive Labour markets – the emerging markets story

Introduction

Many people will have been surprised by recent research that showed that executive pay in some areas of emerging markets are at or above the level of mature markets such as the USA and UK.  A study by the global management consultancy Hay Group shows, for example, that in 2011 the average total cash level for senior management was $154,847 in the USA compared with just over $150,000 in South Africa and $204,421 in the UAE.  While appreciating that emerging markets are not a homogenous group of countries; there is a clear trend of rapidly rising executive pay.  The drivers for these increases have been identified as high growth, high inflation and high demand.

This high growth in cost is accompanied by very high levels of geopolitical uncertainty that both adds upward pressure on packages but also means that careful consideration needs to be given to the nature and quantum of investments in a number of emerging market areas.  In more mature markets there are often unspoken assumptions about robust legal systems and continuing political legitimacy (although that is starting to be questionable).  Those are assumptions that need to be examined in the light of current events in a number of emerging market territories.    

It’s a humpty dumpty world

The changes in levels of reward in emerging markets turn traditional assumptions on pay on their heads.  We are seeing increasingly that higher pay is required in some emerging market countries than say the USA or France.  In addition to base pay many EM countries have a structure of large cash allowances for housing, cars, education and so on leading to a very rich cash package before LTIPS, options and the like are taken in to account.

In a phrase, the executive markets in emerging markets are hot.  This is similar to the conditions seen in the mature markets a few years ago.  As an example, senior executives moving jobs in China are likely to generate a salary premium of more than 30%.

New thinking is required.  It is no longer enough to treat EM remuneration as a subsidiary consideration to the parent market.  EM labour markets have their own dynamic which is much faster moving and fluid than we have seen in the west for many years.

The fuel on the executive race track

Most commentators such as Hay Group and CT Partners agree that there are three factors fuelling the explosion in remuneration:

  • High demand for executives in high growth countries and sectors
  • High inflation in some emerging markets together with stronger currencies
  • High growth in both sectors and countries in emerging markets

There is a high demand for senior executives in a number of emerging markets.  Asia Pac is a key example where for some time now demand has considerably outstripped supply.  Given that economic growth rates continue to look very healthy (and certainly when compared with very weak growth in a number of western economies). It is likely that pay levels will outstrip mature markets if that has not already happened.

Inflation adds to the fuel.  EmergingMarkets.org quote pay inflation in Venezuela at 29% and in Argentina at 24.5%.  Brazil and Mexico are likely to rises in excess of 5% – and that is just to stand still – not taking account of the high demand for experienced senior management in these areas. 

Concentrate on tactics rather than strategy

The fast moving and fluid nature of a number of emerging market labour segments means that it may not be possible to have a prescriptive approach.  Nimbleness is the order of the day; reacting slowly or inappropriately will simply mean losing talent to competitors, be they local start-ups seeking a piece of the pie or established national or international players.

CT Partners have suggested that it may be appropriate to treat some EM markets as start-ups and structure remuneration accordingly.  This will mean some innovative thinking.  Larger equity grants (perhaps using local equity market listings) or higher gearing than we are seeing in mature markets.  Yes, this will create internal equity issues – but, to mix a metaphor, if you want flesh in the game you are going to have to gamble the pot.

Differentiated approach

My view is that to compete in the hot markets a highly differentiated approach is required.  The focus must be on individual country and sector labour markets both in terms of the quantum of reward and in terms of the total reward framework reflecting the innovations and retention products of that particular market.

Retention is very important and, given “transfer” premium costs, much more economic than recruitment.  I return once again to the concept of treating some emerging market countries as “start-up” territories.  This may mean offering equity or equity like vehicles with a mixture of time and performance vesting; weighted towards time vesting with steep steps at each annual anniversary.

Affordability

A cost benefit analysis should show that the potential revenue from emerging markets, with their relatively rapid growth in GDP and the expansion of a consumer orientated middle class should provide the revenue to fund the higher levels of executive remuneration that emerging markets are now demanding.  However, there is a fly in the ointment – the risks.

