Ali Samad-Khan Photo © Nathan Mandell

Not worth the risk

Experts at the Kellogg Risk Summit urge executives to consider risk when making business decisions

By Matt Golosinski

In finance, risk is intimately related to reward. But in recent years, too many investors and executives have de-emphasized the downside of a business gamble.

So said experts at the Kellogg Risk Summit, which took place Nov. 20 at the Kellogg School's James L. Allen Center. With the economic crisis unfolding daily, participants sought to take a serious and scholarly look at the factors behind the collapse.

Risk is a "nebulous" concept, not well understood by senior managers, said Ali Samad-Khan, one of three presenters at the half-day event. Defining the problem is not just a matter of semantics, but part of developing a viable solution, he added.

Samad-Khan, a principal and global leader in the operational risk consulting practice at Towers Perrin, argued that traditional models — those preoccupied with high probability/high-impact events — are tactical in nature and focused on "preventing the next business loss."

That is an important concern, he acknowledged, but added that traditional models are fundamentally flawed. Modern models consider risk — a neutral measure of uncertainty, in Samad-Khan's terms — from a strategic standpoint, and examine the potential for high-impact but low-probability events.

Samad-Khan advised business leaders to factor risk into their planning and to remain aware that a decision based on "accounting profitability" will define risk quite differently than one made after considering "risk-adjusted profitability." Too often, he said, incentives are aligned in a "heads I win, tails someone else loses" fashion, which leaves managers free to take excessive risks. Incentives should be changed so that decision-makers share in the upside gains, but are also responsible for the losses, he said.

Leo Tilman, president of L.M. Tilman & Co. and former chief institutional strategist at Bear Stearns, also spoke at the summit. Tilman took a dim view of traditional models, noting that managing risk is about adapting and evolving as a business. But when firms work with what he called a static view of profit models, responding to a dynamic world becomes more difficult. He blamed poor overarching models for the financial crisis, rather than investor or managerial "greed and complacency."

Finally, Marcelo Cruz, senior risk management consultant and former chief risk officer of Aviva, provided a glimpse into the challenges of managing risk at Lehman Brothers, where he had served as global head of operational risk analytics and quantitative risk analytics. The firm filed for bankruptcy protection in September 2008.

Risk governance and incentives were key problems at his former employer, Cruz said. Even his own salary bonus, he noted, was contingent upon the performance of the frontline practitioners who made the deals and took the risks. Risk management should be considered less "a cost of doing business" and more a "value creation" function for a firm, he said. He added that companies need "parallel processes" to manage risk, alongside those that manage profitability.

As business leaders look ahead, Russell Walker, assistant director of the Kellogg School's Zell Center for Risk Research, said that Kellogg will produce additional events on risk management.

"To prevent a repeat of the financial crisis, a new focus on risk management is needed, one that requires shareholders, regulators, employees and business partners to seek information on risks and make decisions on that information, not simply on short-term earnings," he said. "Our summit demonstrated the importance of that."