Leveraging Risk Management

Effective risk management practices present a great opportunity for companies to enhance their financial performance. This is becoming increasingly apparent, as evidenced by the “2004 Protecting Value Study” undertaken by Harris Interactive on behalf of FM Global. This study of the world’s largest companies reveals several significant findings, including:

Divergent views about which risks pose the greatest threat to the bottom-line;

Differing opinions on companies’ abilities to protect top revenue sources; and

Consensus that risk management is becoming a board-level issue.

What are these risks? How much of an impact do companies think they could have on their revenue? Are companies adequately addressing them? Are stakeholders (e.g., investors, customers, employees, suppliers, business partners, etc.) aware of what companies are doing to manage such risks?

These are just some of the questions that were posed to hundreds of the world’s leading risk managers, financial executives (chief financial officers and treasurers), and investment professio- nals. Their responses prove somewhat surprising, very revealing, and critically important to business executives around the world. They also may raise other pertinent questions about the current state of business risk.

DIFFERENT PERSPECTIVES

Nearly 70% of risk managers and financial executives agree that, collectively, property-related hazards (e.g., fire/explosion, natural disaster, supply-chain and production-related disruptions) are “the top hazard” that would cause a major disruption to their companies’ top revenue driver (note: The study defines “top revenue drivers” as those assets that contribute most to corporate earnings, that companies are most concerned about protecting, and if affected by a major disruption, would have the greatest impact on their organizations’ financial gains).

In contrast, nearly 80% of investment professionals who analyze such companies feel that non-property-related hazards (e.g., pricing fluctuations, government or regulatory hazards, and management/employee malfeasance) represent the top threat to companies. There appear to be at least two possible reasons for the disparity of these findings: investment professionals either view companies as too internally focused on many of their hazards, or lack awareness of some aspects of the internal operations and hazards of the companies they analyze.

Digging deeper, the majority of risk managers and financial executives rate their companies as either “good” or “excellent” in their abilities to protect their top revenue drivers (investment professionals are on the fence in this regard). However, the corporate world may be contradicting itself on this issue, because a combined 60% of risk managers and financial executives also indicate that a disruption caused by a top hazard would either cause a “sustained hit to revenue” or “threaten business continuity”. Are companies as confident in their risk management abilities as they claim in the study, or are they overstating the extent to which a disruption would affect their business?

MISCOMMUNICATION?

The FM Global study also finds that most risk managers and financial executives (nearly three out of four) rate their stakeholders’ understanding of top company hazards as “good” or “excellent.” Interestingly, investment professionals hold a different view, believing that corporate stakeholders are unlikely to understand fully those top hazards.

Companies’ financial statements rarely contain substantial assessments of operational risks (e.g., the potential for property loss). However, they often contain details on legal or financial risks, which, typically, can be estimated and have an imminent, probable, and material impact on future revenue. So it should come as no surprise that more than half of the investment professionals polled note that the information contained in companies’ financial statements, and on which they base their analyses, is inadequate for them to make proper or meaningful assessments.

When investment professionals seek risk management information from companies, they typically discuss such issues with the chief financial officer (CFO) and treasurer who, while possessing a detailed perspective of strategic risks, may lack vital information about day-to-day operational risks faced by risk managers. While this may explain the glaring difference between corporate and investment respondents to the study, it also presents a valuable opportunity that risk managers may want to seize. They can do so by informing corporate officers that risk managers can be called upon to assist investment professionals who request more detailed information about the risk management procedures that companies are following to protect their top revenue drivers.

ON-BOARD

Amid all the disagreement, the study finds a promising piece of common ground. As much as they may disagree on specific risk management issues, nine out of 10 companies and investment professionals agree that risk management in general (i.e., identifying all business risks, managing those risks effectively, and raising the importance of such activities to the highest levels of an organization) should be a board-level issue. Interestingly, European companies appear to be making more progress (at around 93%) than their North American counterparts (65%) in elevating risk management issues to the board level. This may be attributed to European legislation requiring those companies to disclose their risk management activities.

The 2004 Protecting Value Study serves as a benchmark that risk managers and financial executives can use to elevate the importance of prudent risk management. The findings provide a framework for the beginnings of an important discussion at the highest levels of an organization. Based on the findings of this study, it is evident that a valuable opportunity exists for companies to enhance their financial performance.