Risks

As Doctor Robert Davis the leading global strategy advisor notes, “We are on the edge of a major revolution in how the world is organised.”  This applies very much to the world of emerging markets.  The Arab spring, it may be argued, it just the start of fundamental change in the region. (Pun intended)  Also of note is the continuing rise of nationalism in certain EM countries that will also lead to a new understanding of geopolitics not just in Asia but across the globe.     Dr Davis goes on to note some major geopolitical risks:

• Social cohesion in Europe
• Rising nationalism in Asia
• Conflict (1), not in military terms, but in terms of the emergence of economic imperialism
• Conflict (2), in military terms, as the hypothesis that the world is becoming a safer place needs to be tested. The South China Sea and Iran head up the list
• the impact of NATO’s scheduled withdrawal from Afghanistan
• Emerging indications of a rejection of consumerism
• Unfolding events in the Middle East particularly pathways to or away from democracy, the robustness of current geographic borders and the emergence of theocracy.

Executive labour markets are going to be impacted strongly by these issues so we have to contend not only with high demand but high uncertainty.  This means HR and reward in particular are going to have to develop a competency in the analysis of geopolitical structures, risks and themes if we are to protect our organizations from unexpected shocks and Black Swans.  This will mean a different approach to termination clauses as well as considerations within EM packages of security and evacuation – as recent events in Mali have demonstrated.  This uncertainty and current events can only lead to further upwards pressures on packages as well as the factors identified above.

Conclusion

The rapidly increasing costs of employing senior executives in emerging markets are a vital consideration when undertaking business in these areas.  It is important to be both nimble and innovative to stand a chance of competing.  Competitive advantage is possible but difficult.  The changes in these labour markets must lead to a challenge on existing assumptions of what is “fair” and appropriate in a rapid changing and fluid environment.  Taking account of what is happening in each country and sector; both in terms of quantum and design is essential; albeit leading to the possibility of highly contextualised and fragmented approaches rather than a centrally driven strategy.

The other side of the coin for executive employment in emerging markets is the very high level of risk and uncertainty.  The interaction and correlation between the factors noted by Dr Davis above are likely to bring many downside surprises over the next twelve months.  This reinforces the need for nimbleness as well as having appropriate exit strategies (both in a physical and organisational sense) as well as robust business continuity arrangements.

One could use the simile of the old Wild West frontier; there are many risks and dangers but the potential for high rewards means that not being in this game is, in itself, a major business risk.  You pays your money (mostly to senior executives) and you takes your choice.

There is a supporting info graphic for this blog at http://prezi.com/_iiuwhlufol1/executive-labour-markets-the-emerging-market-story/

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January 23, 2013

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Executive Reward, HR, Reward, Reward communication, Risk

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Visualisation of reward risks – the appetite for risk

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Introduction

The profile of reward and the risks it runs can hardly be higher.  Just in the last few days we have seen media headlines about alleged million pound plus salary overpayments in an NHS trust to further issues around votes on remuneration reports, for example the report in the Telegraph of Imperial Tobacco facing investor revolt over its bonus revamp.

These risks include operational reward risks (an often overlooked area) such as making sure that payrolls are run accurately with appropriate tax accounting and payments through to communications between remuneration committees and the shareholder advocacy groups such as, in the UK, the ABI or in the US ISS.

Risk is part of business operations.  What is important, if not essential, is to measure and manage those risks in a systematic framework.    This allows us reward professionals to discuss risk issues confidently with the business, our colleagues in external and internal audit as well as the regulators.  A systematic process allows us to define and agree our risk appetite with our organisations and reduces (although will never abolish) surprises from our reward activity.  I am a great believer in two philosophic approaches.  One is that we always underestimate the frequency and impact of random events.  The recent best seller “Thinking fast and slow” by Kahbneman is a fascinating book on these issues. Likewise, we will always be subject to “black swans” the disruptive large scale random event that no one was expecting.

An overall approach to reward risk

Rosario Longo has published a very good blog “Risk and Reward Risk Management” which gives an excellent overview and structure for looking at reward management risk.   He identifies the key stages and stakeholders in the analysis of risk – mostly from an operational reward risk perspective but the approach is also applicable to the wider questions of strategy, executive remuneration and so on.

His approach on risk measurement and evaluation is very similar to an approach I developed that allows the use of a relatively simple Microsoft Excel spread sheet to generate a visualisation of risk scores in an organisation.  Rosario makes the excellent point that risk scores and measurements are not absolute numbers but an expression of relativity in relation to the known reward risks that organisations may face.

