Risk Management Failures Research Articles

Its Time to Replace Toxic Governance with Good Governance

The Australian financial system is exposed to the same toxic governance practices that caused the financial crisis in 2008. The US Government’s 2011 commission of inquiry into the crisis concluded that a “key cause” was “dramatic failures of corporate governance and risk management”. However, the Australian Prudential Regulatory Authority enforces US practices that become particularly toxic with Australia law. A shared source of toxicity arises from corporate constitutions providing directors with absolute power to corrupt themselves, their firm, and in the case of prudentially regulated institutions, the financial system and so the real economy. The solution is to amend constitutions to separate the power to govern from the power to manage while engaging with stakeholder constituencies to empower them to become co-regulators. A fundamental problem is that regulators, governance rating agencies and experts who formulate governance codes have not identified the objectives of good governance and so do not know where to head. Parliament is required to give direction. Good governance requires organizations to act ethically and fairly while minimizing harms, inequities, costs and risks on society by improving their self-governance. Self-governance is found in nature to allow creatures with little intelligence to reproduce in dynamic, complex unknowable environments. The paper describes how the laws of nature can be used to design the constitutions of organizations to follow the compelling success of simple creatures. The paper concludes that a Parliamentary inquiry is required to rectify the commitment by regulators, governance codes, and practitioners and their professional bodies to toxic governance.

Enterprise Risk Management (ERM) Implementation: Some Empirical Evidence from Large Australian Companies

According to Economist Intelligence Unit (Economist Intelligence Unit Limited and SAS, 2008), risk management failure is one of the major triggers of the recent global financial crisis. Enterprise risk management (ERM), an organisation wide process which identifies potential adverse events and provides strategies to manage risks, has been suggested as an approach to combat the volume and complexities of the risks faced by today's organisations (see, for example, Beasley et al., 2009). Despite of the recent emphasis given to risk management by the Australian Securities Exchange (ASX), there is scant empirical evidence on ERM implementation among the Australian listed companies. This study aims to provide some evidence on the extent of ERM implementation among the Top 300 companies listed on ASX. Questionnaires were used to collect data for this study. The outcomes of the study show that the majority of the firms involved in the survey not only extensively implement ERM but also extensively embed ERM into their corporate strategic processes. Further, they have also implemented the system for more than five years. Potential limitation of these findings are acknowledged.

Dissecting the JPMorgan whale: a post-mortem

In many respects, the "London whale" scandal at JPMorgan Chase is similar to other "rogue trading" events, in that a group of traders took large, speculative positions in complex derivative securities that went wrong, resulting in over US$6 billion of trading losses to the firm. As in other rogue trading cases, there were desperate attempts to cover up the losses until they became too big to ignore and eventually had to be recognized in the financial accounts of the bank. However, the whale case, so-called because of the sheer size of the trading positions involved, differs in several important respects from other rogue trading cases, not least because the sheer size and riskiness of the positions were well-known to many executives within JPMorgan, a firm that prided itself on having advanced risk management capabilities and systems. The role of Model Risk in this scandal, while not the primary cause, is important in that at least part of the impetus to take huge positions was due to incorrect risk modeling. Various external and internal inquiries into the events have concluded that critical risk management processes in the bank broke down, not only in the Chief Investment Office, the division in which the losses occurred, but across the bank. In particular, deficiencies in the firm's Model Development and Approval processes allowed traders to trade while underestimating the risks that they were running. Under Basel II regulations, losses due to process failure are classified as operational risk losses and hence this case demonstrates a significant failure of operational risk management in JPMorgan. This paper dissects the whale scandal from an operational risk perspective using the late Professor Barry Turner's framework for analyzing organizational disasters. The paper also makes suggestions as to how model risk may be managed to prevent similar losses in future.

CROs: The high-wire act in the financial sector

This paper proposes that the financial crisis of 2008–2010 demonstrates the need for a robust enterprise-wide risk management programme at financial institutions. Responding to the significant deficiencies that were found in risk management practices at some larger financial institutions, the ‘Dodd–Frank Wall Street Reform and Consumer Protection Act’ (Dodd–Frank) was enacted, effective 21st July, 2010 by the 111th US Congress. Dodd–Frank Section 165 requires, among other requirements, that certain financial institutions create independent board-level risk committees and practise enterprise-wide risk management. As required by Dodd–Frank, The Board of Governors of the Federal Reserve proposed Regulation YY, which brings greater clarity and detail to Section 165. This paper also proposes that, while Regulation YY provides for a sound structural foundation for the practice of risk management at financial institutions, the regulation cannot prescribe the human interaction and constructive dialogue between the chief executive officer, chief financial officer and chief risk officer with the board of directors required to prevent future risk management failures. The paper concludes by proposing possible solutions to this governance issue.

