This post discusses risk management and corporate governance.

WHAT IS RISK MANAGEMENT?

Risk management encompasses identifying, analysing, and responding to risk factors that form part of the life of a business. Risk management identifies, assesses, and controls a firm’s capital and earnings threats. Effective risk management means influencing future outcomes as much as possible by acting proactively rather than reactively. Effective risk management can reduce the possibility of a risk occurring and its potential impact. These threats or hazards could stem from various sources, including financial uncertainty, legal liabilities, strategic management errors, accidents, and natural disasters. Hence, risk management is beneficial to business organisations.

IMPORTANCE OF RISK MANAGEMENT

Understanding and controlling risk makes organisations more confident in their business decisions. An organisation can save money and protect its future by implementing a risk management plan and considering the various potential risks or events before they occur. A robust risk management plan will help a company establish procedures to avoid potential threats, minimise their impact if they materialise and cope with the results. Furthermore, strong corporate governance principles focusing specifically on risk management can help a company reach its goals.

Benefits of risk management include:

1. Creates a safe and secure work environment for all staff and customers.

2. Increases business operations’ stability while decreasing legal liability.

3. Protects from events detrimental to the company and the environment.

4. Protects all involved people and assets from potential harm.

5. Helps establish a firm’s insurance needs to save on unnecessary premiums.

RISK MANAGEMENT PROCESS

The risk management process is a framework for the actions that should be taken. There are five basic steps in managing risks. These steps are known as the risk management process. 

Here are the five steps of a risk management process:

Step 1: Identify the risk

Step 2: Analyse the risk 

Step 3: Evaluate and rank the risk

Step 4: Treat the risk

Step 5: Monitor and review the risk

WHAT IS CORPORATE GOVERNANCE?

The term governance is associated with achieving a purpose or performing an activity. The word “Governance” has its origin in the Latin term “gubernare” and Greek term “kybernan”, which were notated to “guide”, “direct”, or “steer”. Corporate governance in the business context refers to the systems of rules, practices, and processes by which companies are governed. It combines rules, processes and laws by which businesses operate, regulate and control.

The term encompasses the internal and external factors that affect the interests of a firm’s stakeholders, including shareholders, customers, suppliers, government regulators and management. Corporate governance promotes trust, transparency and accountability to ensure long-term investment, financial stability and integrity, supporting business growth and society.

RISK MANAGEMENT AND CORPORATE GOVERNANCE

Corporate governance is all about managing risks. Good corporate governance entails establishing security, transparency, equity, compliance, reliance and accountability principles for managing organisations. The board of directors is responsible for creating a framework for governance that best aligns business conduct with corporate objectives. Corporate governance ensures sound risk management within an organisation.

The Corporate Governance Code in most countries clearly states that the board is responsible for determining the nature and extent of the organisation’s risks. In most countries, corporate governance practices are developed with risk management as a priority. Corporate governance breakdown is often caused by poor organisational risk management. Integrating risk management into a company’s planning is beneficial to ensure that a firm’s risks are identified and adequately managed in the context of its risk appetite.

IMPORTANCE OF CORPORATE GOVERNANCE

Corporate governance is critical for the proper functioning of an organisation. Good governance promotes a company’s integrity, overall direction, risk management and succession planning. Demonstrating good corporate governance is essential for maintaining a company’s reputation. Establishing good corporate governance also helps promote profitability for businesses. Bad corporate governance can result in adverse outcomes, including failure to achieve the company’s objectives, loss of support from stakeholders and the community, financial losses, and company collapse.

BENEFITS OF CORPORATE GOVERNANCE

A sound corporate governance system is beneficial to business organisations as it:

1. Ensures that the management of a company considers the best interests of everyone;

2. Helps companies deliver long-term corporate success and economic growth;

3. Maintains the confidence of investors to ensure the company’s performance and effectiveness;

4. Has a positive impact on the price of shares as it improves the trust in the market;

5. Improves control over management and information systems, such as security or risk management;

6. Gives guidance to the owners and managers about what are the goals and strategy of the company;

 7. Minimises wastages, corruption, risks, and mismanagement;

 8. Helps to create a strong brand reputation; and

 9. Enhances a firm’s resilience and its competitive capability.

PRINCIPLES OF CORPORATE GOVERNANCE

Good corporate governance practices transform principles into attitudes. Applying corporate governance principles ensures access to capital, enhances performance and increases the firm’s value. While corporate governance structures may vary, most organisations’ corporate governance systems include the following key elements:

1. Equity,

2. Accountability,

3. Diversity,

4. Oversight and management,

5. Transparency, and

6. Corporate responsibility.

ELEMENTS OF GOOD CORPORATE GOVERNANCE

Good corporate governance depends on complying with general and industry-specific regulations. A firm’s leaders must take responsibility for their decisions and the organisation’s overall performance. For example, the leaders of a company should design and adhere to a code of ethics that helps management promote each of the essential characteristics of good corporate governance.

