BIS says pay should not be linked to profits
Thursday May 12 2011 | 06:32 AM

The Bank for International Settlements has urged large firms to move away from remunerating employees based purely on their profits. 

Instead companies should look to implement economic efficiency measures such as risk-adjusted returns on capital, which take account of the number of capital risks that their activities are exposed to, it says in a report. 

This would see less risky activities that perform well being remunerated better than activities which raise similar profits but at a higher level of risk.

Published on Thursday, the aligning remuneration of risk and performance report also calls for firms to consider using performance predictions to help judge the funds that should be set aside for remuneration. This would have to be based on its risk profile and strategy. 

However this method may prove less effective for new entrant firms whose predicted performances may be harder to judge, it adds.

The report discourages against basing remuneration purely on their economic performance, noting that this can create a "severe distortion" between short-term profitability and long-term outcomes. 

"For example, an employee that is paid a commission based on the number of mortgage loans made, where each loan is priced the same, could increase unit sales (and the employee's remuneration) simply by making a greater number of riskier loans. While this might be desirable from the employee's perspective, it exposes financial institutions to a high degree of 'un-costed' risk," it states.

"In general, firms should exercise caution when using operating efficiency measures to benchmark performance as such measures rarely capture the full range of risks which employees' activities pose for the firm.