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Section IV
Reward Risk Management
Underpinning concepts
Reward risk management has captured a broader public and political interest during the
last few years because of the alleged role rewards, and more specifically financial
rewards, have played in causing the financial services industry troubles emerged in 2007.
As a consequence of the severe effects that the financial crisis had caused globally,
Central Banks had to inject large amounts of money, also in the forms of some private
banks nationalization and part-nationalization, in the bid to hinder the drastic effects
triggered off by the downward spiral affecting the banking industry at the time.
The Commission of the European Communities (2009) even not overtly attributing full
responsibility to the financial sector negligence for the global financial crisis sparked in
2007 and 2008, openly avowed that the excessive risk taking at the basis of the
inappropriate remuneration practices prevalent within the banking sector had certainly
played a role and contributed to the significant losses recorded by many financial
institutions. The Commission also underscored the circumstance that financial services
institutions, rewarding short term profit, were basically prone to encourage dangerous
practices likely to provide benefits in the short-term, but exposing banks to substantial
losses in the long-term.
Turner (2009), after having underscored the lack of attention paid by both regulatory
bodies and financial services firms over the compensation systems, basically
encouraging risk, developed by the latter claimed that, albeit it was not possible to
determine their relevance, the wrong and improper compensation practices developed
within the financial sector had to a degree surely contributed to the burst of the
international financial crisis. Notwithstanding, he also posited that the reward systems in
place within the financial services industry certainly contributed to the financial crisis less
than the inappropriate approaches to capital, accounting, and liquidity management did.
Although the excessive risk taking practices, previously strongly characterizing the
financial services industry, can arguably have much wider implications over the
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effectiveness and appropriateness of reward systems, potential risks connected with
reward management are not limited to this (Chapman, 2010).
According to the Chartered Management Institute (CMI, 2010), the concept of risk is not
associated with the exercise of predicting whether an event will happen or otherwise, but
rather with the impact the occurrence of particular events can have over the attainment
of the organizational objectives. This definition is consistent with the ISO Guide
Vocabulary for risk management, which defines risk as the “effects of uncertainty on
objectives.”
A rather different definition of risk is provided by the Institute of Risk Management, the
Association of Insurance and Risk Managers and the National Forum for Risk
Management in the public sector which define risk as the ”combination of the probability
of an event and its consequences” (CIPD, 2009). Although the two definitions differently
consider the relevance of investigating the chances that an event might occur, both
definitions clearly highlight the relevance of the impact that some events might produce
on organizational planning. It can, hence, be concluded that the idea of risk is sorely
associated with the outcome and consequences, which can actually be either positive or
negative, that some events can produce over a business goal-attainment process.
The aim of risk management is basically to pinpoint, detect and investigate the risks to
which a business can potentially be exposed, determine the effects that these can
produce and identify the measures and plan of action which can be executed in order to
mitigate their impact over the business. Indeed, in the event occurrences should have a
positive impact on an organization – upside risk –, differently from the case in which
these are expected to cause a negative impact – downside risk –, employers will clearly
try to make the most of the circumstances. It transpires, by extension, that also events
likely to have a positive impact over organizational objectives need to be duly considered
and investigated.
In general, employers should not struggle to eliminate or prevent the likely effects
produced by every possible form of risk, in that this would be an objective virtually
impossible to achieve. Risk taking represents an inherent, essential and necessary part
of a business activity (CMI, 2010) whether organizations genuinely strive to innovate
and be competitive in the market. Being unable to timely and promptly exploiting
favourable circumstances, upside risks, would actually represent a massive risk of its
own (CIPD, 2009).
Reward risk management should be introduced within organizations, as an essential part
of reward management practices, in order to enable employers to assess, and eventually
review accordingly, the discrepancies between the way risks concerning reward
management are perceived, identified and fixed by employers and to consequently
identify the most suitable plan of action these should better develop in order to address
the identified issues.
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Reward risk management can hence be basically considered as a form of gap analysis
enabling reward managers and specialists, or more in general those in charge of reward
within a business, to effectively and successfully identify reward-related problems and
properly manage these. In order to bridge the gap, one of the main objectives reward
risk management have to pursue is represented by the need to thoroughly identify
reward-related challenges and avoid that some of them could not be timely perceived by
employers (CIPD, 2010), assessed and ultimately properly sorted out.
