Thursday, April 25, 2013

Inhibiting Excessive Risk Taking by Executives

The Federal Reserve Board has been doing some arm twisting with U.S. financial services companies to adjust their executive compensation plans - and those plans are in fact being modified to cap bonuses associated with achieving performance goals.  These actions have their genesis in the financial crisis where it appeared that incentives could encourage excessive risk taking by management.  A Wall Street Journal article* notes “regulators are still looking at ways to lower risk in the banking system, even if it means interfering with private pay practices.”  This follows a similar trend in Europe and where some firms are considering increasing salaries to make up for less bonus potential.

These actions merit some thoughtful consideration within the U.S. nuclear industry.  While the Fed’s concern is excessive business risk, the analog in nuclear operations is safety risk.  Both go to ensuring that the “system” (banking or nuclear production) remain within controlled limits.  As we have noted in prior blog posts (July 6 and July 9, 2010), there have been trends for nuclear executive compensation to both escalate and include significant performance based components.  The increased salaries probably reflect competition for the best qualified executives and are indicative of the great responsibilities of nuclear management.  However the trend to include large short-term bonuses (comprising up to 60-70% of total compensation) may be indicative of the evolution of “nuclear generation as a business” and the large profit potential available at high capacity factors.  Whatever the nominal amount of pressure on nuclear executives to achieve operating goals, the presence of very large monetary incentives can only increase that pressure.  In a strong safety culture environment where perception of management’s priorities is central, incentive based compensation plans can easily create presumptions regarding the motivation for management decisions.  At least one nuclear utility has concluded that incentives were not appropriate and taken action to adjust their compensation plans.  We have advocated dialing back incentives in favor of more direct compensation.

It is also rather interesting that the Fed decided to step into the province of private compensation practices.  A similar initiative by the NRC seems unlikely given its reluctance to impinge on management performance in any manner.  As noted in our February 28, 2013 post the NRC has included some nominal but poorly focused language on incentives in its Safety Culture Common Language Path Forward.  This seems to indicate that the NRC believes incentives are or could be relevant.  The best approach may be for the NRC to become more intrusive - to determine if compensation plans have the potential to lead to excessive risk taking.  This would require the NRC to obtain compensation plan information from its licensees, characterize the extent and magnitude of performance based incentives, and consider the effect of such incentives in assessing specific operational issues that arise in its normal regulatory oversight activities.  Only if some relationship appeared would the NRC need to consider whether to take action similar to the Fed or other means to ameliorate risk taking.


*  A.Lucchetti and J. Steinberg, "Regulators Get Banks to Rein In Bonus Pay," Wall Street Journal (April 23, 2013).

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