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Risk Management Essentials From Practice to Process

 

  1. Lack of a risk focused approach. Although this has been changing over time, there has been a lack of risk awareness at the executive level in a number of organizations in the past. Especially in the near recent past, there has been a much greater risk awareness (a 40% drop in the stock price that renders stock options worthless will do that), but during the build up of euphoria over the past couple decades has been brought on in large part by the gross neglect of proper risk management processes.
  2. Initial Cost. A good risk management strategy requires a significant amount of initial effort. Effective risk management is not a tactical maneuver, its a strategic move made by an organization looking to maximize long-term organizational value. Short-sighted organizations don’t make these types of investments.
  3. Incompetence. A certain number of executives would be unable to execute an effective risk management plan under any circumstances. End of story.
  4. Adherence to the ostrich principle. In some cases, the management executives prefer to ignore risks and hope bad things happen to somebody else. Think happy thoughts!
  5. Accountability. Proper risk management processes may expose significant deficiencies or material-weakness. This would require management to address known issues, as well as share this information with the shareholders. If a known material weakness is exploited, management must take responsibility. This may have social, legal, and monetary consequences for the management executives. It is far easier to feign ignorance then to deliver an effective risk mitigation strategy.
  6. Executive compensation structure doesn’t match long term objectives. Effective risk management should have a series of short term goals that are designed to deliver long-term value. In the case of many executives, this is a blatant conflict of interest. In the modern era of executive free agency, the goal of many executives is to drive the short-term stock price as high as possible and then ditch with the golden parachute while leaving the shareholders stranded. This is not a case of executives gone bad, this is a case of the board-of-directors lacking knowledge on how to create an incentive structure that rewards long-term results. This is the result of nearly twenty years of economic growth and prosperity that has enabled executives to move freely from one position to the next. The consequences for poor performance were the incredibly lucrative golden parachute, and a new equally lucrative position with a new employer, with a similarly short-sighted set of incentives designed to drive the near term stock price at the expense of future earnings. This hasn’t just affected executives, middle management incentives often are of the same short-sighted ilk. How many times has a product launched before it was ready because a management bonus was based on a predefined date? How many undeliverable sales promises have been made so that the quarter’s sales objectives are met? The examples are numerous, and the results are predictable. Enough said.
  7. Difficult to Measure. – There is currently not a well defined mechanism for measuring the real value of effective risk management.  In many cases, companies don’t have a large amount of historical information relating to loss events.  Insurance companies have been doing this for years, but most companies don’t track this information in a way that could provide measures of the true value of a recently implemented risk management plan.