One way to make units internalize small-probability tail risks that senior management or risk managers may not see or understand is to hold a significant part of a unit’s bonuses in any year in escrow, subject to clawbacks based on the unit’s performance in subsequent years—a suggestion I made before banker bonuses became a political football.
But for how long? Till financial products resolve themselves (and tail risk gone completely)? Is this feasible? Will it distort behavior as well? I guess it could reduce the systemic risk, but the bonus is so small compared with the actual risk, the bonuses won't cover the shortfall. Still motivates traders to take huge risks because on average some will pay off big. Hold all in escrow until retirement? Won't happen. But even if it did, enough times the risks will luckily not materialize and they'll be able to cash in big.
