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Risk Governance
Biases, Blind Spots and Bonuses
Elizabeth Sheedy
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eBook - ePub
Risk Governance
Biases, Blind Spots and Bonuses
Elizabeth Sheedy
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Biases, blind spots and bonuses (or incentives more broadly) have led to numerous risk management disasters. Risk governance is a potential solution to these problems yet is not always as effective as we would like it to be. One reason for that is the current dearth of risk governance expertise.
This book seeks to address this issue, providing:
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- Understanding of the fundamental forces that cause disasters: the biases, blind spots and bonuses. This understanding is drawn from the disciplines of economics/finance and psychology;
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- Explanation of the structures of risk governance and common challenges experienced in their use e.g. board risk committee, risk/compliance function, assurance function, risk appetite statement, risk disclosures;
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- Thorough investigation of risk culture and its importance in risk governance, including the assessment of risk culture;
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- Understanding of the mechanisms of executive compensation and how they link to risk management â one of the most difficult challenges confronting both risk and remuneration committees;
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- Explanation of the risk management process (based on international standards ISO31000), including practical guidance on risk communication, analysis and treatment;
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- Guidance on the management of strategic risk, emphasising the importance of scenario analysis;
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- Application of these principles to cyber risk, climate risk â two pervasive risks affecting almost every organisation;
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- Numerous case studies and examples drawn from various industries around the world; and
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- Discussion of what has been learned about risk governance from the COVID-19 experience.
The book is an essential guide for postgraduate students; participants in professional education programs in governance and risk management; directors; senior executives; risk, compliance and assurance professionals as well as conduct and prudential regulators worldwide.
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PART A
Foundations of risk governance
1
EMERGENCE OF RISK GOVERNANCE
The 2010 Deepwater Horizon incident1 conjures images of environmental catastrophe as well as the tragic loss of 11 lives. An oil rig operating 66 km off the Louisiana coast, the Deepwater Horizon ignited and exploded after a leak of methane gas. This caused the largest ever accidental oil spill, threatening species from whale sharks to sea grass. For BP, the operator of the oil rig, the incident was also disastrous as it faced billions of dollars in fines and reputational damage.
The Dieselgate scandal engulfed Volkswagen and its subsidiaries2 when a âdefeat deviceâ was discovered in 2015 for deceiving US regulators. It created the false impression that the diesel vehicles complied with strict environmental standards for protecting the health of the population, crucial for those with chronic respiratory conditions. Volkswagen subsequently spent billions on vehicle rectification and fines.
In 2019, Australiaâs oldest bank, Westpac, was accused of 23 million breaches of anti-money laundering laws, ignoring transactions likely to be associated with child exploitation.3 If proven, the allegations will also result in significant fines and reputational damage.
Three different scandals, all in the last decade but in different parts of the world and involving different industries. All three failures arguably could have been prevented by better governance. All three resulted in changes in the executive team, the board or both. In the Westpac case, for example, the CEO, the chairman and the chair of the board risk committee all stepped down in the weeks following the news, accepting accountability for serious failures of risk management. Importantly, the push for resignations came from the shareholder community, through institutional shareholders and proxy advisors.
These examples illustrate a worldwide phenomenon: that directors and senior executives are ultimately held responsible for risk management within their organisations. It is no longer possible to hide behind excuses of ignorance or group decision making. Directors are expected to own the organisationâs risk choices, take responsibility for the risk management framework, challenge the executive in relation to risk issues and ensure that a risk culture is established. In other words, risk governance is an expected norm of modern organisations.
Some directors are outraged by what they see as unrealistic expectations or inappropriate intrusion into areas that should be the remit of the executive. But many if not most shareholders see these risk governance tasks as reasonable. From the perspective of the shareholder, often holding shares in anticipation of retirement, directors are well paid and enjoy high status for exercising independent oversight on their behalf. Directors who feel unable or unwilling to take on these responsibilities are free to leave the field; plenty of others are ready to replace them.
So how did risk governance evolve? What are the forces and societal trends that led us to this point? I will argue that risk governance can be explained by three main forces:
- An increasingly litigious and regulated society that led to the development of risk management as a discipline and profession, as organisations defended themselves against reputational damage, legal costs and fines;
- The understanding that humans are prone to poor risk management through a range of biases and blind spots;
- Incentive conflicts that cause managers, acting out of self-interest, to pay insufficient attention to longer-term risk issues that are important to most other stakeholders.
Table 1.1 highlights some of the important risk governance milestones that have both stimulated and signalled change.
1960s |
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1970s |
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1980 |
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1984 |
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1986 |
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1987 |
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1988 |
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1992 |
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1994 |
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1995 |
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1996 |
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1998 |
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1999 |
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2001 |
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2002 |
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2003 |
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2004 |
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2007 |
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2008 |
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200... |