The fundamental issue, of course, is understanding and managing risk. Any time a merger is considered, a new product concept funded or an investment made, success is never guaranteed. Over the years, business has become increasingly sophisticated in developing tools that can help in this analysis, especially in financial matters. Complex mathematical models were created to analyze potential outcomes and probabilities, based on past performance.
Yet, as has been widely reported in the media, many of these same models failed spectacularly to predict or prepare companies for the current global economic crisis, and major efforts are underway on Wall Street to fix these systems.
At the same time, experts at Wharton and elsewhere argue that too much blame is being placed on the risk management model and other tools of the trade, in banking and beyond. The models are not necessarily broken, but instead are only as good as the decisions that get made based on them, they say. As a result, the current crisis may represent an opportunity for companies to re-visit and re-think historical approaches to risk management. When it comes to planning for the future, the new thinking goes, it is not just the model that matters, it is the mindset.
Herring , a professor of international banking and co-director of the Wharton Financial Institutions Center. The first step is to get a fuller picture of risk.
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Most recent coverage of the global economic crisis and its origins, particularly from a risk perspective, has focused on the financial industry; the problems with identifying and measuring the risk in this sector kicked off the chain of events that brought the global economy to a near standstill. Some banks were dramatically more exposed to risks than they thought they were. But there is more than one kind of risk. Another category of risk that companies face — which is even more common — is operational. The delays Airbus encountered in the development of its super-size jetliner are a perfect example.
Over the course of and , Airbus pushed back the launch of the new aircraft three times, ultimately leading to the departure of its CEO and a projected earnings shortfall of more than 4 billion euros. Iridium, a company backed by Motorola, experienced an infamous failure related to operational risk. The high-profile satellite phone venture was launched in late with widespread media coverage, yet it failed within a year.
The company was not able to get enough satellites in orbit quickly enough, causing customer demand to fall far below expectations. The first is that traders, economists and academics think about risk very differently than do most business managers.
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For the former, the key issue in risk is variance — the expected spread of possible outcomes. But that is not how managers think about it. For them, the biggest issue in risk is the potential for loss. The second point is that risk management has no silver bullet. As a result, many companies need to develop a more integrated view of risk. For instance, in the financial world, you would see trading desks staffed with people who were experts in market risk, but they were trading instruments that were laden with credit risk. The skills you need to think about each of those kinds of risk are very distinctive, and unless you have an integrated view of risk, you could encounter major problems.
Nevertheless, risk taking remains what managing is all about, and not just in financial services but in every industry.
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Indeed, from an economic perspective, all firms fundamentally are in the business of taking risks based on their core capabilities. But you have to win more than you lose.
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Of course, we would like to have time to get all the information, but the reality is that managers have to make decisions under uncertainty, if not outright ignorance. To overcome the problem, Michel-Kerjan sees some companies moving beyond traditional risk management practices, which have largely been internally focused.
However, organizations need to look beyond the boundaries of the firm and consider what is happening elsewhere. Indeed, it is the systemic nature of the current crisis and how widespread the impact has been that caught most people by surprise. But historic data does not shape the future anymore, given how rapidly the world is changing.
We usually look at the known issues and make a nice diagram with probability on one axis and impact on the other. Risk Management 2. You can no longer look at the risks independently of each other.
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The key, Michel-Kerjan adds, is to have knowledgeable people in the organization who are looking broadly and challenging assumptions about the future. And then bring some data about that to prove to you that it is something the company has to think about. In addition, new techniques and technologies are now coming into the picture. Consulting firms also are stepping up efforts to provide companies with a more holistic, multidimensional view of their risks.
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Philippe Hellich, vice president of risks, control and audit at Danone, is already moving to the new model. Our approach is based on listening and challenging the operational management, common sense analysis, sound judgment and good governance at the top.
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We now have an effective working session with part of the executive committee twice a year. And we continue to rely on yearly updates of the risk maps of all major business units worldwide. In the last pages of the bestseller on risk, Against the Gods , Peter Bernstein anticipated the challenge many companies are facing today. Is practical and pragmatic: we do not want to create a bureaucracy, instead we are looking to help find solutions that can work for organisations of all shapes and sizes.
We have developed two guidance documents. An Executive Summary aimed at boards and a detailed guidance document for risk professionals. Or download a copy of the executive summary doc here. Read more. IRM chairman Richard Anderson, talks about the guidance paper. Jill Douglas, Head of Risk, Charterhouse Risk Management Risk appetite and performance While risk appetite is about the pursuit of risk, risk tolerance is about what an organisation can actually cope with. Guidance documents We have developed two guidance documents.
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