The visualisation approach

It must be recognised that my approach is essentially a sub-set of the type of systematic approach that Rosario has suggested.  Much of the data feeding in to my spread sheet will have been collected by the methods and collaborations suggested by him.  I would add that much of the generation of indicators in my approach are a result of the implicit knowledge of the person drawing up the risks and metrics.  An experienced reward professional will know where the key choke points in reward operations lie and what issues tend to occur during bonus planning and reward processes.

First step: the listing of reward risks

There are a number of approaches to listing the risks in reward.  I like to use a systematic approach by looking at the individual reward processes and then considering the risks attached to each process.  When I last carried out a process like this I came out with a list of over 300 risks.  Here are some examples of reward risks:

Lack of   understanding by senior management of the reward process

Issues   with Regulators over reward

Levels   of base salary insufficient to recruit

US   Benefit structure not appropriate for culture

Vendor   costs not being controlled

Communications   with employees insufficient

Remco has insufficient market data

Table 1 Examples of reward risks

It would be good practice to collaborate on the list with stakeholders such as Remco, HR business partners, the Finance and Audit departments etc to get their views on what they see as reward risks.

The list of reward risks is not static; it will change with time and such issues as changes in legislation, tax, reporting requirements, code changes and so on. A quarterly review of the list would be a good starting point. 

Some organisations run risk databases; such as Operational Risk departments – or may even have access to external risk databases.  All of these are good sources of intelligence on risk in reward.

Once we have a list of risks we more on to the next stage of probability.

Second step: listing probabilities

This is the most difficult stage of the process.  In the vast majority of cases we look to our (and other) organisational history to see what has “gone wrong” or “needs improvement” in the past.  In addition we must also scan events to look for issues that have occurred in other organisations, either in our sector or elsewhere.  Again, access to an external risk databases is a good way of keeping up with risk issues.  Advisors can also be a good source of advice around incipient risks.

At the end of the day risk is largely down to individual judgement.  Unless you have risks with a high frequency which allows mathematical modelling such as Monte Carlo simulations then you have to make an informed judgement call on the probability of risk based on history.  However, as investment advisors are keen to point out, past performance is no predictor for future results”.  Also any risk listing will be specific to the organisation to which it relates – it is all about context.

My model uses a risk weighting of 1 to 10.  Where a rating of one is highly improbable and ten is certain.    Once again, the rating is not static.  Risk probabilities change over time, so the probabilities must be reviewed frequently to ensure we are capturing as many of the issues as possible with their shifting probabilities. 

I am sure that statisticians or actuaries would have much more sophisticated approaches to this process; but I have designed the approach so that HR and reward professionals have a basic framework to start their risk mapping, if you have access to more sophisticated approaches then do use them.

It is important, from a methodological standpoint, not to read false accuracy in to the risk probability approach.  At the end of the process we are looking at the relative levels of risk in our organisation to give some focus as to where we should concentrate resources; not a forecasting tool.

 Third step: listing impact

This is perhaps easier than listing probabilities.  Again we use a simple 1-10 scale where one indicates no impact to ten – the end of life as we know it.  What we are looking at here is what impact would the risk have on our organisation?  For example, would incorrect tax payments on employee remuneration lead to reputational and financial damage?  Would not paying our R&D staff insufficiently result in them leaving with long term damage to our research effort?   Again, we are looking at an estimate of impact, ranging from some minor inconvenience to putting the existence of the organisation at risk.  As an example of this we have seen some companies run in to very serious financial problems in the UK as they had not fully considered the risks they were taking with their final salary pension schemes and the funding requirements nearly bankrupted them.

Another story around impact and probability.  When working in the City I was advised to carry an emergency gas mask.  I questioned the advice.  It was pointed out to me that the probability of a terrorist gas attack in the City was small (although perhaps higher now than in the past), the probability of being on an over ground or underground train catching fire and filling with smoke was considerably higher – but still low.  However, the impact of either of these events was a ten.  So while I hope I never have to use the mask, it only takes one occurrence of the above and me to have the mask to save my life.  We do tend to underestimate low probability, high impact events; as a former scout leader, “be prepared” it a good motto for reward risk as well as scouting.

At this stage we have a list of risks, a listing of probability against each risk and a score for the potential impact of the risk.

