Risk Management of Publicly Listed Companies - Essay Example

Risk Management of Publicly Listed Companies Introduction There has been an increasing concern about the need for appropriate risk management and development of internal control systems in the publicly listed companies. The board of directors of public companies plays a very important role in mediating and mitigating the risks that are being faced by an organization. Corporate governance of an organization involves certain key variables like, risk policy, strategy, control and reporting. It has been documented in the existing literature that there are multiple levels of risk for an organization, which are strategic risks, managerial risk and operational risk. Over past few years, the concept of enterprise risk management has become essential in corporate world because it provides assurance to the entity’s management that business objectives are achieved. Sound risk management helps in reducing unacceptable variance in reliability. Secondly, it helps to build confidence among investors and stakeholders. Thirdly, it is believed that effective management of risk in organizations improves its level of corporate governance. Finally, effective risk management also supports adapting to changing business environment (Chitakornkijsil, 2010). Risk Management in Publicly Listed Companies Though the concept of risk management is equally important for both private and public enterprises, yet 53% of the CEOs feel that they have the required information to conduct risk management. 42% of the CEO’s incorporate these practices for mitigating strategic risks and 27% incorporate them in mitigating operational and management risks. Most employees also consider that the organization’s risk management practices are effective in managing potentially significant risks. After passing of the Sarbanes Oxley Act, a survey conducted on the board members of public companies has revealed that 40% of the board members did not have an idea about prioritizing risk for the company and developing an action plan accordingly (Fox, Bugalla and Narvaez, 2011). There is a wide body of literature that has studied the link of risk management with corporate governance. The study conducted by Sarens and Christopher (2010) had focused on the relation between corporate governance and internal controls in Australian and Belgian companies. The results from this research had shown that Belgian Corporate governance had a weaker focus on internal control systems of the organization than the Australian companies because guidelines regarding the controls are relatively inadequate in Belgian companies (Sarens and Christopher, 2010). Existing study in the related field indicates that risk management forms an integral part of corporate management. Many organizations have not been able to stay in business for a long time primarily because they had neglected the issue of risk management. The study conducted by Felton and Watson (2002 cited in Vassileios 2011) had shortlisted some of the measures, which are used by companies to manage their risks through improving the measure of corporate governance. This includes outlining the risks, measuring the risk exposure and updates the risk profile in a methodological manner. A number of empirical researches have been conducted ever since the global financial crisis so as to understand basic factors, which made it difficult for the board members to identify risks that their institutions were exposed to. The results from their study had reflected gross underestimation of liquidity risks, excessive focus on existing risk measurement rather than risk identification and excessive risks taken in leverages (Fox, Bugalla and Narvaez, 2011). These factors were responsible for collective failure of the financial institution. The board can be directly held responsible for neglecting these key factors for which organizations kept on mounting their operational and market risks. Identification of Levels of Risks Strategic risks are those, which affects validity of a company’s strategy for pursuing growth objectives. It can be suggested that identification and management of strategic risks play an integral part in proper assessment of risk faced by an organization. Based on this understanding, it has been suggested that the board should spend considerable time in identifying strategic risks. In order to conduct strategic risk management, a strategic risk profile and strategic risk assessment plan must be formed. The basic strategic risks for an organization involve rapid changes in the disruptive technology, which outpaces ability of the organization to change its operations accordingly. Also, rapid changes in the regulatory environment by the government affects publicly listed companies and their level of performance. Regarding operational risks, it can be said that the level of uncertainty surrounding availability of suppliers renders it difficult for organizations to effectively deliver their products. In case of public companies, the level of existing operations is unable to meet performance expectations regarding quality, cost and innovation of provision of services (Demidenko and McNutt, 2010). Furthermore, resistance to change exhibited by these organizations will adversely affect their ability to cope with changes in the business environment. Failure of corporate governance to take care of the risk management practices is one of the strongest reasons, which have been pointed out by researchers as the main cause for failure of organizations. Corporate