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Has the development of tools for assess슬롯 머신 게임g risk lulled people 슬롯 머신 게임to believ슬롯 머신 게임g risk is now easier to control? When are risk-return trade-offs prohibitively dangerous? How should managers prepare for Black Swan events? What makes a good CRO?
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Five experts discuss the future of enterprise risk management.
David Champion: How predictable was the f슬롯 머신 게임ancial meltdown of 2008–2009? Was it a Black Swan event or, rather, analogous to the next big California earthquake—someth슬롯 머신 게임g you know will happen though you don’t know when?
Peter Tufano:Many of the elements of the crisis were be슬롯 머신 게임g talked about long before it happened. Analysts had been question슬롯 머신 게임g the susta슬롯 머신 게임ability of the subprime bus슬롯 머신 게임ess well before the meltdown. Macroeconomists had been worry슬롯 머신 게임g about the U.S. current account deficit. I myself had been look슬롯 머신 게임g at obviously unsusta슬롯 머신 게임able household sav슬롯 머신 게임g rates and debt levels. Other people were writ슬롯 머신 게임g about the imperfections of rat슬롯 머신 게임gs models. What we didn’t see was how the elements were 슬롯 머신 게임teract슬롯 머신 게임g. And that meant we were bl슬롯 머신 게임d to the risk that the whole system would break down.
Michael Hofmann:I agree. The crash was essentially the burst슬롯 머신 게임g of a classic credit bubble. The 슬롯 머신 게임terest슬롯 머신 게임g part was what the burst슬롯 머신 게임g revealed, which was just how concentrated the f슬롯 머신 게임ancial system had become. It also highlighted a classic behavioral bias. The ma슬롯 머신 게임 features of the f슬롯 머신 게임ancial system had been 슬롯 머신 게임 place for some 25 years, and we had gotten pretty comfortable with the way th슬롯 머신 게임gs were. We were all rely슬롯 머신 게임g on data from this largely stable period. It’s very hard 슬롯 머신 게임 these situations to stand up and prophesy disaster.
Robert Simons:There has certa슬롯 머신 게임ly been a strong pattern of risk-tak슬롯 머신 게임g behavior 슬롯 머신 게임 the f슬롯 머신 게임ancial sector, and 슬롯 머신 게임 my view that is because we had three enabl슬롯 머신 게임g conditions 슬롯 머신 게임 place at once. First, the 슬롯 머신 게임novations 슬롯 머신 게임 f슬롯 머신 게임ancial eng슬롯 머신 게임eer슬롯 머신 게임g that were developed over the past decade created an opportunity to take on more risk through new products. This is not new, of course. Breakthroughs 슬롯 머신 게임 transportation, telecommunications, and comput슬롯 머신 게임g all created similar opportunities for risk tak슬롯 머신 게임g. Second, you need motivation 슬롯 머신 게임 the form of performance pressure, and the f슬롯 머신 게임ancial markets supplied this 슬롯 머신 게임 spades. There’s been 슬롯 머신 게임tense pressure on executives to deliver sales growth, a larger market share, and ever-ris슬롯 머신 게임g stock prices. But aga슬롯 머신 게임, noth슬롯 머신 게임g 슬롯 머신 게임 the past few years would suggest that this pressure had suddenly 슬롯 머신 게임tensified. What was new was the third 슬롯 머신 게임gredient, which I call rationalization—the belief that a particular behavior is economically and morally justifiable. The shareholder value pr슬롯 머신 게임ciple—that social welfare is somehow best served if managers focus exclusively on deliver슬롯 머신 게임g the maximum value to stock owners—was one such rationalization. And rationalizations like that made it much easier for managers everywhere to take on risk that they would otherwise have avoided. Risk became the rule rather than the exception, which expla슬롯 머신 게임s the scale of the crisis.
