Professional Documents
Culture Documents
Journal of
APPLIED CORPORATE FINANCE
Bankers Trust and the Birth of Modern Risk Management 19 Gene D. Guill, GPS Risk Management Advisors, LLC
University of Texas Roundtable 30 Marshall Adkins, Raymond James; Greg Beard, Apollo
Financing and Managing Energy Investments in a Low-Price Environment Global Management; Bernard Clark, Haynes and Boone;
Gene Shepherd, Brigham Resources; and George Vaughan,
ConocoPhillips. Moderated by Sheridan Titman, University of
Texas McCombs School of Business.
Why FX Risk Management Is Brokenand What Boards Need to Know to Fix It 46 Hkan Jankensgrd, Lund University, Alf Alviniussen,
Lars Oxelheim, University of Agder, and
Research Institute of Industrial Economics
Derivatives: Understanding Their Usefulness and Their Role in the Financial Crisis 62 Bruce Tuckman, New York University Stern School
of Business
Opaque Financial Contracting and Toxic Term Sheets in Venture Capital 72 Keith C. Brown and Kenneth W. Wiles, University of Texas
McCombs School of Business
Three Approaches to Risk Managementand How and Why 86 Niklas Amberg and Richard Friberg, Stockholm
Swedish Companies Use Them School of Economics
Are U.S. Companies Really Holding That Much CashAnd If So, Why? 95 Marc Zenner, Evan Junek, and Ram Chivukula,
J.P. Morgan
Seeking Capital Abroad: Motivations, Process, and Suggestions for Success 104 Greg Bell, University of Dallas, and Abdul A. Rasheed,
University of Texas at Arlington
The Beliefs of Central Bankers About Inflation and the Business Cycle 114 Brian Kantor, Investec Wealth and Investment
and Some Reasons to Question the Faith
Risk Managementthe Revealing Hand
by Robert S. Kaplan, Harvard Business School, and Anette Mikes, HEC Lausanne
he combination of financial reporting transgressions the expected consequences from risk-taking behavior. Most
Private Bank Role of risk function: Business partner and compliance champion
Scope and skillset of CRO (expert, devils advocate but not decision maker)
Mikes A., Rose C. S. & Sesia A. Action-generation by
(2010). J.P. Morgan Private Bank: +tools: risk models and sensitivity analyses
Risk Management during the +processes: face-to-face meetings with traders, weekly asset allocation meetings
Financial Crisis 2008-2009. +culture of individual autonomy in risk perception (everyone must have a view)
Harvard Business School Case. +dual risk function includes embedded (business partner) versus independent (compliance) risk
managers
Corporate Bank (Wellfleet, Role of risk function: Business partner and compliance champion
pseudonym) Scope and skillset of CRO (expert, devils advocate but not decision maker; compliance champion)
Action-generation by
Mikes A. (2009). Risk Management +tools: risk models and sensitivity analyses
at Wellfleet Bank: All That Glitters Is +processes: face-to-face meetings with relationship managers, credit approval chain, credit risk
Not Gold. Harvard Business School committee
Case. +culture of powerful risk voice
+dual risk function includes embedded (business partner) versus independent (compliance) risk
managers
Retail Bank (Saxon Bank, pseud- Role of risk function: Business partner and compliance champion
onym) Scope and skillset of CRO (devils advocate but not decision maker; compliance champion)
Action-generation by
Hall M., Mikes A. & Millo Y. (2015). +tools: scenario planning
How Do Risk Managers Become +processes: face-to-face, quarterly performance reviews
Influential? A Field Study of Tool- +culture of individual responsibility for action-generation (star chambers with CEO)
making in Two Financial Institutions. +dual risk function combines embedded (business partner) and independent (compliance) risk
Management Accounting Research, managers
26, 3-22.