Minimizing a 'Key Cause' of the 2008 Financial Crisis: Governance Failure

The US Financial Crisis Inquiry Commission Report stated: “dramatic failures of corporate governance and risk management at many systemically important financial institutions were a key cause of this crisis.” The Lehman Brothers liquidator’s report and other sources explain the systemic deficiencies in the dominant centralized system of corporate governance. Evidence is provided that: (a) Stakeholders possessed knowledge of both systemic and firm specific risks; (b) Centralized governance denied stakeholders engagement to identify and mitigate risks. This leads to the hypothesis that decentralized governance described as “network” governance, provides a basis to reduce the “key cause” of firm and regulatory failure. The hypothesis is supported by system science that has identified the impossibility of reliably regulating complexity without a requisite variety of communication and control channels. We recommend that regulators introduce network governance to provide a requisite variety of stakeholder boards as co-regulators of large complex firms.

How Might Corporate Charters Be Amended to Enhance Investor Returns?

The research question of this paper is how might investors enhance their returns by amending corporate constitutions and/or by-laws of investee corporations? Porter (1992) identified how European and Japanese firms obtained systemic competitive advantages over US firms because US firms lacked feedback, independently of management, from their stakeholders like customers, suppliers and employees and host communities on firm performance, risks and opportunities. Hippel (1986) identified customer feedback as a major source of innovative opportunities. Evidence of systemic risk of US corporations was provided by the US government commission of inquiry into the 2008 financial crisis that identified as a “key cause” the “dramatic failures of corporate governance and risk management”. Forensic research has since revealed that stakeholders who knew of risks were not connected to individuals with the incentive, power and capability to take corrective action. Stakeholder controlled firms illustrate how appropriate changes in corporate constitutions can introduce a requisite variety of private feedback connections with a diversity of stakeholders, independently of management, to directors and when required also to shareholders. The feedback can not only cross check the integrity of management information but also identify for directors and shareholders completeness of executive knowledge of the known known’s and known unknowns while also adding value with intelligence on the unknown unknowns. Shareholder participation is recommended for developing appropriate resolutions to amend constitutions of investee firms.

Bridging the Risk Gap: The Failure of Risk Management in Information Systems Projects

OVERVIEW:New product development projects are highly risky technical undertakings. Organizations frequently seek to manage the risk involved using standard risk management procedures, knowing that a company that better manages risks is less vulnerable. Nevertheless, NPD projects continue to fail to meet expectations for delivery time, budget, and outcomes. In this paper, we explore reasons why, despite employing self-evidently correct risk management procedures, adversities occurred in 19 major information systems projects. Project managers focused on the familiar, the measurable, the favorable, the noncommittal, and the controllable while excluding other risks that significantly affected their project performance. We have characterized this tendency as a series of five lures that leave projects vulnerable to risks.

Integration of Strategic Management, Governance and Risk Management: Impact of the Crisis of 2008 in Two Companies of Food

During the crisis of 2008, several Brazilian companies have accumulated losses that worth billions, as the result of a high foreign exchange rate exposure and failures in risk management and Corporate Governance. The aim of this research is to identify the strategic factors that contributed to two very similar companies to follow different paths in the financial crisis of 2008. To better understanding the subject, it was made a brief analysis of the foundations of the Corporate Governance, the requirements listed by BMFBOVESPA and the principles of the financial risk management. The research identified that the practice of risk management is crucial in implementing best practices of corporate governance and that despite numerous initiatives of various institutions and regulators in establishing self-regulatory mechanisms to ensure the use of these practices, there are still flaws able to allow companies previously considered solid incurring in strategies that may jeopardize its existence.

Integration of Strategic Management, Governance and Risk Management: Impact of the Crisis of 2008 in Two Companies of Food

During the crisis of 2008, several Brazilian companies have accumulated losses that worth billions, as the result of a high foreign exchange rate exposure and failures in risk management and Corporate Governance. The aim of this research is to identify the strategic factors that contributed to two very similar companies to follow different paths in the financial crisis of 2008. To better understanding the subject, it was made a brief analysis of the foundations of the Corporate Governance, the requirements listed by BMFBOVESPA and the principles of the financial risk management. The research identified that the practice of risk management is crucial in implementing best practices of corporate governance and that despite numerous initiatives of various institutions and regulators in establishing self-regulatory mechanisms to ensure the use of these practices, there are still flaws able to allow companies previously considered solid incurring in strategies that may jeopardize its existence.

