Once detecting operational risk conditions is in existence, we can think about deploying risk countermeasures. Could any CEO shark engineer himself some huge pay-off based on undisclosed benchmarks?
Frankly, yes and no. Yes, they could get away with it easily in the old days. General Motors was a classic example where the head of a modern corporation could do what he liked in the era of Roger Smith. Pressure from the board, CalPers and H. Ross Perrot eventually forced him out. More recently, NYSE chairman Richard Grasso was pressured into resigning after the resultant furore that erupted when his $140m pay package was made public. Was this a case of Kalashnikov risk management used successfully? Some would say with justification that the aggrieved Western shareholders are amateurish when it comes to reining in the wayward behaviour of boards and CEOs. The professionals in the Japanese mafia do it so much better.Western shareholders could well adopt this tactic as a last resort. The UK GSK and the US GM meetings do not even compare in skill. This is one of the positive role models of the Yakuza systematically ignored in the Western world. They could teach shareholders how to level the corporate playing field by disrupting the AGM. If they get continually fobbed off, then they could always shoot the directors one supposes.
Badgering and damaging leaders’ reputation certainly can have effect. Corporate governance is coming along slowly. It would arrive faster if we could borrow some of the Yakuza’s tactics in Western companies. In the meantime, we have the regulatory cogs slowly grinding around the Combined Code, Higgs Report and Sarbanes–Oxley to protect us.
The covering up of negative financial reports and losses are examples of corporate misgovernance to head off risk of reputation damage. The eventual cost on ongoing business may be greater where the fundamental causes of the original loss have not been remedied, but merely swept under the carpet until recurring later.
This behavioural trend increases systemic risk where greater eventual damage is vested upon the wider industry. We have already seen this in Lloyds insurance, where a nepotistic code of doing business with “our sort of chaps” represents a sclerosis risk that nearly blew the UK insurance industry. The more we ignore it, the more it can blow up in our faces.
These hidden losses and weaknesses make it more difficult to value a company and its assets. The persistent ramping of a company’s value, and the love of M&A to increase company size instantly, creates additional problems for investors in Western firms. It is a problem rooted in the modern business culture, much influenced by the USA.
The weaknesses inherent in embedded value methods are repeated and added to in US GAAP reporting. These need to be anticipated, adjusted for and fully understood before reliance should be placed on the results.
How to discourage the executives from acting in an irresponsible fashion?
Posts Tagged ‘business’
RISK COUNTERMEASURES
Monday, October 19th, 2009MORAL HAZARD
Monday, October 5th, 2009Investor risk is perceived as fear or underperformance, notably in losing the value of the original investment. Substantial benchmarking occurs, notably in the comparison of returns against inflation, stock-market and other industrial yardsticks. Similar executive peer-group pressure and benchmarking lead them to see who gained the highest award from the remuneration committee. Not all CEOs are intent on removing value from the company, a fine minority contribute by increasing investor wealth whether in share price or earnings per share.
The hazard remains that many CEOs are executive recruitment failures. They create negative shareholder return and blacken the name of the company. Reputational risk emerges as one of the more obscure risks, while being costly too. An incompetent executive seems to be excusable in the markets, certainly if we believe the newspaper accounts; being crooked is not. Either way, CEO tenure is usually short term, so CEOs may adopt the attitude: “Better clean up the company assets before they boot me out.”
We have seen that the Board of Directors is not always an adequate counter to the ego of the CEO and the wish for more M&A and self-aggrandisement. Non-executive directors, who are enlisted in a cabal to add to the existing yes-men on the Board, can never serve to deter the company from embarking on an unacceptably risky course. We need an essential set of conditions for successful corporate guidance.1
An appropriate range of multidisciplinary skills Power to ensure effective implementation of decisions Ability to undertake effective assessments of the soundness of decisions associated with projects
Suitably qualified and dedicated support staff for the collection and analysis of data
Otherwise, we are condemned with the dire corporate leadership that has steered so many companies on the rocks.
An incompetent or crooked CEO underperforms colleagues and rivals. The bottom line is either the profit level or the share price. They fail on both scores. Failure should destroy their reputation in the industry. While the CEO can inflict great damage upon the company, reputational risk decrees that the executive can be punished with the embarrassment of being summarily ejected. By then it may be too late. There are two subrisks operating here – stemming from:
an inept executive; a crooked executive.
What to do? Risk management becomes an empirical business study in corporate control. We have seen how risk comprises:
hazard; catalyst; result.
The shark has a large dorsal fin that alerts us to its impending attack. We have already detailed an AEW warning system to alert us to the adverse CEO choice.
There are various risk management techniques to shed light upon a dark corporate operational area. These can include more effective interviewing to bring unsuitable executive candidates under the spotlight. Another is to undertake a management review of the control structure for recruiting key staff.3 Redesign the audit processes to block potential fraudulent financial statements passing the accounting process.4
Compare this risk management arsenal against the risk of a fraudulent CEO. Fraud needs conditions:
1. motivation; 2. opportunity; 3. rationalisation
We deploy risk countermeasures:
1. Anti-fraud motivation measures – better training of staff and recruitment, screening and interviewing of new applicants, monitor HR performance at work plus instigate an effective ethics programmes.
2. Anti-fraud opportunity measures – better staff monitoring, accounts screening, external audits, limit IT systems access and raise security physical access limits.
3. Anti-fraud rationalisation measures – raise chances of detection, raise punishment levels to act as deterrent, lower expectations of profit.
Risk management is really about a logical sequence of tasks to protect the business investment. The enterprise risk management strategy or life-cycle could be outlined as the series of tasks.
I. Risk detection. II. Risk countermeasures.
III. Risk monitoring.