Risk Management and Corporate Governance Ana Bulgaru, Corporate Governance 2013
Dec 22, 2015
Content1. Corporate Governance2. Risk Management
2.1. Risk Types2.2. Risk Management processes2.3. Internal Controls
3. Dealing with Risk – Approaches3.1. Risk adjusted value3.2. Probabilistic approaches3.3. Value at Risk (VAR)3.4. Real Options
4. Risk management – Associations5. Case Study: New Star Financial vs Lehman
Brother 5.1. NewStar Financial 5.2. Lehmen Brothers
6. Conclusions 7. References
Internal Controls:
• COSO- Control environment- Risk assessment- Control activities- Information and communication- Monitoring
• Turnbull Guidance- Strategy- People- Detail- Tasks- Drivers
Dealing with risk – ApproachesRisk adjusted value.
Downside risk
• Risk adjusted discount Rate : calculate present value at a discount rate.- Cost of equity = Risk Free Rate + Beta + Risk Premium- Cost of Capital = Cost of Equity (Equity/Debt + Equity) + Cost of Borrowing (1+t)
(Debt/(Debt + Equity))
• Certainty equivalents: calculate the present value of an uncertain expected CF using a risk free rate
-
Dealing with risk – Approaches Probabilistic approaches.
Downside risk• Sensitivity analysis• Scenario analysis• Decision Tree• Simulation Analysis
Discrete/Continuous
Correlated/Independent
Sequential/Concurrent
Risk Approach
Discrete Independent Sequential Decision TreeDiscrete Correlated Concurrent Scenario AnalysisContinuous Either Either Simulations
Dealing with risk – Approaches Value at risk (VAR).
Downside risk• Variance covariance matrix• Historical data simulation • Monte Carlo Simulation
Real Option. Upside risk• Option to expand • Option to abandon • Option to delay or wait
Case Study: NewStar Financial vs Lehman BrothersSuccess story: NewStar Financial
NSF story:• Focused on risk management• Discuss and deliver
• Founded in 2004.• Buying and distributing risk• Capitalyze on opportunities• Market value of $863 million.
Success story: NewStar FinancialReasons.
• Appropriate stuffing• Individual credit selection (clearly defined approach)• Constant portfolio monitoring• Regular communication• Use of risk appetite
Impact:
• Assets of 2.28 billion in June 2013• Continuity• Client trust• Risk management sharing experience
Case Study: vs Lehman BrothersFailure story: Lehman Brothers• Founded in 1850• The fourth largest investment bank in US.• Doing business in: investment banking, equity and fixed-income sales
and trading, research, investment management, private equity, and private banking.
LB story:• End of mortgage boom in 2007• Invested $15 Mln in Archstone-Smith Trust (real-etate)• Largest bankruptcy in US having a worldwide impact.• Collapsed in 2008,• Debts: $613 billion
Failure story: Lehman Brothers.Reasons.
• Unmeasured risk of mortgage investments.• Bad communication between managers and CEO• English Authority for Financial Services didn’t approve the transactions with Barklay• Largest bankruptcy in US
Impact:
• American Government did not refused to “save”.• Worldwide impact on investment market.• Dow-Jones index lost 504 points.• American government invested over 62 MLD in other banks to keep the
balance later.
Failure story: Lehman Brothers.Recomandations.
• Plan and analyze better the risks associated with the business.• Avoid being exposed to risk hazard,• Improve communication• Create clear guidelines for risk management• Create/improve the department(s) responsible for internal control.
Conclusions:
• Risk management -> key important in corporate governance.
• Focus on healthy risk management can drive considerable profits
• Wrong (ignoring) the risk management can lead to bankruptcy.
• Best approach: “Learn from other’s mistakes”!
• Risk management journey is never complete.
• Is impossible to avoid all risks but a good management should be able to deal with it through various tools.
Reverences.• http://www.garp.org/media/991488/theroleofriskgovernanceineffectiveriskmanagem
ent_tunji_adesida_071312.pdf
• “RISK MANAGEMENT & CORPORATE GOVERNANCE” by Richard Anderson & Associates http://www.oecd.org/daf/ca/corporategovernanceprinciples/42670210.pdf
• “RISK MANAGEMENT: A CORPORATE GOVERNANCE MANUAL” by Aswath Damoradan, 2010, http://people.stern.nyu.edu/adamodar/pdfiles/papers/RiskManual.pdf
• “ Corporate Governance and Management of Risk (M_o_R)” by John Fisher, Unconfuseu, 2010, http://www.best-management-practice.com/gempdf/Corporate_Governance_and_Management_of_Risk.pdf
• DSM, Oct, 2013, https://www.dsm.com/corporate/about/corporate-governance/risk-management.html
• “ International Finance Corporation, June, 2012, http://www.ifc.org/wps/wcm/connect/9ff11a804c40464698dddaf12db12449/RiskGovJuly2012.pdf?MOD=AJPERES
• “Cum a contribuit Richard Fuld la daramarea Lehman Brothers, un imperiu pe care l-a construit de la zero” , 16 nov. 2008, Ciprian Botea, http://www.zf.ro/business-international/cum-a-contribuit-richard-fuld-la-daramarea-lehman-brothers-un-imperiu-pe-care-l-a-construit-de-la-zero-3505638
• http://www.conference-board.org/retrievefile.cfm?filename=TCB%20DN-V3N2-11.pdf&type=subsite