Remove profit-based incentives: FINSIA

Profit-based incentives within the financial services industry should be eliminated given its detrimental impact on compliance and risk culture, according to a study.

Joint research by the Financial Services Institute of Australia (FINSIA) and Macquarie University showed profit-based incentives had an adverse effect on compliance within financial services firms, and where managers and staff were profit-focused and when incentives were linked to profits, compliance rates fall.

The study, titled ‘Are profit-based incentives compatible with a risk culture?’, which revealed links between risk culture, incentives, and the behaviour of financial services staff, also showed profit-based incentives did not markedly increase the number of profitable investments.

“Given the significant adverse impact on compliance noted above, the study supports the elimination of profit-based incentives currently being debated within the financial services industry,” the study said.

The study, where 300 financial services executives (all FINSIA members) participated in an experiment where they could invest in up to 60 transactions, showed the proportion of people who always complied with risk policy decreased from 68.6 per cent to 42.3 per cent when incentives were introduced, while fewer ‘bad deals’ were rejected (78.4 per cent of the bad deal versus 85.9 per cent).

The study also discussed profit framing, which is when workplace compliance with risk policy had a low priority compared with meeting profit targets and where non-compliance was common, and where managers rarely discussed risk policy but emphasised meeting budgets.

The study found when incentives were included without profit framing, the compliance rate per deal was 78.4 per cent. However, when profit framing was combined with incentives, the compliance rate dropped considerably to 63.7 per cent.

Macquarie Applied Finance Centre’s specialist in financial risk management specialist, Associate Professor Elizabeth Sheedy, said: “It reveals the impact of incentives and how signals from managers and co-workers affect organisational culture”.

“The study validates that risk culture is an important determinant of compliance behaviour effected by incentives and the behaviour of managers and co-workers.”