Understanding and Managing Risk Attitude

David Hillson

• Publisher: Routledge
• Year: 2017
• ISBN:
  9781351877060
• Edition: 2
• Topic: Betriebswirtschaft
• Subtopic: Industriemanagement

Despite many years of development, risk management remains problematic for the majority of organizations. One common challenge is the human dimension, in other words, the way people perceive risk and risk management. Risk management processes and techniques are operated by people, each of whom is a complex individual, influenced by many different factors. And the problem is compounded by the fact that most risk management involves people working in groups. This introduces further layers of complexity through relationships and group dynamics. David Hillson's and Ruth Murray-Webster's Understanding and Managing Risk Attitude will help you understand the human aspects of risk management and to manage proactively the influence of human behaviour on the risk process. The authors introduce a range of models, perspectives and examples to define and detail the range of possible risk attitudes; looking both at individuals and groups. Using leading-edge thinking on self-awareness and emotional literacy, they develop a powerful approach to address the most common shortfall in current risk management: the failure to manage the human aspects of the process. All this is presented in a practical and applied framework, rather than as a theoretical or academic treatise, based on the authors' shared experiences and expertise, rather than empirical research. Anyone involved in implementing risk management will benefit from this book, including risk practitioners, senior managers and directors responsible for corporate governance, project managers and their teams. It is also essential reading for HR professionals and others interested in organizational or behavioural psychology. This second edition is updated to strengthen the understanding of individual risk attitudes and reinforce what individuals can do to manage those risk attitudes that are leading them away from their objectives. For people who want to embrace this subject, the book highlights ways forward that are proven and practical.

Part 1
The Problem

Chapter 1
Risk Management Status Quo – Efficient but not Effective?

The Risk Environment

The Danish Nobel Prize-winning physicist Niels Bohr (1885–1962) rightly said that ‘Prediction is very difficult, especially about the future.’ And yet people constantly seek to look ahead in an attempt to see what might be coming, to prepare themselves to respond appropriately and to be best positioned for all eventualities. This is true of individuals, families, communities, teams, organizations, businesses and nations. Each tries in different ways to predict the future for their own advantage. This may be a unique characteristic of humans as we attempt to make sense of our environment and our place within it, since forward planning seems to be both an innate skill and a psychological necessity that features in nearly all human activity.

The key factor underlying the difficulty in predicting the future is the existence of uncertainty. As Plato (427–347 BC) realized, ‘The problem with the future is that more things might happen than will happen.’ With an infinite number of possibilities ahead, it is hardly surprising that the task of selecting the one which will eventually materialize is problematic. And as the time horizon of prediction extends further into the future, the number of degrees of freedom increases exponentially, further complicating the ability to predict. In the desire to increase predictability, considerable attention has therefore been paid to defining, understanding and managing uncertainty. Many philosophers, theologians and scientists through the ages have addressed this issue, taking a range of different approaches to the problem, and arriving at significantly different proposed responses and solutions. At one extreme is the suggestion that the universe is inherently unknowable, ineffable and ‘other’, so the search for understanding, certainty or predictability is futile. The other extreme holds that advances in human science and technology constantly reduce the scope of uncertainty, improving the ability to understand and predict the behaviour of the observed universe, and that ongoing discoveries will continue this trend.

It is neither possible nor desirable to detail here the full scope of the debate on the nature of uncertainty. It is, however, useful to distinguish two key elements which contribute to uncertainty, since these are fundamentally different, and require managing in different ways. These two aspects of uncertainty are variability and ambiguity.

• Variability refers to the situation when a measurable factor can take one of a range of possible values. The classic example is dice. Each die has six faces marked 1–6, and a throw always results in one side facing upwards. There is no doubt that the result will be one of the numbers 1–6, and the chance of any particular number resulting from a throw is one in six, but the precise value of the result for a given throw is not predictable in advance (assuming the die is fair and unbiased). This type of uncertainty is known as aleatoric, from the Latin alea (a game of chance using dice). The event is defined but its outcome is uncertain because it is variable.
• Ambiguity is defined on the other hand as uncertainty of meaning. It can be used about whether or not a particular event will happen at all, or whether something else unforeseen might occur. Here the issue is not the probability of an event producing a particular value from within a known range; instead there is uncertainty about the event itself, with lack of clarity over some aspect of its existence, content or meaning. This type of uncertainty is described as epistemic (from the Greek episteme, meaning knowledge), since there is incomplete knowledge about the situation under consideration.

Both variability and ambiguity must be recognized and actively managed if the task of predicting the future is to be attempted. These two types of uncertainty exist in all areas of life, and humans react to them in a variety of ways. Human behaviour in the presence of uncertainty is not always rational, but efforts can and should be made to understand the possible range of such behaviours so that they can be managed appropriately. This book aims to make a significant and positive contribution to creating such understanding by addressing the specific question of risk attitudes.

This introduces two more terms which deserve careful definition, namely risk and attitude. These are addressed in the next two sections.

What is Risk?

Risk is not the same as uncertainty, so how are the two related? The word ‘risk’ is a common and widely used part of today’s vocabulary, relating to personal circumstances (health, pensions, insurance, investments and so on), society (terrorism, economic performance, food safety and so on), and business (corporate governance, strategy, business continuity and so on). Yet, somewhat surprisingly, there is still no broad consensus on the meaning of this term. Various national and international standards and guidelines exist which mention risk, but there are many different definitions and underlying concepts in these documents. Even among risk practitioners in the various professional bodies there is an ongoing debate about the subject matter at the heart of their discipline. And of course there is huge variation in the general literature, reflecting the lack of official agreement on the basic definition of risk.

