Corporate Risk Management Decisions - Essay Example

CORPORATE RISK MANAGEMENT IN PRACTICE – CRITICAL REVIEW Introduction “The art of corporate risk management is to identify risks specific to an organisation and to respond to them in an appropriate way.” (Merna & Al-Thani, 2011, p. 2). This means that corporate risk management is a system through which a firm uses a proactive approach to examine important matters that can impede the operation of the firm. Risk management is about defining a set of concerns that a firm must continuously look out for and adjust the firm in order to prevent these concerns from adversely affecting the firm in its operations (Chew, 2012). Evidence indicates that firms around the world spend trillions of dollars each year to conduct corporate risk management and most of this money goes into the pockets of top-level executives of the largest corporations (Culp, 2012). This paper examines the elements and features of corporate risk management decisions and what they entail. It will critically evaluate the various costs and benefits related to corporate risk management decisions. And this will come through the examination of the direct and indirect benefits of risk management decisions in the corporate world. Corporate Risk Management Decisions Corporate risk management decisions “are decisions made by the utilisation of specialised market expertise in functional units while assuming a longer-term company-wide risk perspective aimed at addressing the net exposures rather than addressing individual company risks at every point in time” (Andersen & Schrøder, 2013, p. 118). This implies that risk management decisions are made within the framework of examining serious corporate risks and issues and this is done by taking into account all the views and needs of the strategic business units of an organisation. This enables a firm to position itself in a situation whereby they can plan for the entire organisation and over a longer-term horizon as opposed to taking individual decisions for individual functional units. Risk management decisions are made by factoring in various ideas and concepts relating to a firm and this includes important choices relating to stakeholder views and other matters of relevance and importance to a given situation or set of variables for the executives of a given firm (Chew, 2012). This typically includes the integration of financial and risk issues in order to take a unified decision that will ensure the growth and survival of a given organisation. Corporate risk management decisions are not made in vacuum, rather, they are made on the foundation of an established and functional enterprise risk management infrastructure that is set up as part of corporate governance in a company (Batten, MacKay, & Wagner, 2013). An enterprise risk management system is usually set up and maintained by the topmost managers and top executives of a firm and it is often done by the COSO framework to detect and deal with normal and popular risks that are most likely to happen to a firm (Fraser & Simkin, 2009). The COSO framework includes a set of 8-interrelated activities that evaluates the risk of the organisation and its environment and also evaluates important critical aspects that affect the operation and activities related to a firm (IMA, 2012). Therefore, most authorities argue that Corporate Risk Management decisions come in two main components: 1. Designing and Instituting a Risk Management framework; 2. Taking Decisions in relation to issues and matters that unfold (Culp, 2012). Clearly, the two stages and components of corporate risk management are interrelated. There is the need for a firm to set up and maintain a process through which the firm can be steered and ran and this must be done in a way and manner that ensures there is sensitivity to risks and potential threats to the operation of the firm. Therefore, the top management of the firm and the executives of the firm will have to decide and agree on a given approach and framework that fits the risk profile of the firm and implement it with stated objectives and roles to various employees and managers of the firm. When the decision on ERM strategy is taken it has to be monitored continuously. This continuous monitoring will typically be done in response to changes in the internal and external environment of the firm as well as market conditions. This will help the firm to detect issues and changes in the risk variables and decide on which course of action to take. Therefore, the first component allows a firm to decide on which approach to use to detect and deal with risks. The second component involves reviewing the existing system and taking decisions in the light of new information and new facts that are relevant to the firm. Direct Costs and Benefits of Risk Management Decisions Direct costs and benefits are the obvious and fundamentally observable costs and benefits that a firm accrues by making corporate risk management choices and implementing them. This includes the obvious benefits and costs that one can easily identify in a process of evaluating risk management variables and preventing or controlling risks. These are direct costs and benefits that are of a short-term or immediate nature. They help the firm to operate and it enables the firm to also gain the best of results and builds up the foundation for continuous improvement. Direct Costs The direct costs are incurred as and when management spend money to directly decide on risk-oriented activities that affect the operation of the firm. This includes direct costs that can be reasonably quantified and presented in relation to the risk management processes and systems. Executive Remuneration First of all, there is a cost of maintaining executives who are directly related to risk management decisions and choices. Central to this process is the Risk Committee which is often set up as part of companies’ corporate governance structure. The Risk Committee evaluates risks and it is made up of non-executive directors. However, these risk-oriented directors also work with executive directors as well as managers. The direct cost of maintaining such persons on the corporate governance team can be attributable to the cost of risk management decisions and choices. Consultancy Costs From time to time, a firm will need to employ experts to evaluate important activities and important costs. This will come with extra bills that the firm will need to handle in order to survive. Such expert advice and costs relating to risk management decisions and choices add up to the direct cost of running an organisation. Data Collection and Analysis Costs There is the cost of gathering data in order to evaluate and analyse risks. This is the process and the system through which there would be the gathering of data in an organisation in order to provide important information that can be used to gather information about trends on the ground. This includes financial information and other operational information that are presented in meetings and other forums where decisions are taken in relation to the approach and plan that can be put in place to help the authorities in a company to take decisions on how to manage their risks and deal with processes through a proactive and an appropriate manner. This includes information that is taken from various accounting departments and units in order to provide financial justifications and evaluation of information relevant to efficiency and effectiveness. The cost could be summed up to include the payment being given to the accountants and other preparers of information used in taking decisions. There are also times when a firm will need to go out and conduct research about the external environment. This might mean there will be the need for the purchase of reports and other forms of information that is important and relevant guidelines for the directors of a firm to take the right decisions concerning risks. Operation of ERM System: Implementation and Supervision Most firms have a running Enterprise Risk Management system that is used as a yardstick to protect the firm from these risks. This risk management system provides an active and responsive procedure that can be invoked on a routine basis to attain results in preventing losses and other negative situations and matters. However, the operation and implementation requires paying for some people and some groups of people to evaluate it. Also, most companies have an audit committee and monitoring committee that is to overlook the risk management system put in place by the firm. The decision-making and procedure of the firm will use feedbacks of these groups and helps them to analyse things and take relatively better decisions. Insurance & Preventive Costs In certain cases, the risk of a company has to be transferred to a third-party entity or group. And this includes the payment of the risk premium to third party entities who will ensure that they intervene in situations and matters whereby a loss actually occurs in the firm and there is the need for some kind of replacement to be made. The insurance premium is a direct cost for risk management decision processes. Direct Benefits Optimisation of Resources Reduction of Risks Continuous Operations Indirect Costs and Benefits of Risk Management Decisions Indirect Costs Executive Remeration in General Sacrifices in Profits Complicated Systems Stakeholder Benefits Indirect Benefits Survivability (Going Concern) Reputation Enhancement Fulfillment of CSR and Ethics Conclusion Read More