Managing Risk and Opportunity: The Governance of Strategic Risk-Taking

204 Pages·2014·1.07 MB·English

by  Torben Juul Andersen

Managing Risk and Opportunity

Managing Risk and
Opportunity
The Governance of Strategic Risk-Taking
Torben Juul Andersen
Maxine Garvey
Oliviero Roggi
1
3
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©TorbenJuulAndersen,MaxineGarvey,andOlivieroRoggi2014
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n PREFACE
Ourwaysmetinearly2010whentheWorldBankGroupthroughtheIFC
CorporateGovernanceUnitdecidedtoembarkonatrainingprogramon
riskgovernanceforboardmembersandseniormanagerswiththeaimof
promotinggoodriskmanagementpracticeslinkingcorporaterisk-taking
with strategic decision-making. In preparing this work, we combined
complementary insights from the corporate governance, corporate
finance, and strategic management fields in fruitful collaboration within
anacademicframespear-headedbyAswathDamodaran.Wetrulyappre-
ciateAswath’sengagementinthisdevelopmentprocessandhisgenerosity
in sharing ideas, models, and frameworks. Many of his perspectives are
apparentinthisbookandweacknowledgethisinfluencewithgratitude.
We also believe the current book has the potential to break new
ground through its unique triangulation of three academic disciplines
that seem to complement each other very well around the intensified
focus on strategic risk governance. Corporate governance considers the
fiduciary and forward-looking business responsibilities of the board,
corporate finance provides the foundation for the risk analytical tech-
niques with a strong logic for risk decisions, and strategic management
lays out the frameworks that consider responsive actions in a changing
risklandscapegirdedwithuncertaintyandunpredictability.
Thebookreflectsacollaborativeeffortamongusbornfromalongseries
of joint interventions although particular chapters are influenced by
primary contributor(s) as noted: Chapter1, Maxine Garvey; Chapter2,
TorbenAndersen,MaxineGarvey,andOlivieroRoggi;Chapter3,Oliviero
Roggi;Chapter4,TorbenAndersenandOlivieroRoggi;Chapter5,Torben
Andersen.TheIntroductionandPostscriptwereframedbyTorbenAnder-
senbutthemanuscriptinitsentiretywasstructured,discussed,andscru-
tinizedbyusall.
Itisourhopethatthisstructuredsummaryofthesejointlydeveloped
and practiced strategic risk governance guidelines will prove useful to
directors, executives, and managers who take an interest in shaping
effectivestrategicriskmanagementprocessesintheirownorganizations.
Copenhagen TorbenJuulAndersen
WashingtonDC MaxineGarvey
Florence OlivieroRoggi
June30,2013

OUPCORRECTEDPROOF–FINAL,5/4/2014,SPi
n CONTENTS
FIGURES xi
TABLES xiii
BOXES xv
Introduction 1
Risk-taking—afundamentalbusinessactivity 2
Strategicriskgovernance 2
Outlineofbook 3
1 Risk,RiskManagement,andRiskGovernance 5
Riskandrisk-taking 5
Upsideanddownsideofrisk-taking 7
Howpeopleperceiveandbehavewhencopingwithrisks 7
Corporategovernance 11
Corporategovernance:avoidinggreed,sloth,andfear 13
Riskgovernance 19
Riskgovernancevs.riskmanagement 20
Hazard,financial,projectrisk,andenterpriseriskmanagement 21
Traditionalriskmanagement(TRM) 21
Financialriskmanagement(FRM) 22
Projectriskmanagement(PRM) 22
Enterpriseriskmanagement(ERM) 23
Strategicriskmanagement(SRM) 23
Objectiveofriskgovernanceandriskmanagement 24
Roleoftheboardinrisk-taking 25
Riskaversion,policy,tolerance,capacity,appetite,culture,etc. 26
Riskappetitestatementsbytheboard 27
TheInstituteofInternationalFinance(2009) 29
TheInstituteofRiskManagement(2011) 30
TheSocietyofActuariesinIreland(2011) 30
TheCommitteeofSponsoringOrganizationsoftheTreadwayCommission 31
CasualtyActuarialSociety2012 32
Conclusion 34
OUPCORRECTEDPROOF–FINAL,5/4/2014,SPi
viii CONTENTS
2 Risk,Uncertainty,andProactiveRisk-Taking 35
Riskanduncertainty 35
Theriskenvironment 42
Sourcesofrisk 44
Dealingwithriskanduncertainty 47
Risk-returnmodelsinfinance 56
Thecurseofthenormaldistribution 58
MeasuringeconomicassetsunderRisk:RiskAdjustedValue 60
RiskManagement 62
StandardsandFrameworks 62
Conclusions 66
3 ValueBasedEnterpriseRiskManagementPractices 68
Theenterpriseriskmanagementapproach 68
Riskmanagementandenterprisevalue 69
Theenterpriseriskmanagementprocess 72
Riskpoliciesandobjectives 74
Riskassessment 74
Riskanalysis 75
Riskevaluation 88
Theeffectsofmarketimperfections 91
Risktreatment 91
Riskavoidance 92
Risktransfer 92
Riskdiversificationandotherpolicies 93
Riskretention 94
Monitoringrisks 95
Capitalmanagement,riskmanagement,andretainedrisk 96
Retainedriskandsuppliersoffinance 97
Thestandardmodel 97
Theinsurancemodel 98
Conclusion 99
4 ValueCreationThroughRiskManagement 101
Strategicrisk-taking 101
Risksincorporatedecisions 106
Individualcognitivebiases 109
Strategicrisk-takingandvaluecreation 113
Betterrisk-takingdecisions 128
Conclusion 131
OUPCORRECTEDPROOF–FINAL,5/4/2014,SPi
CONTENTS ix
5 TheStrategicRisk-TakingOrganization 132
Organizingstrategicrisk-taking 132
Problems,risk,anduncertainty 134
Respondingbyuseofrealoptions 142
Realoptionsdevelopment 144
Thevalueofrisk-takingoptions 149
Organizationalconcernsinrisk-taking 150
Riskmanagementculture 153
Corporateriskculture 153
Aligninginterests 156
Engagingtherightpeople 156
Incentivesforgoodrisk-taking 157
Ariskcultureintunewithrisk-taking 157
Integratingriskanalysisinstrategicdecision-making 158
Operationalriskmanagementandcontrol 159
Monitoringtheriskprofile 161
Conclusion 162
Postscript 164
BasicElementsofGoodRiskManagement 165
APPENDICES
APPENDIX1GOODRISKCOMMITTEEPRACTICES 169
APPENDIX2THECAPITALASSETPRICINGMODEL(CAPM) 174
APPENDIX3ASSESSINGTHESTRATEGICRISKGOVERNANCEENVIRONMENT 176
REFERENCES 177
INDEX 185