Managing Risk and Opportunity: The Governance of Strategic Risk-Taking PDF
Preview Managing Risk and Opportunity: The Governance of Strategic Risk-Taking
Managing Risk and Opportunity Managing Risk and Opportunity The Governance of Strategic Risk-Taking Torben Juul Andersen Maxine Garvey Oliviero Roggi 1 3 GreatClarendonStreet,Oxford,OX26DP, UnitedKingdom OxfordUniversityPressisadepartmentoftheUniversityofOxford. ItfurtherstheUniversity’sobjectiveofexcellenceinresearch,scholarship, andeducationbypublishingworldwide.Oxfordisaregisteredtrademarkof OxfordUniversityPressintheUKandincertainothercountries ©TorbenJuulAndersen,MaxineGarvey,andOlivieroRoggi2014 Themoralrightsoftheauthorshavebeenasserted FirstEditionpublishedin2014 Impression:1 Allrightsreserved.Nopartofthispublicationmaybereproduced,storedin aretrievalsystem,ortransmitted,inanyformorbyanymeans,withoutthe priorpermissioninwritingofOxfordUniversityPress,orasexpresslypermitted bylaw,bylicence,orundertermsagreedwiththeappropriatereprographics rightsorganization.Enquiriesconcerningreproductionoutsidethescopeofthe aboveshouldbesenttotheRightsDepartment,OxfordUniversityPress,atthe addressabove Youmustnotcirculatethisworkinanyotherform andyoumustimposethissameconditiononanyacquirer PublishedintheUnitedStatesofAmericabyOxfordUniversityPress 198MadisonAvenue,NewYork,NY10016,UnitedStatesofAmerica BritishLibraryCataloguinginPublicationData Dataavailable LibraryofCongressControlNumber:2013950541 ISBN 978–0–19–968785–5 Asprintedandboundby CPIGroup(UK)Ltd,Croydon,CR04YY LinkstothirdpartywebsitesareprovidedbyOxfordingoodfaithand forinformationonly.Oxforddisclaimsanyresponsibilityforthematerials containedinanythirdpartywebsitereferencedinthiswork. 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
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