Is your firm’s risk appetite in line with your risk-bearing capacity? Companies with risk appetite disproportionate to their risk-bearing capacity often find themselves realigning performance expectations – downward. Ask these five questions to find out:
- Is your firm stretching too thin or moving too far, too fast? Indicators may include a rapid increase in scale or leverage, or a significant commitment to new markets or offerings.
- What do the analysts and stock prices say about your firm? Negative analyst reports or a decline in share price or credit rating without a corresponding decline in financial performance may show that the market thinks you are taking on too much risk.
- What are your employees telling you about the business? Increased employee and management departures may suggest a loss in confidence. Additionally, top talent flight can mean you aren’t investing enough in employee opportunities.
- Is the bar too high for new projects and innovation? When management demands a high return on resource allocation before approving a new project, often the number of potential opportunities is reduced. This can reduce risk exposure, but it poses a real risk to growth and innovation.
- How much capital are you allocating to shareholders? The market may signal that your dividend rate is unnecessarily high (and a sign of risk aversion) with a decline in share price unrelated to earnings, market conditions or competitor prices. Investors may worry the firm is missing marketing and reinvestment opportunities.
Most companies recognize that effective risk management depends on developing a clearly articulated statement of risk appetite and a robust framework to cascade this through the organization. But who articulates the risk appetite – the risk team or the board?
The Art of Balancing Risk and Reward is a white paper based on research conducted by Longitude Research. Longitude Research interviewed firms to ascertain the role of the board in setting, implementing and monitoring risk appetite. The paper explores how having a thorough understanding of the amount and types of risk that the organization is willing to take in pursuit of a desired level of return provides boards and senior management with clear direction and ensures alignment of expectations across a broad range of key internal and external stakeholders.
What is your expectation of the board’s role in setting risk appetite at your firm?