The Institute of Internal Auditors has published a new practice guide to provide an overview of key executive compensation risks that should be understood before assessing whether the controls and governance over executive compensation and benefits programs are effective.

The risks could include financial reporting hazards. Excessive, illegal or unethical executive compensation and benefits could be misclassified or otherwise hidden within the financial statements. Operating or financial data could be manipulated to trigger incentive-compensation payments or artificially inflate the value of stock options.

Failure to effectively construct, communicate and, if necessary, defend executive comp and benefit strategies could also expose an organization to reputation-tarnishing challenges from shareholders, employees, the media, regulators and other stakeholders, the IIA warned. An organization’s reputation also could be negatively affected if stakeholders perceive that its programs reward failure or socially unacceptable behavior such as disregard of the environment.

If a compensation program is not competitive with those of peer organizations, key executives could depart, and the organization could be unable to attract replacements with comparable skills and experience, the IIA noted. The resulting leadership void could render the organization incapable of meeting the performance expectations of investors and other stakeholders.

Highly complex executive comp and benefit programs could trigger errors or fraud because calculating proper payments requires the effective operation of many in-house departments and systems. Poorly designed programs tempt management to take excessive risks, commit fraud, or engage in unethical behavior to gain compensation tied to the achievement of short-term performance targets.

The guidance, whose application is strongly recommended but not mandatory under the IIA’s International Professional Practices Framework, also provides audit approaches and considerations. The guide is available at http://www.theiia.org/guidance/standards-and-guidance/.

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