Here are the seven elements of good corporate governance:

1. Clear organisational strategy

2. Effective enterprise risk management

3. Discipline and commitment

4. Fairness to employees and customers

5. Transparency and information sharing

6. Corporate social responsibility

7. Regular self-evaluation

DEPLOYMENT OF CORPORATE GOVERNANCE 

The corporate governance function must steer an organisation’s direction across various vital dimensions. Corporate governance practice is helpful and relevant in several aspects of business operations, including: 

1. Enterprise Risk Management

2. Strategic Planning

3. Accounting and Disclosure

4. Talent Management

5. Succession Planning

6. Business Continuity Management

CORPORATE GOVERNANCE KEY ACTORS

Effective corporate governance requires a clear understanding of the roles of the board, management and shareholders; their relationships with each other; and their relationships with other corporate stakeholders. Core actors in corporate governance practice include (1) the board of directors, (2) management, and (3) shareholders. Companies should disclose their procedures and bases for selecting those practices.

COMPOSITION OF THE BOARD OF DIRECTORS

Boards and directors of companies are not the same. They face different challenges, and various factors shape their structure. Companies with a sound corporate governance system and experienced boards with a growth and sustainability mindset will be better positioned to prosper in the short and long run.

Factors influencing the board of an organisation include:

1. Geography’s legal and regulatory obligations,
2. Company ownership structure,
3. Key stakeholders’ expectations and interests, and
4. Company’s Attributes.
5.  

TRANSLATION OF CORPORATE GOVERNANCE TO RISK MANAGEMENT BEST-PRACTICES

Risk governance promotes a sound organisational structure to ensure a good and well-implemented risk management framework. Risk governance is developing an organisational structure to address a precise road map of defining, implementing, and authoritative risk management. 

The board of directors analyses the significant risk and rewards in a chosen firm’s business strategy. The board of directors is responsible for shaping and authority in risk management. Moreover, it touches on the transparency and establishment of communication channels within which organisations, stakeholders, and regulators engage.

THE RISK APPETITE STATEMENT

A statement of risk appetite is one of the critical components of corporate governance. Risk Appetite Statement contains a precise aggregated amount and types of risks a firm is willing to accommodate or avoid to achieve its business objectives. A well-articulated risk appetite helps maintain the equilibrium between the risks and return, cultivating a positive attitude towards the risk exposures to enhance the firm’s value.

IMPLEMENTATION OF BOARD-LEVEL RISK GOVERNANCE

The essence of having several committees is to ensure the effective implementation of corporate governance policies within an organisation. In the banking and insurance industries, the board of directors charges the committees like risk management committees, among others, with ratifying policies and directives for activities related to risk management. The committees’ frame policies related to division-level risk metrics concerning the overall risk appetite set by the board.

THEORIES OF CORPORATE GOVERNANCE

Several theories describe the relationship between business stakeholders’ duties and responsibilities. Some of the prominent theories of corporate governance include agency theory, stewardship theory, resource dependency theory, stakeholder theory, transaction cost theory, political theory, and sociological theory.

IMPLEMENTATION OF CORPORATE GOVERNANCE POLICY

Here are the core guiding principles in implementing a corporate governance policy:

1. The board approves corporate strategies to build sustainable long-term value, selects a chief executive officer (CEO), oversees the CEO and senior management in operating the company’s business, including allocating capital for long-term growth and assessing and managing risks; and sets the “tone at the top” for ethical conduct.
2. Management develops and implements corporate strategy and operates the company’s business under the board’s oversight to create sustainable long-term value.
3. Under the oversight of the board and its audit committee, management produces financial statements that fairly present the company’s financial condition and results of operations. 
4. The board’s audit committee retains and manages the relationship with the outside auditor, oversees the company’s annual financial statement audit and internal controls over financial reporting, and oversees the company’s risk management and compliance programmes.
5. The board creates the governance committee. The board plays a leadership role in shaping the company’s corporate governance, building an engaged and diverse board, and actively conducting succession planning for the board.
6. The board creates the compensation committee. The board’s compensation committee is responsible for developing compensation policies for executives, the CEO and senior management. 
7. The board and management should engage with long-term shareholders on issues and concerns that are of widespread interest to them and affect the company’s long-term value creation. 
8. In making decisions, the board may consider the interests of the company’s constituencies, including stakeholders such as employees, customers, suppliers and the community in which the company does business.

FACTORS INFLUENCING GOOD GOVERNANCE

Good governance is an approach to creating a system founded on justice and peace that protects individuals’ human rights and civil liberties. According to the United Nations, good governance is measured by eight factors: 

1. Participation, 

2. The rule of law, 

3. Transparency, 

4. Responsiveness, 

5. Consensus-oriented, 

6. Equity and inclusiveness, 

7. Effectiveness and efficiency, and 

8. Accountability.

STEPS TO IMPROVE CORPORATE GOVERNANCE PRACTICE

The Enron scandal was caused by the failure of the Enron board to follow basic governance rules. Enron was allowed to engage in risky accounting principles, conflicting interest transactions, undisclosed off-the-book activities, and excessive executive compensation.

Here are five basic steps to improve corporate governance:

1. Increase diversity

2. Appoint competent board members

3. Ensure timely information

4. Prioritise risk management

5. Evaluate board performance

See the full video on Risk Management and Corporate Governance: https://youtu.be/eiGFsI_36wQ