Investment Bank Role of risk function: Business partner and compliance champion
(Goldman Sachs) Scope and skillset of CRO (devils advocate but not decision maker; compliance champion)
Action-generation by
Authors Interview with Chief Risk +tools: quantitative risk management enhanced by mark-to-market (fair value) accounting as an
Officer Craig Brodercik and Chief independent window to risk; expensive infrastructure (people and technology)
Accounting Officer Sarah Smith in +culture of respect for risk management, challenge culture: controllers have final say on valua-
New York, 4 February, 2010 tion, not traders
+ risk function works closely with accounting and asset management/traders
34. Pidgeon (1997); Vaughan (1999); Edmondson et al. (2005); Watkins and Bazer- 37. Turner (1976), p. 379..
man (2003). 38. Weick (1998), p. 74. We thank HEC student Jeannine Jeitziner
35. Roberto et al. (2006). for this reference.
36. Vaughan (1996); Edmondson et al. (2005). 39. Simons (2009, 2010).
Source: Quail, R. Defining Your Taste for Risk, Corporate Risk Canada. Spring 2012: 24-30.
settle, every single private law suit brought against the company. radar chart identifies a set of objectives and a targeted confi-
He was confidentbased on Mercks strong culture and value dence level associated with meeting each of those objectives.
systemthat even under the extraordinarily intrusive discovery Second, the management team chooses a target risk appetite for
rules during litigation, no Merck employee would be found to each of the companys major stakeholders on an ordinal scale
have ignored or suppressed scientific information suggesting that that is designed to be comparable across all dimensions. By so
Vioxx put its patients at risk. Merck ended up winning all of the doing, the managers acknowledge the reality that they cannot
litigation, either at trial or upon appeal. maintain equal risk exposure across their diverse constituents.
The FDA regulatory agency later judged that Vioxx could They must make trade-offs in time and resource commitments
be returned to the marketplace, reflecting the ambiguous nature among goals such as delivering high return-on-investment
of the evidence and the ability of consumers to make personal for shareholders, retaining and developing employees, build-
judgments between immediate and sustainable pain relief versus ing long-term customer relationships, becoming an excellent
a modest increase in cardiac risk. But Merck refused to reissue corporate citizen in local communities, and reducing the
the drug because putting patients first was such a core value.40 environmental footprint, beyond what is mandated to comply
Companies under pressure and facing ambiguous threats with regulations.
should rely upon strong belief and boundary systems, especially Hydro Ones risk appetite scale (see Table 2) and radar
their core values, to determine whose interests come first when chart shown in Figure 1 provide the visual representation of
difficult trade-offs must be made.41 This was precisely the situa- these trade-offs. The risk appetite scale enables managers and
tion faced by the groups NASA empowered to make decisions board members to discuss their willingness to compromise on
for the Challenger and Columbia missions. Firms reveal their any particular objective, should a trade-off become necessary,
actual risk appetite not when making boilerplate statements, expressing the strength of commitment and priority attributed
but when they have to act upon their underlying value priorities to the value or stakeholder group associated with that objective.
in truly testing situations under circumstances that force them The radar chart provides the mechanism for managers to discuss
to make trade-offs among their multiple stakeholder groups. and agree on adaptations of the firms risk appetite, as circum-
Some companies use a so-called radar or spider chart stances evolve, making clear the firms choices (as proposed by
to stimulate discussions and clarify beliefs about their risk management and ratified by the board). At periodic risk review
appetite.42 For each of the companys key stakeholdersinclud- meetings, managers can compare their actual decisions to those
ing customers, employees, suppliers, and regulatorsa risk espoused in their risk radar chart. In this way, the chart enables
40. Mercks chief competitor, Pfizer, with a very similar drug, Celebrex, and facing mons (2010), p. 4.
similarly ambiguous evidence, left it on the market after adding a black-box warning. By 41. Simons (2010), p. 4.
so doing, Pfizer shareholders thus avoided losing billions of dollars in profits, as the 42. Quail (2012).
Pfizer executives maintained their primary commitment to shareholder value. See Si-
Shareholder Return
Safety Safety
5 5
Technical 4 Technical 4
Innovation Customer Innovation Customer
3 3
2 2
Target Appetite
1 1
Employee Employee
0 Environment Relationship 0 Environment
Relationship
Exhibited
Appetite
Shareholder Return
Shareholder Return
Source: Quail, R. Defining Your Taste for Risk, Corporate Risk Canada. Spring 2012: 24-30.
managers to monitorand then decide whether to tighten or Mercks CEO at the time of the Vioxx scandal. Creating such
relaxits risk exposure among multiple constituents. awareness and confidence requires intrusive, interactive, and
To see how this might work in practice, lets return to the intensive debates about the organizations multiple values
case of the financial firm selling CDOs during the financial crisis. and stakeholders, the decision-makers attachment to each of
Suppose that its decision-makers had an active mental model (a them, and the potential long-term consequences from diffi-
mental risk radar chart) that visualized
Safety the firms core values cult decisions made at defining moments. The risk radar chart
and stakeholder objectives. Then,5when it had become clear that provides a summary of the conclusions from such debates and
the music hadTechnical
stopped, the decision
4
to sell soon-to-be-worth-
Customer serves as a continuous guide for management decisions about
Innovation
less CDOs would have triggered3 a discussion of the trade-offs the long-run consequences of difficult decisions.
