Quiz: 02: Relationship Between Risk Management and Corporate Governance

Relationship between risk management and Corporate
Governance
6/2/2020
Quiz: 02
Sabir Shah
SP17-BBA-011
RISK MANAGEMENT:
Risk analysis and risk management is a process, which enables the proactive understanding and
management of individual risk events and overall risk, optimizing success by minimizing threats
and maximizing opportunities and outcomes.
Importance of risk management:
A company can save money to secure its futures by adopting a risk management strategy by
understanding the multiple possible threats or incidents before they arise. This is because a
comprehensive risk reduction strategy would help a business develop policies to prevent future
risks, mitigate their effects should they emerge and deal with the outcomes. This awareness and
management of risk encourages companies to have more trust in their strategic decisions. In
addition, better corporate governance standards, which explicitly focus on risk management, will
help an organization achieve its goals.
Many Risk Management opportunities include:
 Creates a healthy and comfortable working climate for both staff and customers.
 Increases operational stability while also decreasing legal liability.
 Provides insurance against events, which affect both the business and the environment.
 Protects all individuals and properties involved from any potential damage.
 Helps to determine the insurance needs of the company to save on needless premiums.
Relationship between risk management and Corporate Governance:
Instruments for risk assessment and risk management are difficult to hire and track. Knowledge
them also requires a clear understanding of mathematics and statistics. Consequently, it is not
obvious whether members of the audit committee will be able to track the in-and-outs of
reporting and even the speculations posed to them, mostly in short and very overview form,
without any formal experience. For example, nine relevant topics were included on the agenda at
the Enron audit committee meeting on February 12 2001, two of which were related to risk
evaluation and risk control. The conference had lasted 85 minutes! Even though the committee
consists of leading experts in management and university studies, it is doubtful that any of these
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issues might have been discussed in detail, particularly those relating to transactions that may
have seemed dubious or tinged with conflict of interest concerns. It is now well established that
issues of risk management will lead to conflicts of interest between corporate executives and
shareholders, especially when executives are remunerated with the stock options of their
company. Take the example of gold mines risk control, which has been a topic of extensive
research for many years. The key random variable correlated with firms ' financial risk in this
sector is the sale price of one ounce of gold. The three key questions consistently raised by the
mining industries' executives are
• Will the sale price be hedged against potential fluctuations?
• If so, to what proportion?
• And with what tools?
It is now established that one of the main goal of risk management is to maximize the firm’s value or
shares. However, risk management can also serve to maximize the well-being of executives and this
second objective can be in conflict with the first, especially when the executives in question are
remunerated to a significant degree with stock options. This type of conflict can produce problems of
governance. Indeed, Tufano has observed that, in the North American gold mining industry, executives
remunerated in stock options undertake fewer risk management activities that those who are not . This
finding can be explained by the fact that the value of executives’ options will increase with the volatility
of shares or with the volatility of the firm’s value. Even if managers are risk averse with respect to their
own wealth, they are risk leaning towards the firm’s value when they hold stock options in the firm they
manage. This is what explains their decisions to engage in fewer risks management activities, since such
activities would reduce the volatility of the firm’s value and, thus, the value of their options. Carpenter
has recently presented a theoretical counter-argument in the literature. According to this author. Holding
options has two consequences for the wealth of executives. The first is the one reported above: The
wealth of managers will increase with the volatility of options because the value of the latter will increase
accordingly. The second argument is that the value of the options portfolio will drop when shares fall in
value because the probability of exercising the options will also decline. We thus have an ambiguous
relationship between holding options and risk management, but the empirical results mentioned above
seem to confirm the dominance of convexity of preferences among managers and the source of conflict of
interests between executives and shareholders. Finally, another study shows that firms most active in
hedging against risks are those that have the largest number of external directors on their board; however,
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these authors did not check whether these directors were independent. These results call into question the
composition of the risk management committee appointed by boards, as the stock options of firms on
whose boards they sit may also be held by more than a few directors. This is a crucial issue, as the board
of directors will authorize and track general risk management policies. The risk management committee
should also be comprised, in our view, of knowledgeable and autonomous directors and, above all, of
directors who have no options to purchase the stock of the company! It is not clear that merely controlling
the makeup of the audit committee would be enough to curtail possible conflicts of interest associated
with risk assessment and risk management, especially in firms with a committee dedicated to these tasks.
Governance is essentially a guidance system aimed at achieving objectives i.e. it is objectives-focused.

Risk management is an essential element and the following statements outline the relationship between
risk, control, strategies and governance —
• An organization is a group of people working together to achieve objectives and is multi-layered.
• Objectives are the results or goals set by the organization and are multilayered with alignment of
objectives and organizational layers.
• Risk management develops risk treatment plans that are at the same time the controls and strategies
associated with each objective. Risk management is therefore part of each objective at all levels of the
organization and is multilayered by this alignment to objectives.
• By associating the management of risk with objectives at all levels of the organization it becomes fully
integrated as an enterprise-wide system.
• Risk management develops the control environment and provides reasonable assurance that
objectives will be reached within an acceptable degree of residual risk. This is governance.
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Relationship between risk management and Corporate

Importance of risk management:

Many Risk Management opportunities include:

Relationship between risk management and Corporate Governance:

• Will the sale price be hedged against potential fluctuations?

• If so, to what proportion?

• And with what tools?

Governance is essentially a guidance system aimed at achieving objectives i.e. it is objectives-focused.

• An organization is a group of people working together to achieve objectives and is multi-layered.

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