Corporate Governance and Risk Management: The Role of Risk Management and Compensation Committees

Abstract:     
This paper examines the role of compensation and risk committees in managing and monitoring the risk behaviour of Australian financial firms in the period leading up to the global financial crisis (2006-2008). This empirical study of 716 observations of financial sector firms demonstrates how the coordination of risk management and compensation committees reduces information asymmetry. First, we show that the compensation committee motivates risk-taking, revealed by the positive association with risk. In contrast, a large risk committee reduces risk-taking. Next, we show that firms experiencing increasing risk benefit from a compensation committee when directors are independent, have professional qualifications, industry and board experience and frequent meetings and a large risk committee. Finally, when a director is a member of both committees there is a positive association between risk and firm performance thus reducing information asymmetry between committees. A director with dual committee membership is able to oversee the association between the firm’s risk exposure and the proportion of risk-taking incentives in compensation packages. The findings have theoretical and practical implications for the current debate on how to improve the governance of financial institutions.

Number of Pages in PDF File: 39

Keywords: Corporate governance, risk management, compensation committee, risk management committee, firm performance

JEL Classification: M14, M4

working papers series