Despite differences of detail, all definitions agree that risk has two characteristics: it is related to uncertainty, and it has consequences. Risk, however, is not the same as uncertainty, whether aleatoric variability or epistemic ambiguity. The key distinction between uncertainty and risk arises from consideration of the consequences. Perhaps the simplest definition of risk is ‘uncertainty that matters’, since uncertainty without consequence poses no risk. In this sense, risk cannot be defined unless it is related to objectives of some kind.

A more complete definition of risk would therefore be ‘an uncertainty that could affect one or more objectives’. This recognizes the fact that there are some uncertainties that do not matter in the relevant context. For example a particular child may be taking an examination tomorrow with an uncertain (variable) outcome (that is pass or fail), but this has little or no impact on anyone outside the child, the family and the school. To most people the exam result is an uncertainty that does not matter, and so it is not a risk. Uncertainty (ambiguity) about whether or not it will rain heavily in Kazakhstan tomorrow is irrelevant to the majority of businesses or individuals, so this too does not pose a risk. If, however, the child is a Kazakh and his father has promised a fishing trip as a reward for passing the exam, both uncertainties become relevant in the context, and represent risks to the desired objective of going fishing tomorrow after a successful exam result.

Linking risk with objectives makes it clear that every facet of life is risky. All types of human endeavour are undertaken in order to achieve objectives of some sort, including personal and informal objectives (for example to be happy and healthy), project objectives (including delivering on time and within budget) and corporate business objectives (such as to increase profit and market share). Since the environment within which these human endeavours are undertaken is inherently uncertain, it follows that wherever objectives are defined, there will be risks to their successful achievement.

Defining this link between risk and objectives is essential to the process of risk management, since it is a prerequisite for identifying risks, assessing their significance and determining appropriate responses. It is also, however, a crucial factor in understanding risk attitudes, since these are driven by the objectives of the individual, group or organization concerned, and the extent to which the risk ‘matters’.

Another interesting trend emerges from the definition debate when the various official published risk management standards are examined. This also arises from the concept of risk as ‘uncertainty that matters’, since it relates to the nature of the consequence.

• Before 1997, all official published risk management standards used an exclusively negative definition of risk, with the term being synonymous with danger, hazard, loss and so on. In these definitions, risk was seen as ‘an uncertainty that could have a negative/harmful/adverse/unwelcome/bad effect on one or more objectives’, that is, risk equals threat.
• From 1997 onwards, standards publications started to appear which presented either a neutral risk definition of ‘an uncertainty that could affect one or more objectives’ (where the type of impact is undefined), or a broad definition including both downside and upside impact: ‘an uncertainty that could have a positive or negative effect on one or more objectives’. These give a definition of risk including both negative threats as well as positive opportunities.
• Since 2000 the clear majority of newly published or updated official standards relating to risk management have explicitly treated risk as including both threats and opportunities.

Although the definition debate is continuing and not all risk practitioners agree, adoption of a widened concept of risk seems to be growing. There is increasing awareness that risk management can and should be used to minimize the negative effect of downside threat-risks, while also attempting to maximize the positive effect of upside opportunity-risks, in order to optimize achievement of objectives.

For the purposes of this book, the broader definition of risk is used. This is not simply to reflect the current trend in the definition debate. It is also relevant to the subject of risk attitudes, since the perception of risk is a key driver of attitude to risk. Clearly people who see risk as wholly negative will have a different approach to it from those who are also aware of potential upside. The recognition of opportunities which can be proactively managed is a significant influence on risk attitude, and it can also provide a powerful motivation for attitudinal management and modification.

What is Attitude?

Attitude is another word used commonly but loosely, and in a book dealing with risk attitudes it is essential that this too is clearly defined. Dictionaries offer two differing definitions. The first relates to the inner working of the human mind, where ‘attitude’ is ‘state of mind, mental view or disposition with regard to a fact or state’. A second equally valid definition describes the positioning of an object in space, such as an aircraft, spaceship, or missile, where ‘attitude’ is said to mean ‘orientation of axes in relation to some reference plane, usually the horizontal’.

It is interesting to note that both definitions insist that attitude can only exist in relation to a datum point – either a fact towards which one holds a mental disposition, or a reference plane such as the horizon against which orientation is measured. In this respect ‘attitude’ is similar to ‘risk’, which is defined in terms of objectives.

Although at first sight mental views and aircraft positioning do not seem to have much in common, in fact the two definitions of attitude are not incompatible or unrelated. The second meaning gives the sense of attitude as describing ‘direction of lean’. This can be seen as a metaphor for the internal approach adopted by an individual or group towards a given situation, and a number of useful insights arise as corollaries of this view, with each individual or group being the pilot of their own attitudinal aircraft.

• Just as the pilot makes a decision on what attitude to adopt for the aircraft in three-dimensional space in order to position it to execute the desired manoeuvre, so an individual or group can make an attitudinal choice to lean towards a particular desired response, behaviour or outcome.
• The attitude of an aircraft does not in itself result in motion, although it is a direct influence on the direction taken. In addition to attitude some force must act on the aircraft to generate motion – analogous to motivation.
• Aircraft attitude needs to be followed by movement if it is to result in execution of a manoeuvre, and similarly individual or group attitudes must be translated into action if the desired outcome is to be achieved.
• Attitude in space can be described using a number of elements, usually termed ‘pitch’ (rotation about the axis from wing tip to wing tip), ‘roll’ (rotation about the axis from nose to tail) and ‘yaw’ (rotation about the axis from ceiling to floor). It is also possible to subdivide human attitudes into their component dimensions to enable them to be better understood and managed.
• As the number of degrees of...