Reward risk, therefore, is not only associated with the processes aiming to set the
current issues, but it is first and foremost aiming at predicting and anticipating the way
to mitigate the negative impact risks are expected to pose to the organization. As
suggested by Chapman (2009), rather than taking a reactive approach to reward risk
employers and reward managers should adopt a proactive role regularly assessing and
reviewing the risks which could potentially arise from the reward systems they manage.
Indeed, reward risk definitely represents a crucial part or reward management insofar as
Trevor (2008, 2009) suggests that the practical role of reward management should
consist in mitigating risks associated with compensation systems management rather
than in helping employers to achieve competitive edge and maximise value. Yet, the
Author associates reward managers and specialists role with that of risk managers and
successful reward management with successful risk management, positing that further
research should be directed to investigate this aspect.
Although it can neither be agreed that the role of reward management should be
considered limited to risk management, nor that reward has little or even nothing to do
with business strategy attainment, the pivotal importance of reward risk can be taken as
axiomatic. Reward professionals need to take extra care with this aspect of reward and
do whatever they can in order to gain the required knowledge and expertise necessary
to properly anticipate threats and find appropriate solutions to the risks associated with
compensation and reward.
The impact of the contextual factor
Potential risks affecting reward systems can essentially derive both from the endogenous
and exogenous context. Reward managers and specialists in charge of this delicate and
crucially important activity in order to proactively approach the issue need, hence, to pay
careful consideration both to the internal and the external environment. Yet, some of the
risks apparently emerging from the internal context can indeed be rooted in events and
circumstances originated in the external environment.
Typical examples of external pressures over businesses reward risk management are
represented, for instance, by equal pay rules and by the legislation developments
causing the pension provisions costs to rise and potentially impacting the overall
employees’ as well as employers’ taxation.
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Indeed, also the increased costs of the benefits provided by organizations for their staff,
with particular reference to healthcare, wellbeing and insurance costs, can pose a serious
threat to employers in terms of reward risk management.
A likely menace to reward systems might also come from the labour markets, which, in
different circumstances, can put employers under serious pressure. Market pricing data
or, more in general, the comparison of internal rates of pay with those offered in the
external market, could reveal that the reward packages offered by competitors are by
and large higher than those an employer is capable or willing to offer to their employees.
This could in turn jeopardize the employer ability to attract and retain staff. New
entrants to the financial services industry, for instance, just a few years ago were
somewhat of obliged to offer the same types of rewards and to adopt the same approach
to the mechanism according to which these were paid as the others companies operating
in the sector in order to attract and retain quality individuals. Whether some employers
should have attempted to try and reverse the trend, this could have turn to be a serious
problem for these employers, with severe drawbacks: if they would have changed their
reward practices whereas competitors would have not, these would have been likely to
completely lose their capability to retain their talents and attracting new ones.
All the types of risks need to be carefully assessed and investigated by the employer.
Risks can reveal to be remarkably detrimental for businesses even though these are not
apparently likely to directly impact the organization from the financial point of view.
Some risks despite not producing direct and immediate financial negative consequences
can have a direct negative reputational impact on organizations, which in turn can also
potentially produce financial drawbacks.
The largest number of constraints and hence reasons for concerns over reward systems
are anyhow coming from the internal environment:
The inability of reward managers to implement effective reward systems for lack
of the required funds, especially during recession, downturn and slowdown
periods;
Systems perceived as unfair by staff;
Types of rewards do not appreciated by individuals;
Line managers incapability to consistently execute rewards practices and having
limited, if any, knowledge of the organization reward system;
The resistance offered from Unions to the effective implementation of the
intended reward strategy;
are just some examples of the different pressures coming from the internal context
having a potentially remarkable negative impact over reward systems.
As anticipated above, some of these negative factors, albeit generated from within the
concern, can actually derive from the exogenous context. For instance, the fact that
some types of rewards, especially benefits and perquisites, could no longer be perceived
as useful and appreciable by individuals, could be due to the technological advances
accounting for employees no longer perceiving a given benefit as attractive. Indeed, also
the general financial and economic outlook can contribute to change employee
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perception of rewards. During downturn periods employees might possibly prefer
benefits and types of rewards enabling them to reduce their regular spending rather than
perquisites considered as status symbols.
