Risk Management: A Corporate Governance Manual

Abstract

As we sift through the debris of the last economic crisis, we are reminded again that most business disasters can be traced back to bad risk taking. In particular, when managers over reach and expose their businesses to the wrong type of risks or too much risk, investors in these firms (stockholders and lenders) bear the immediate cost, but employees, customers and taxpayers all suffer collateral damage. Of all the tasks that make up corporate governance, none is more critical than oversight of risk: Are the decision makers in the firm taking the right risks and the right amount of these risks, hedging the appropriate risks and allowing the correct risks to pass through to investors? In this manual, we aim to lay out the scope of risk management, by first defining risk and looking at how human beings react to risk in the first three chapters. We then look at measuring and dealing with risk in the next few chapters, by examining how risk measures have evolved over time and the different tools that we use to incorporate risk into decision making. We close the manual by arguing for a much broader view of risk management and its impact on the value of a business and by developing a template for building a good risk taking organization.

Each chapter begins by stating a theme for that chapter, followed by a brief examination of the key issues relating to that theme. At the end of each chapter is a set of tasks that can be used to convert the abstractions and propositions in that chapter to real world corporate governance tests/measures for any organization.

Keywords: risk management, risk hedging, risk aversion, corporate governance