Forth step: Risk correlation multiplier

My initial model of risk in reward did not contain a risk correlation multiplier.  However, I have come to the conclusion that difficult as it is, consideration has to be given to this issue.  What is a risk correlation multiplier?  Simply put, if a risk occurs how likely is it that the risk will cause an increase in another risk factor.  Taking a simple example of payroll.  The risk is that we are not paying our employees correctly.  There is a correlation (and I am not strictly talking of statistical correlation here) between not paying employees correctly and not paying the correct statutory deductions in the relevant country.  What I have done is added a correlation multiplier to the score for the risk of not paying employees correctly to reflect it will increase risk in other areas.  If you pay employees in different countries, perhaps on split contracts, the issue of where payment is made, where, and how much tax is due and the implications of getting it wrong, impact on a number of other risks and pose a real operational threat.

Once again we are in the world of estimates.  The more statistically aware will see I am multiplying estimates by estimates by estimates; giving a number which arguably has no real meaning.  However, as noted above we are not looking for an arithmetical answer but relativities of risk in our organisation to allow us to focus resources in the most effective way possible.

We are nearly at the end of the process…

Fifth step: Generate the risk score

This is simply the product of the probability, impact and risk correlation multiplier.  The risk score is a single number that allows us to rank our scores and see where the highest risks in our environment appear to exist.  

Final step: mapping the risk

As figure one above shows, it is possible to produce a useful graphic that shows where are key risks are concentrated.  This is really beneficial when talking to stakeholders, who may not need the detail of the process, but allows them to focus in on the key risk factors. 

Clearly if you have 300 risks, mapping them like this will not work.  In that case it is easy to return to our original process map of reward and use this approach to map risk against each process with an overall map showing a cumulative risk for each process in our reward product stable.  Once again individual circumstances and trial and error will lead us to a process that is optimal for us and our organisation.

Managing the risks

Once we have the information on the likely risks in our reward environment we need to consider how to manage them.  In my model I use a column called “mitigation”.  That is what we can do to reduce the risk.  It may be, for example, that we review the risk with an external advisor or with our Finance department to see how the risk can be reduced.  Linked to this is the next column which I have called “Controls”.  So, for example, if we are concerned about inappropriate payments being made from payroll we can have four eyes, or even six eyes sign off on non-regular payments.  Or, perhaps mandate a random sampling and checking of the payroll.  Again, our colleagues in external and internal audit can be of great help in designing controls on our key risk areas. 

Having appropriate key performance indicators is one approach to managing risk matrix issues.  We need to know and measure before we can attempt to control.   It is not possible to attach KPI’s to every reward process; but there are many that we can.  For example, we can look at attrition statistics, together with leaver interviews to deduct if pay levels are an issue and track this over time.  Payroll and pension payment errors are easy to use for KPI’s.

Many years ago when I worked for Ford Motor Company, everyone in the business, over a certain level or employed in certain key areas were required to undertake a course in statistical process control (SPC).  I suspect this may be a little old fashioned these days; but I found it a very useful way to look at error occurrences and decide if they were random issues or there was an underlying systematic problem that needed to be addressed.  KPI’s and SPC taken together are very powerful tools for spotting issues before they become (or as they become) problems.  Every organisation will have their way of managing risk, but having an organised systematic approach, from the very simple to the very sophisticated is a very good way to start on the risk management journey.

For me, the final part of the risk management mapping is identifying the risk owner.  Who has responsibility for the process in which there are risks?  This helps focus our attention on the whom as well as the what of stakeholder risk management.

Risk appetite

One of the other important outputs from risk mapping is to agree with management the risk appetite of an organisation.  What risks within the matrix are acceptable and which are unacceptable.  Risk is part of business and the costs of mistakes are again part of the cost of business.  The question arises as to how much cost (including indirect cost such as reputational damage) is an organisation prepared to “allow”?  What risks are completely unacceptable and need to be completely removed if that is possible or a willingness to spend more or less on mitigation of risk.  This is an area where a risk mapping in reward can add real value to a business.

Conclusion

The mapping of risk in reward is a key process.  It gives some comfort to management, auditors and regulators that we are aware of the risks of our activities and the steps we have taken to measure, control and mitigate as appropriate. 

The two frameworks, from Rosario Longo and my spread sheet based approach provide a very useful toolkit for a systematic approach to risk in reward and at least forms the basis for a comprehensive risk structure.

Risk mapping adds value to our activities and processes for the business as it both prevents unnecessary costs and contributes in a very positive way to the governance of our organisation.

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