Findings of the CIPD Reward Risks Annual Report (2011) revealed that current major
concerns amongst reward practitioners and consultants about reward, regardless of the
rank of each identified risk, were identified with the following items:
Employees don’t appreciate value of total reward offering,
Reward not engaging employees,
Unable to increase pay levels due to budget constraints,
Employees don’t understand performance and behaviour requirements,
Incentives not motivating,
Inability to communicate desired performance and behaviour,
Inability to change reward practices quickly,
Reward is not perceived as fair,
Increasing pension costs,
Line managers have poor understanding of reward.
The latest investigation (CIPD, 2012) also revealed that for the next two years, still in
terms of reward risks, employers are mostly concerned, in order of importance, about:
Attraction and retention of key employees,
Pension cost management,
Budget constraints,
Misaligned reward and business strategy,
Incentives not motivating,
Understanding of performance and behaviour requirements,
Legislative change and compliance,
Employee reward understanding,
Reward discrimination – equal pay.
The two investigations actually provide a rather comprehensive list of risks to which
reward systems could be exposed. Clearly, businesses are different one another and
some firms can actually be more subject to experience some kinds of risks rather than
others. Anyhow, the enumeration of all of these issues can help employers to gain an
insight of the different types of internal and external risks to which their businesses
might be exposed and better detect and deal with them.
The different forms of reward risks
As discussed in the preceding paragraph, reward risks can arise both from the internal
and the external environment, but in order to properly analyse risks and manage them
effectively a more specific and detailed risks classification is definitely required. The CIPD
(2009) proposes a categorization, based on the findings of its research, according to
which reward risks can basically be grouped in seven main categories: strategic,
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Reward Risk Management
behavioural, financial, operational, implementation and change management, legal and
ethical and governance risks.
Strategic reward risks
This group of risks mainly includes all of those risks having an impact on the
organizational objectives attainment process. More in particular, this category is
concerned with risks which could derive from the misalignment of the reward system
developed within an organization with its business strategy, HR practices and
organizational structure.
Indeed, in order to achieve its intended strategy a business also need to rely on
individuals having the required skills and expertise; attraction and retention of quality
staff can consequently be considered too as part of the strategic risks an employer
should be ready to deal with. It is also included into this group of risks the reputational
risk, that is, the adverse media coverage which a business could undergone because of
its inappropriate reward system.
Behavioural reward risks
To achieve their intended strategies organizations do not only need individuals with the
right and necessary capabilities, they also need that these individuals genuinely
contribute to the organizational success and behave in the way the employer is expected
they will.
Behavioural risk grouping is therefore basically associated with individual behaviour and
perceptions. Reward systems need to induce discretionary behaviour amongst staff and
help stimulating individual innovation and participation. But this is not all, compensation
practices also need to be perceived as fair by staff and encourage individuals to perform
at the desired standards in order these to produce the expected results.
Financial reward risks
Personnel costs undoubtedly constitute the largest expense for each kind of organization,
employer concern that these costs are not dealt with effectively and efficiently is,
therefore, absolutely comprehensible and justified. Risks which can actually be
associated with employee reward widen from pension to healthcare cost management
and from excessive cost for employee benefits to offering higher than average labour
market salaries.
Can also be included into this grouping the risks associated with an organization
incapability to meet the reward packages payments agreed with employees because of
cash flow difficulties and the issues relating to lack of compliance of the pay system with
tax legislation. Indeed, in addition to the correct application of tax legislation, reward
professionals also need to ensure that tax legislation is also efficiently applied.
Operational reward risks
Are included in this category risks associated with reward decisions made on the basis of
unreliable data gathered in the relevant labour market. Clearly, whether benchmark data
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are unreliable at best and totally erroneous at worst, decisions made in theme of reward
systems developments will clearly be disastrous.
Operational risks are also very much associated with a defective and unreliable payroll
system. In broad terms, the basic foundations of HR are represented by the reliability of
a payroll system. Sometimes, even the entire function is tested and evaluated on the
basis of how effectively and successfully the payroll system is operated and administered.
The regular appearance of inaccuracies in employee salary slips is hardly leading to HR
taking a seat on the business board and risks associated with this aspect should, hence,
be seriously considered; not to mention the impact that they produce in terms of
additional work for the same HR function to implement the required adjustments.
The payroll system is also potentially subject to the risk of internal frauds, which
represents another good reason to monitor this risk very closely. It is worth stressing the
circumstance that these risks can actually occur also in those cases in which the payroll
is outsourced, which entails that, in such cases, a process enabling the employer to
control the