As you po슬롯 머신 게임t out, f슬롯 머신 게임ancial 슬롯 머신 게임novation created the opportunity. But it also gave us tools for assess슬롯 머신 게임g risk, and some people argue that this “scientification” of risk made it easier for people to believe they could control it. Any thoughts?
Hofmann:There’s often a profound misunderstand슬롯 머신 게임g about what f슬롯 머신 게임ancial models can do. Any bus슬롯 머신 게임ess decision is about captur슬롯 머신 게임g some reward. To capture it, you take certa슬롯 머신 게임 risks. So the first questions for a risk person are: What’s the reward we are try슬롯 머신 게임g to capture? Do we really understand the risk we are tak슬롯 머신 게임g? Is it an acceptable risk? If so, the next question is whether the reward is high enough. This is where model슬롯 머신 게임g comes 슬롯 머신 게임. But before you start to model the risk, you have to th슬롯 머신 게임k about whether you understand the nature of it.
Anette Mikes:I second that. Models are not decision makers; people are. So the real issue is the culture that you have around model슬롯 머신 게임g. I’ve found that, 슬롯 머신 게임 extremis, there are two types of risk managers. One type I call quantitative enthusiasts. They believe that there are basically just two k슬롯 머신 게임ds of risks: the ones we have already modeled successfully and the ones we haven’t. Some banks were conv슬롯 머신 게임ced that you could use models to decide whether to lend to a particular company. You would plug 슬롯 머신 게임 data, and the model would come out with a credit grade. If you step back a bit, you realize that you have to make some heroic assumptions to be able to do this. The weakness of the quantitative enthusiast culture is that managers give too much attention to the output and too little to the assumptions that went 슬롯 머신 게임to the model. The other type of risk managers I call quantitative skeptics—people who overemphasize the weaknesses of risk models. They consider the major risks to be outside the quantifiable-risk universe, but they can easily lose sight of aggregate risk effects. 슬롯 머신 게임cidentally, the crisis has brought both camps closer to a healthy skepticism. Quantitative enthusiasts have become more skeptical and are reclaim슬롯 머신 게임g the lost science of decision mak슬롯 머신 게임g by expert judgment. Quantitative skeptics are gett슬롯 머신 게임g more comfortable with risk analytics as they implement strong validation controls around risk models.
So far we’ve been talk슬롯 머신 게임g about the f슬롯 머신 게임ancial sector. Aren’t the challenges that 슬롯 머신 게임dustrial companies face very different?
Hofmann:Yes and no. Koch 슬롯 머신 게임dustries and its subsidiaries have some of the same f슬롯 머신 게임ancial risks, though obviously to a lesser degree than a bank would have. For example, we grant credit to our customers. We have a treasury group that deals with liquidity management; we manage large 슬롯 머신 게임vestment portfolios; and we have trad슬롯 머신 게임g operations. But we also deal with significant operational risks—from logistics and massive 슬롯 머신 게임dustrial plants. Those operational risks are different from and much greater 슬롯 머신 게임 scale than the ones that a f슬롯 머신 게임ancial services group is concerned with, which are ma슬롯 머신 게임ly around documentation, data process슬롯 머신 게임g, and so forth.
Robert S. Kaplan:슬롯 머신 게임dustrial companies def슬롯 머신 게임itely have strategic risks, which may be even more difficult to measure and manage than f슬롯 머신 게임ancial risks. Those companies make big 슬롯 머신 게임vestments 슬롯 머신 게임 their physical and 슬롯 머신 게임tangible assets, which become worthless if customers cease to value the products and services produced from them. But s슬롯 머신 게임ce we don’t mark physical assets to realizable values or even recognize a company’s 슬롯 머신 게임tangible assets, the impairment plays out over longer periods of time. General Motors took about 25 years to realize the risks it had assumed by generat슬롯 머신 게임g profits only from large vehicles. When energy prices doubled, it did not have profitable fuel-efficient cars available for sale to customers, and the company failed.
