Question

Identify why risk management can be beneficial to shareholders.

Answer 1

In todays constantly changing global business environment, a myriad of risks faces any organisation. As conducting business itself becomes increasingly complex, managing these risks and dealing with them adequately as and when they arise becomes vital.

But what is risk Ask yourself the question: What are the factors that could seriously inhibit your ability to achieve your business goals These then are your organisational risks.

In a business setup, the risks can be classified into business risks (relating to the economy, technology and competition); financial risks (relating to liquidity, interest rates, exchange rates and the misuse of financial resources); compliance risks (such as a breach of stock exchange regulations, non-compliance with accounting standards or company law, and non-compliance with tax or environmental regulations and any other governing statutory law or regulation); and operational risks (such as loss of assets, poor service levels, employee-related issues, or a shortage of raw materials).

And what is risk management Risk management is simply clear thinking leading to systematic development of realistic solutions to practical management problems. Helping the company to focus on risk management decisions that maximise shareholder wealth is one of the major areas of concern in any risk management plan along with increasing the company's understanding of its overall risk portfolio and providing management with a better perspective on how the balance sheet, income statement and cashflow(s) would be affected if a loss occurred. In todays marketplace, improving shareholder wealth is central to business success, thus highlighting the role of risk management.

Risk management can now be considered a standard tool for each responsible and conscious manager, company director and board member.

The process of risk management constitutes the following steps:

• Identifying relevant risks in the organization

• Evaluating key risks

• Mapping and scoring of risk exposure to enable prioritisation of management action

• Quantifying risk exposure in terms of impact and likelihood

• Establishing a companys risk appetite given its overall corporate strategy

• Developing a risk management framework and implementing effective infrastructure and process

The necessity for risk management also arises from the legal requirements to continuously control risk of the company's assets as mentioned in various legislations for instance the Sarbanes Oxley Act in the United States, rules as outlined in 91 (2) of the German Stock Corporation Act and in the European legal standard ISO/ IEC 1799.

Perhaps, ignorance of risk management was one of the prime reasons, which brought the downfall of some large global corporations. As detailed in their manuals, these global corporations' internal guidelines for managing financial risk required board members as well as senior managers to evaluate the overall value at risk, yet in some instances it was found that key board members apparently were in the dark about many facts. Economists and insiders have been of the view that the downfall of many large corporations might never have happened had the directors on their audit committees followed the system of checks and balances outlined in these companies own risk-management rules.

As business leaders seek new ways to build shareholder value, they are discovering a connection between value creation and risk management. Many are realizing that risks are no longer just hazards to be avoided. Risk creates opportunity, opportunity creates value, and value ultimately creates shareholder wealth. The critical question now is how to best manage risks to extract that value. Efficient risk management can contribute to shareholder value enhancement by enhancing capital allocation and improving returns through value based management. Further, studies have clearly shown that risk reduction directly impacts future cash flows and in turn business valuations and shareholder value.

The role of internal audit in risk management has developed considerably over the last decade. In the UK, the publication of the Cadbury Report on corporate governance and the Turnbull Report on internal control have accelerated this process and it is now a well recognized fact that efficient risk management can help establish the right culture for your business which in turn will give you confidence in your people and systems to deal with the risks, should they arise.

The risk management function has a positive obligation to assess and respond to risks and to develop and maintain a continuing two-way dialogue with every stakeholder group. Its role is not to reduce the cost of risk, the mantra that has consumed the discipline for almost twenty years, but to enable an organization to build a higher level of confidence and trust within each stakeholder group.