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Corporate Risk: What Does Management Really Know?

A short list of questions that every board member and senior manager should be able to answer.

Fortnightly Magazine - February 2005

the time demands on today's CEO, the former is less likely to occur than the latter, but in the current environment it is more important than ever for executives to understand the information being presented to them. Not understanding is not an excuse! It is incumbent on senior management to put the burden on the risk management staff to make their material understood.

8. How does our disclosure of risk management activity compare to our peers?

Traditionally, the "Quantitative and Qualitative Disclosures About Market Risk" section of a company's financial report has been viewed as the place where companies are required to disclose information about exposure to market risks and derivatives activities. Rather than look at risk disclosure as a burden brought to bear by FASB and the SEC, market leaders look at risk disclosure as their company's opportunity to:

  • Communicate to investors and analysts which risks the company has chosen to bear and which ones it has chosen to ignore;
  • Convey how the company plans to mitigate those risks it does not desire to keep; and
  • Inform stakeholders of how much of each risk it desires to reduce.

They also view risk disclosure as an opportunity for their company to link risk-management objectives to overall corporate financial objectives such as EBITDA, free-cash flow, and financial-ratio targets.

Although investors and analysts would like to have as much information as possible, disclosure should be limited so as not to reduce a company's competitive advantage. In this regard it is helpful to differentiate between strategic and tactical risk management activity.

Strategic risk management activity can be disclosed as much as possible without significant loss of competitive advantage. For example, a utility that has decided that it will not hedge its exposure to floating interest rates should be willing to disclose that strategic risk information to allow analysts and investors to better understand the impact of changes in interest rates on future earnings.

Tactical activity, however, should not be disclosed at a level of detail that would allow other market participants to take advantage of the company's position. The level of detail for disclosing information should be adequate to allow shareholders and analysts to properly assess a company's exposure to various risks, but limited enough that it does not convey information that could facilitate speculative trading against the company or a loss of competitive advantage.

Many utility CEOs pass off the development of risk management policy to "the financial guys"-the CFO or treasurer. In today's environment of ever-increasing scrutiny over corporate governance practices, CEOs and the board cannot plead ignorance to the trading and risk-management activities at the companies in their charge. The questions described herein are ones that every CEO should be able to answer in detail.

Once a CEO or CFO has an understanding of the topics addressed by these queries, he or she can confidently say, on behalf of his or her company, "We pursue a disciplined approach to risk management."

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