Eleven questions to ask senior managers about their risk-management objectives.
Brett Friedman and Tim Essaye are consultants at Risk Capital, a risk-management consultancy based in New York. They can be reached at bfriedman@ riskcapital.com and firstname.lastname@example.org, respectively.
It is almost impossible to design an effective hedge program without first determining the exact objectives a company wants to achieve. Although this sounds obvious, it rarely is. Management usually can agree that the firm should hedge to reduce risk, but “risk” is too vague a term to justify hedging on its own.
Risk is best defined as the uncertainty around the firm’s ability to meet its stated objectives. Board members, senior management, traders, and the risk manager do not always share the same views of the company’s objectives, and therefore may define risk differently. For example, the CFO may be most concerned with achieving earnings-per-share (EPS) forecasts given to equity analysts; the risk manager with avoiding surprises in the mark-to-market; senior management with accumulating cash for strategic acquisitions; and the board with achieving other broad strategic goals.
Since objectives rarely are discussed, the parties involved usually are unaware that their opinion of the company’s objectives often differs from that of everyone else. Different objectives are exposed to different risks, so hedging and risk management strategies will vary.