Incentive compensation in many organizations has evolved over recent years.

Executive Summary

Management must manage. An incentive compensation formula will not be sufficient, argues Willis Re's David Ingram. Here, he describes the evolution of incentive compensation programs and uses examples to demonstrate why they will fail to align incentives with corporate goals. This applies to all corporate goals, including risk, according to Ingram, whose expertise is in ERM consulting.

What started with the intent to increase the alignment of top management with shareholder interests, later developed into a means of replacing partnership profit-sharing in investment banks. In the most recent evolution, it now competes with hedge fund manager type compensation.

The issue of aligning management and shareholder interest was identified as a potentially critical principal-agent conflict in the early years of the development of corporations in the 19th century. A common solution to this problem has been to include a significant amount of company stock in the incentive compensation plan. Plan designers reason that management members’ interests must be aligned with shareholders if they themselves are shareholders.

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