Target Appetite
about to be made, and their likely 2
consequences both for the
short termEmployee
and beyond. Following 1 the decision, the mental or Conclusion
explicit risk radar
Relationshipchart of the firms
0 Environment
actual risk appetite would be The widespread failure of quantitative risk management
updated to show
Exhibited a greater willingness to put long-term trading- during the financial crisis should not be the death knell for
partner relationships
Appetite at risk relative to the firms risk appetite for quantitative risk-management models. Value-at-risk, sensitiv-
financial performance and, perhaps, survival.Revenue
Corporate Image
The decision
Growth
to ity analyses, risk maps, scenario planning, and risk appetite
quickly exit the CDO asset class before the anticipated market radar charts are important components of a firms risk-
decline revealed that the value of corporate
Shareholder Return survival superseded management practices. The models, however, should not be
the value of long-term client relationships. Other firms decided the soleand rarely even the most importantbasis for deci-
not to merely exit or hedge their subprime risk exposure but sion-making. They cannot replace management judgment.
rather to place a major bet by shorting the subprime market. They are best used to trigger in-depth, analytical, and rigor-
After the financial crisis, these firms were widely criticized and ous discussions among managers and employees about the
litigated. But these examples illustrate the difficult choices firms different types of risks faced by the firm, and about the dilem-
can face; they are complex dilemmas that bring tension among mas (financial and moral) involved in responding to them.
the firms commitment to serve its multiple and diverse stake- Used in this way, firms avoid the artificial choice between
holders, including its own financial interests. quantitative and qualitative risk management, allowing both
No Wall Street firm, to our knowledge, explicitly to play important roles in identifying and assessing risks, and
documented such trade-offs, nor would we expect them to then in making decisions and allocating resources to mitigate
have done so. But we believe that the Revealing Hand of risk the risks in a cost-efficient and moral manner.
management should make decision-makers aware of the poten-
tial conflicts of interests and moral dilemmas that are inherent in Robert Kaplan is Senior Fellow and Marvin Bower Professor of Lead-
their most difficult decisions and actions. The Revealing Hand ership Development, Emeritus at the Harvard Business School.
should also prepare decision-makers for the inevitable backlash Anette Mikes is Professor of Accounting and Control at the Univer-
that follows such defining moments43 and give them the confi- sity of Lausanne (HEC).
dence to defend those actions, as illustrated by the actions of
Mary Barth Kenneth French Donald Lessard Laura Starks Associate Editor
Stanford University Dartmouth College Massachusetts Institute of University of Texas at Austin John L. McCormack
Technology
Amar Bhid Martin Fridson Joel M. Stern Design and Production
Tufts University Lehmann, Livian, Fridson John McConnell Stern Value Management Mary McBride
Advisors LLC Purdue University
Michael Bradley G. Bennett Stewart Assistant Editor
Duke University Stuart L. Gillan Robert Merton EVA Dimensions Michael E. Chew
University of Georgia Massachusetts Institute of
Richard Brealey Technology Ren Stulz
London Business School Richard Greco The Ohio State University
Filangieri Capital Partners Stewart Myers
Michael Brennan Massachusetts Institute of Sheridan Titman
University of California, Trevor Harris Technology University of Texas at Austin
Los Angeles Columbia University
Robert Parrino Alex Triantis
Robert Bruner Glenn Hubbard University of Texas at Austin University of Maryland
University of Virginia Columbia University
Richard Ruback Laura DAndrea Tyson
Christopher Culp Michael Jensen Harvard Business School University of California,
Johns Hopkins Institute for Harvard University Berkeley
Applied Economics G. William Schwert
Steven Kaplan University of Rochester Ross Watts
Howard Davies University of Chicago Massachusetts Institute
Institut dtudes Politiques Alan Shapiro of Technology
de Paris David Larcker University of Southern
Stanford University California Jerold Zimmerman
Robert Eccles University of Rochester
Harvard Business School Clifford Smith, Jr.
University of Rochester
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