“A diet of pure risk aversion likely will lead to extinction.”
David Apgar, Risk Intelligence: Learning to Manage What We Don't Know, 2006.
In business, just as in sports, you can’t succeed over the long-term by using ‘defensive’ strategies alone. To win, you also need to go on the ‘offensive’. In the words of Will Rogers “you’ve got to go out on a limb sometimes because that is where the fruit is.”
Leaders who see risk only as something negative make the mistake of trying to protect organizational value by avoiding, eliminating, or controlling all risk. The flaw in this risk averse mindset is that in attempting to eradicate the threat of loss, the potential for gain is also diminished. But to take risks with no consideration or weighing of the possible losses can lead to unnecessary exposure to threats.
The trick is to define a risk appetite that strikes a healthy balance between risk taking in order to create value and risk management to protect value. It’s up to a company’s leaders to articulate the organization’s risk appetite. Explicit conversations about risk appetite help executives, board members, managers and employees to get on the same page about which risks are palatable and how much risk the company can stomach.
Here are three reasons to articulate your organization’s risk appetite:
1. Your leadership team and board have a duty to define the company’s risk appetite. Over the past decade, risk oversight has become an expected governance practice. Leading groups such as the National Association of Corporate Directors, the Canadian Coalition for Good Governance, and ratings agencies such as Standards & Poors have all weighed in on the importance of articulating and approving risk appetite as a fundamental component of risk oversight. Even with this information, a minority of organizations explicitly articulate their risk appetite. One common reason is that the leaders mistakenly believe that if they don't formally commit to an acceptable level of risk then they can't be held accountable for setting it incorrectly. Furthermore, they will tell you that they've gotten along just fine up to now without explicitly defining risk appetite, so why fix something that’s not broken?
By not providing clear guidance for risk taking to their people, these executives mistakenly believe they are protecting themselves. The cold hard truth is this: whether or not senior executives express their risk tolerances explicitly, they implicitly dictate the organization's risk tolerance and culture through the decisions they take and the business practices they permit.
Pioneering leaders of organizations that have established and applied a risk appetite statement know that when the Executive Team and Board have frank conversations about risk appetite, they discover they are able achieve unprecedented levels of clarity and alignment on the types and amount of risk that their organization should take in the pursuit of their objectives.
2. It gives your people the clarity they crave. Most companies I see do a great job of defending against risks that could threaten their survival. However, some find it difficult to go on the offensive and confidently take risks to achieve their objectives. Often that’s because they fear that if their risk-taking doesn’t bear fruit, it will be perceived as poor judgement by their peers and their leaders, so they opt to ‘play it safe’ and avoid the upside risks necessary to move the company forward.
Yet, we know people don’t come to work each day to avoid risks, they want to make a difference. But if leaders leave it to employees to figure out which risks and how much risk is acceptable, they leave the company wide open to risk exposure from poor decisions and inadequate business practices. This can lead to situations where managers take more risk than the organization’s leaders (the executive team and board) consider acceptable, or not enough risk to create the value that customers, shareholders and other stakeholders expect.
Engaging your people in risk appetite conversations helps to ensure they know the parameters for risk taking, empowering them to make the kind of contributions that keeps them motivated and the company strong.
3. It enables you to optimally allocate your management resources. Robert Mittelstaedt, Dean Emeritus of the W. P. Carey School of Business, warns that “if you do not make any mistakes, you may not be taking enough risk, but failing to take any risks at all may be the most dangerous type of mistake that a business can make.” Chronic risk aversion skews the distribution of resources toward value protection and away from value creation.
Articulating risk appetite gives you a yardstick to gauge if you are under- or over-managing your risks. This enables you to close any gaps between your target risk appetite (as defined by your executive team and board) and your actual risk appetite (as manifested in your people’s decisions). By monitoring your actual risk appetite, you will gain valuable insight to re-align your target risk appetite to keep pace with any significant changes in your company’s business environment.
The clients we have supported to articulate an explicit risk appetite statement and metrics find that it gives them a practical basis for considering risk in setting priorities and allocating resources. For example, measuring their risk appetite helps them tap into stakeholder intelligence to deliberately and confidently direct management attention and resources to issues where risk exposure exceeds risk appetite rather than on those that are aligned with risk appetite.
They appreciate that it also gives them a strong basis to create efficiencies by reducing resources on issues where risk exposures are far less than the target risk appetite.
Are your people on the same page about the nature and level of risk your organization’s wants to take in pursuit of your objectives? If not, you may be missing a golden opportunity to drive alignment and value. Contact Diana Del Bel Belluz at Risk Wise to find out how you can engage in effective, pragmatic risk appetite conversations.
Diana Del Bel Belluz is President of Risk Wise Inc. For over 25 years, she has helped management teams and boards to achieve more effective management and oversight of risk. She helps her clients to gain the clarity and confidence that comes from having better conversations about complex or difficult risk issues.