Hindsight-biased Courts and the Efficiency of the Legal System

This paper examines the implications of a cognitive deficiency called “hindsight bias” on two legal standards: negligence and probable cause. This focus illustrates the implications of hindsight bias depending on whether a court intervenes following a failure vs. success in risk management (respectively). When the court applies the negligence standard, I find that hindsight bias discourages (encourages) preventive measures that reduce the likelihood (severity) of an accident. When the court applies the probable cause standard, I show that hindsight bias discourages aggressive searches that increase the likelihood of police seizures. I also study the effectiveness of counterfactual thinking as a remedy for hindsight bias, and find that it is only unambiguously effective under the probable cause standard.

The new German Ringfencing Act establishing criminal liability of banking and insurance executives for failures in risk management

The German parliament recently approved a new law regarding individual criminal liability of banking and insurance executives, which will take effect as of January 2014. Under the new so-called Ringfencing Act (Trennbankengesetz), specific duties and responsibilities for risk management will be imposed on these executives. Failure to comply with these duties will be punishable by a maximum of five years’ imprisonment if it causes a threat to the viability as a going concern of a bank, or insolvency or over-indebtedness of an insurance company. This paper provides a description of the risk management duties and the corresponding criminal penalties. It also discusses the regulatory background and provides an initial assessment of the likely implications for risk management at German financial institutions.

Risk Taking, Principal Agent Problems and Breakdown of Corporate Social Responsibility (CSR): How to Reestablish Safe-Assets and Capital Funding for Social Security?

The breakdown of the financial markets in fall 2007 and the following debt crisis in the EU has produced an enormous mistrust in financial products and the monetary system. The paper describes the background of the crisis induced by functional failures in risk management and the multifold principal agent problems existing in the financial market structures. The innovated nontransparent financial products have mixed up different risk weights and puzzled, or even fooled formerly loyal customers. Contemporaneously abundant liquidity on the international financial market accompanied by easy money policies of the Fed in the US and the ECB in the euro zone have depressed the real interest rate to zero or even negative values. Desperate investors are seeking for safe-assets, but their demand remains unsatisfied. Low real interest rates and the consequently lacking compound interest effect in the same time jeopardize private as well as public insurance schemes being dependent on capital funding: the demographic crisis becomes gloomy. Therefore, the managers of the financial markets have to reestablish CSR and to divide the markets into safe-asset areas for the usual clients and “casino” areas for those who like to play with high risks. Only with transparency and risk adequate financial products can the lost commitment be regained.

The failure of risk management for nonfinancial companies in the context of the financial crisis: lessons from Aracruz Celulose and hedging with derivatives

The main contribution of this article is to present hard evidence on hedging strategies and relate it to behavioural and agency problems resulting from speculation with derivatives. We focus on the case of Aracruz Celulose. We show how the real hedge position of Aracruz – that lost US2.1 billion in currency derivatives – deviated from its optimal hedge as the result of speculation with Over-the-Counter (OTC) derivatives.

Institutional Economics, Risk Management, and Breakdown of Corporate Social Responsibility: Towards a New Architecture of Financial Markets

The breakdown of the financial markets in fall 2007 and the following debt crisis in the EU have produced an enormous mistrust in financial products and the monetary system. The paper describes the background of the crisis induced by functional failures in risk management and the multifold principal agent problems existing in the financial market structures. The innovated nontransparent financial products especially by the so-called shadow banks have mixed up differential risk weights and puzzled or even fooled formerly loyal customers. Contemporaneously abundant liquidity on the international financial market accompanied by easy money policies of the Fed in the US and the ECB in the euro zone have depressed the real interest rate to zero or even negative values. Desperate investors are seeking for safe-assets but their demand remains unsatisfied. Low real interest rates and the consequently lacking compound interest effect in the same time jeopardize private as well as public insurance schemes being dependent on capital funding: the demographic crisis becomes gloomy. Therefore, the managers of the financial markets have to reestablish CSR and to separate the markets into safe-asset areas for the usual clients and “casino” areas for those who like to play with high risks. Only with transparency and risk adequate financial products the lost commitment can be regained.

Risk Management and Organizational Failure

Risk Management and Organizational Failure

Poor Credit Risk Management and Bank Failures in Nigeria

The study was designed to evaluate the relationship of poor credit risk management and bank failures in Nigeria and propose strategies for remedial actions. Credit risk management is one of the most crucial banking functions that involve the appraisals of requests for banking facilities. It is critical to bank survival or failure because banks traditionally earn their huge profits from interest on their risk exposures. The survey research design was adopted and researcher’s self designed instrument was used to generate data for the study. Chi-square statistic method was used for data analysis. It was found that poor credit risk management influences bank failures. Literature also provided credible evidence to show that weak corporate governance accelerates bank failures. Ten (10) recommendations were made based on the findings of the study.

The Reliability-Quality Relationship for Quality Systems and Quality Risk Management

Engineering reliability typically refers to the probability that a system, or any of its components, will perform a required function for a stated period of time and under specified operating conditions. As such, reliability is inextricably linked with time-dependent quality concepts, such as maintaining a state of control and predicting the chances of losses from failures for quality risk management. Two popular current good manufacturing practice (cGMP) and quality risk management tools, failure mode and effects analysis (FMEA) and root cause analysis (RCA) are examples of engineering reliability evaluations that link reliability with quality and risk. Current concepts in pharmaceutical quality and quality management systems call for more predictive systems for maintaining quality; yet, the current pharmaceutical manufacturing literature and guidelines are curiously silent on engineering quality. This commentary discusses the meaning of engineering reliability while linking the concept to quality systems and quality risk management. The essay also discusses the difference between engineering reliability and statistical (assay) reliability. The assurance of quality in a pharmaceutical product is no longer measured only "after the fact" of manufacturing. Rather, concepts of quality systems and quality risk management call for designing quality assurance into all stages of the pharmaceutical product life cycle. Interestingly, most assays for quality are essentially static and inform product quality over the life cycle only by being repeated over time. Engineering process reliability is the fundamental concept that is meant to anticipate quality failures over the life cycle of the product. Reliability is a well-developed theory and practice for other types of manufactured products and manufacturing processes. Thus, it is well known to be an appropriate index of manufactured product quality. This essay discusses the meaning of reliability and its linkages with quality systems and quality risk management.

The little engine who could not: “rehabilitating” the individual in safety research

Safety science is one of the enduring enlightenment projects, which believes that rationality can create a better, more controllable world. Accidents are not seen as meaningless coincidences, but as failures of risk management, as something that can be improved in the future. The tragedy of safety research is that it has to simultaneously deny and affirm the primacy of human agency. As it has gradually expanded away from the sharp end to see accidents as bureaucratic or administrative in origin, the research keeps supplying linguistic and analytic resources that focus on individual shortcomings in leadership, communication or supervision. This paper concludes that individual human agency is useful to safety work, but not just as an instrument of political or organizational expedience. It is useful because it deeply reflects and reinforces how in the West we understand failure and success. The explanatory power of this discourse is confirmed or taken for granted by safety researchers because it appears so ordinary, self-evident and commonsensical.

The art of managing risk in complex field operations and volatile energy markets

The energy sector faces a steeply rising risk profile, due to a combination of more complex field development projects, volatile commodity prices and unstable credit markets. Ruud Weijermars outlines a framework for corporate risk management, illustrates risk management failures, and gives recommendations for improving risk mitigation practices.

The governance of strategic risks in systemically important banks

Among the many market weaknesses highlighted by the global financial crisis, the widespread failures of corporate governance and risk management were identified by official inquiries as being critical. As a result, banking regulatory bodies have responded, proposing long overdue principles of good corporate governance, in particular tightening up on the roles and responsibilities of boards of directors. Strategic risk is arguably, because of the immense uncertainty in the global economy, the greatest risk facing any firm, most especially systemically important banks (SIB); however, strategic risk management, or the management of the risks to a firm's long-term corporate strategy, is not a well-developed discipline. The lack of maturity in the discipline stems, in part, from a fundamental conflict of interest in that the board and management ‘own’ a firm's strategy but they are at the same time also responsible for implementing the strategy and managing the strategic risks. There is no independent review of the strategic risks taken by many firms, which constitutes a serious deficiency in corporate governance. This paper considers the governance of strategic risks, using Lehman Brothers as a case study, identifying areas of deficiency of governance of strategic risk in practice. The paper also proposes some potential solutions to help address such governance problems.