medium · FRM Part 1 Foundations of Risk Management
A bank's internal audit department (third line) finds that the CRO and the CEO have a joint incentive compensation plan based on quarterly trading profits.
Why does this represent a critical governance weakness?
- It ignores the diversify-away property of idiosyncratic risk
- It compromises the CRO's independence to say no
- It creates a negative convexity in the firm's capital structure
- It violates the law of one price in equilibrium
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