Chapter 1 - The global risk environment

Question 1

Why do organisations take risks?

Answer 1

Risk is an essential part of any organisation and the management of risk is essential to help preserve and create value for stakeholders. Organisations must take risks that can yield positive benefits for stakeholders, and reduce risks that could cause financial or physical harm.

Question 2

How do stakeholder groups ‘invest’ into a company?

Answer 2

Their time, skills, money or something less tangible, such as their health and wellbeing.

Question 3

Give examples of the types of returns a stakeholder should expect

Answer 3

employees expect organisation to remain in business to ensure they are paid and kept safe at work, creditors are concerned that a company remains solvent to ensure that loan capital is paid back with the agreed rate of interest.

Question 4

Outline three reasons why shareholders may not behave in a risk-averse way

Answer 4

1. Asymmetric returns - the gain realised from the move of an underlying asset in one direction is significantly different from the loss incurred from its move in the opposite direction – more motivated for risk because of the return compared to normal stakeholder with no shares
2. Limited liability – cannot be forced to provide additional funds
3. The diversification of risk – can insulate their investment portfolio from company-specific risk events such as fires, fraud or a decline in sales i.e. ‘do not put all your eggs in one basket’

Question 5

Following the financial crisis, what happened to Northern Rock?

Answer 5

Banks stopped lending to each other - Northern Rock could not get any loans from other banks - consequently, shareholders withdrew their investments and this led to insolvency

Question 6

Outline three reasons why shareholders value effective risk-management

Answer 6

1. Ethical concerns - desire to protect employees and third parties from harm
2. Bankruptcy costs – reduces the chance of shareholders getting any repaid capital – therefore better to take risks
3. Cash-flow fluctuations – can be very disruptive – large fire causing unexpected loss could mean insufficient funds to invest in profitable opportunities.

Question 7

Outline the benefits and disadvantages of risk-management regulations

Answer 7

Benefits of risk management regulation
1. Helps mitigate market failures and protect stakeholders from excessive risk exposure
2. Enables growth and helps stay competitive
3. Avoid catastrophic events
Costs of risk-management regulation
1. Excessive costs due to over-regulation or over reduction of risk
2. Compliance costs – maintaining a compliance function and providing information to regulators

Question 8

Why does risk-management regulation exist?

Answer 8

1. The problem of self-regulation – hard to sustain because of the limited incentives to enforce such an agreement. The UK Code 2018 has elements of self-regulation
2. Market-failures – information is needed – can lead to:
   a. Asymmetric information – problem of opportunism – exploit a customer’s lack of prior information by making a product less safe and saving money but exposing customer to risk
   b. Public goods problem – e.g. environment – organisations may make decisions which harm the environment but benefit itself

Question 9

Why are international regulations and standards relating to risk management required?

Answer 9

International regulations and standards are required because risk exposures often cross national boundaries. Major risks to public goods, such as the environment and the financial system can have far-reaching effects.

Question 10

Outline some international regulation in relation to risk management

Answer 10

1. Corporate governance – G20/Organisation for Economic Co-operation and Development (OECD) 2015 Principles of Corporate Governance – worldwide benchmark for good corporate governance – promote sustainable economic growth on a global level, ensuring that stakeholders are treated fairly and that organisations have cost-effective access to global markets.
2. Environmental regulation – air quality, water quality, waste management, etc
3. Global financial stability – Basel Accords – Basel III – internationally active banks – requirements relating to capital resources and risk-management practices. Their aim is to prevent financial crises through effective risk-management, but, if that fails, the capital resource requirements help to provide a financial buffer.
4. Health and safety - International Labour Organisation (ILO) – standards and code of practice – protecting people from work-related sickness, disease, injury, forced labour and child labour

Question 11

Outline some international risk-management standards

Answer 11

1. ISO 31000:2018 – provides guidelines for managing risk in all types of organisations, regardless of their size, activities or industry sector. This standard places greater emphasis on top management leadership in the creation and preservation of organisational value through risk-management
2. COSO Enterprise Risk-Management – Integrated Framework 2004 and 2017 – provide thought leadership on risk-management, internal control and fraud deterrence to help organisational performance and governance.
3. ISO 19600:2014 –– closely related to ISO 31000:2018 and is designed to help compliance-management practices. Guidance covers: