The comment -- one of hundreds of edits from my rigorous editorial review team (a former CEO as well as a current academic who teaches risk management to business school students) -- struck me as a trick question. I spent a large portion of the summer editing four separate risk management guidelines for CMA Canada, the association that grants a professional designation in management accounting and regulates its members under the authorization of provincial legislation.The back-and-forth with my editorial review team routinely reached a fever pitch -- something I should have expected given the heated and contentious nature of risk
management. The former CEO, for example, repeatedly asserted that any serious discussion of risk that neglected to address opportunity was incomplete, uninformed and irresponsible (a completely valid point, but not always a practical one when presenting a comprehensive framework in less than 4,000 words). The professor, a stickler for specificity and clear prose, began his lengthy edits with the "define risk" comment that sent me back to my research notes, text books and interview transcripts.
How do you define risk?
It's an age-old question as well as a compellingly current one.
Anyone familiar with the insurance industry's origins can tell you how ocean-going Chinese traders split up their cargo with other vessels to help ensure that at least some of their cargo would reach its intended port (and payday) even if their own ship sunk or succumbed to pirates. The spice trade represents another early risk management case study, one of a slightly different flavor. Transporting cinnamon and pepper from India to Italy via Persia, Arabia and East Africa posed great threats and great riches. "[B]ut the hefty prices that the spices commanded in their final destination still made this a lucrative endeavor for both the owners of the ships and the sailors who survived," writes Aswath Damodaran in his book Strategic Risk Taking: A Framework for Risk Management (Pearson Prentice Hall, 2007).
Damodaran also provides a prehistoric illustration of risk management at work: risk-taking cavemen had enough food to survive while risk-averse cavemen starved to death. Of course, it's not that simple (as Damodaran lays out later in his book): cavemen who took the wrong risks in search of food or spent too much time searching for food in the wrong places wound up dead at the hands of predators.
Risk is a concept that contains several elements: uncertainty, likelihood, frequency, impact. It's up to risk managers to sort through these elements, balance them against each other and come to an optimal decision for how to proceed. What is optimal for one organization may be far too risky, or not risky enough, for another company (even one in the same industry).
As my editorial reviewers hammered away at my drafts for greater clarity and specificity, large financial services firms were being hammered for failures that ultimately led to money-laundering, $5 billion trading losses and rate-fixing. I would call these risk-management failures (though at least one of my reviewers would -- and did -- argue that point). But that doesn't mean that the entire company's risk management system (or the financial services industry's risk management approach) is a failure.
Most of our cavemen and cavewomen on Wall Street are venturing into new terrain for their food, and I'm fairly sure they do not yet fully grasp the threats this new terrain (i.e., new markets, new financial instruments, new trading technology) poses. To survive, they and their firms need to redefine what risk management means within this new terrain. The same exercise should prove valuable to companies in other industries, no matter how traditional their existing business landscape is.
A wise place to start when redefining risk in the new business age is with an old Chinese symbol. Damodaran includes the Chinese symbol for risk in his book: the figure actually includes two figures -- one representing danger and the other representing opportunity. Completing the definition depends on each company's unique appetite.