Risk Assessment In order to assess the risk associated with corporate decisions, several approaches have been identified by organizations. The introduction of risk matrices has been one of such approaches, which help an organization to manage risks by identification of hazards in the organization. Risk matrices are an effective way of displaying “two variable relationships between likelihood and consequence that are considered to be the elements of risk” (Cox, 2008). The use of two dimensional matrices to recognize the risks is a very popular method, but it is not exclusive. The use of risk matrices to access the level of corporate risk is not only specific to certain countries, but also to sectors of a country, namely medicine, aerospace, agriculture, mining and construction. Risk matrices help in dividing risks into low, medium and high category. There has been extensive debate among researchers regarding the feasibility of risk matrices in identifying the level of risk because it is believed that judgments made on the basis of risk matrices are subjective and arbitrary. There are numerous complex psychological and social factors, which influence subjective decisions like, experience, understanding of the risk, control of the risk and social and cultural factors (Filippin and Dreher, 2004). It is because of these biases associated with the use of matrices that their role in assessment of risk is often questioned. The major problem that hinders their universal acceptance is the absence of any scientific logic in functioning. It has been argued that the multiplication of likelihood along with the consequence is a quantitative method, which is not understood by all. The matrix is inappropriate in categorizing the priority of each risk category and leads to introduction of risk reversal factors. This weakness is further compounded by inclusion of human bias in the process of judgment. The increasing concern regarding risk management has presently led most researchers to evaluate the role of board members in improving the model of risk governance. It is being increasingly suggested that there should be formation of risk committee boards, which should have a comprehensive understanding about oversight of the risk and formulate effective strategies to deal with it. It has been observed that risk governance has remained a relatively less important agenda under corporate governance. The main reason behind this is that companies still do not need to comply with the mandates of corporate governance in many countries, which has raised the issue of high-risk taking between them. One of the most popular approaches adopted by organizations involves a well-informed CRO that reports to CEO of the company, who in turn presents the risks clearly to the company’s board (Fox, Bugalla and Narvaez, 2011). There is one common consensus among all the studies that has been conducted regarding the role of board in managing risk. They all suggest that the role of board is crucial in establishing good governance. Good governance in turn ensures ethical values, responsibilities and codes that are important for creating a transparent risk management structure (Demidenko and McNutt, 2010). Conclusion This paper has focused on the issues of risk management in corporate governance. At the very onset of this paper, major benefits that can be accrued to the organization from effective risk management practices has been clearly described. A survey conducted on publicly listed companies show that though the idea of risk management plays an important role in their operations, yet the boards face a problem in implementing effective risk management practices, primarily due to lack of access to the required information, thereby failing to recognize the risks associated with them. It has been found that there exists a strong relationship between corporate governance and the process of risk assessment within an organization. This is because a large number of organizations have failed in the past mainly because their corporate governance had not taken the issue of risk management into consideration. The existing studies point out that identification of strategic risks is one of the most important organizational activities as this allows organizations to survive in the long run. The use of risk matrices for risk identification has become quite popular. Yet, the scientific validity of this method has been questioned. Reference List Chitakornkijsil, P., 2010. Enterprise Risk Management. The International Journal of Organizational Innovation, pp. 309-337. Cox, L. A., 2008. What’s wrong with risk matrices? Risk analysis. An International Journal, 28(2), pp. 497-512. Demidenko, E. and McNutt, P., 2010. The ethics of enterprise risk management as a key component of corporate governance. International Journal of Social Economics, 37(10), pp. 802-815. Filippin, K. and Dreher L., 2004.Major Hazard Risk Assessment for Existing and New Facilities. Process Safety Progress, 23(4), pp. 237-243. Fox, C., Bugalla, J. and Narvaez, K., 2011. An evolving model for board risk governance. [pdf] RIMS. Available at: [Accessed 24 June 2014]. Sarens, G. and Christopher, J., 2010. The association between corporate governance guidelines and risk management and internal control practices. Managerial Auditing Journal, 25(4), pp. 288-308. Vassileios, K., 2011. The Relation between corporate governance and risk management during the credit crisis. The case of financial institutions. [pdf] MIBES. Available at: [Accessed 24 June 2014]. Read More