Topics: Risk Management
Topics: Risk Management
December 3, 2020
December 3, 2020
The Report of the NACD Blue Ribbon Commission on Risk Governance: Balancing Risk and Reward recommended 10 timeless principles to assist boards in strengthening their oversight of companies’ risk management. Published in 2009, the report also noted that boards need to “look forward to understand elements in the environment—macroeconomic, political, technological, demographic, climatic/environmental—that may impact the conduct and effectiveness of the business in the future.”
But the risk assessment process as it exists now is often too static because change never ceases, as all of us have learned this year. While every organization has a risk assessment process, most organizations apply that process only periodically. With risk by nature being disruptive, new developments often arise in between periodic risk assessments.
Enter adhocracy. The term “adhocracy” has evolved to describe an organizational approach that cuts across normal bureaucratic lines to capture opportunities, solve problems, and get results, according to Robert H. Waterman in his book Adhocracy: The Power to Change. An adhocracy structure is flexible, adaptable, and open to fresh perspectives on the business environment.
Timely identification of emerging risks between scheduled risk assessments may, in fact, depend more on adhocracy than traditional, formal processes because emerging risks are anticipatory in nature and deal with issues that may not presently be on management’s radar. Ad hoc activities supplement established risk-management processes and lend themselves well to the fluid world of emerging risks.
While smaller organizations usually find adhocracy easier to implement than larger ones, thanks to less bureaucracy and hierarchy, a culture that facilitates the recognition and communication of emerging risks across the enterprise is imperative to enabling critical and creative thinking to flourish no matter the company size. Below are six suggestions for how management can work toward such a culture and, in doing so, inform the board’s risk oversight.
1. Conduct brainstorming sessions. Brainstorming is one of the most commonly applied expressions of adhocracy. It brings people together to focus on one or more issues of mutual interest. While these activities may be carried out through a formal management risk (or other ad hoc) committee, they may also be spontaneous, unplanned knowledge-sharing sessions to ascertain whether changes have occurred internally or externally that warrant closer attention. Executives at one Fortune 500 company describe these activities as “taking a pause” to discuss risks to the business, especially enterprise risks that present obstacles to achieving the organization’s objectives. Brainstorming may focus on identifying extreme but plausible risk scenarios, such as a pandemic similar to COVID-19, a precipitous economic decline, an unexpected spike in interest rates, or signals of impending change in the regulatory climate in key markets.
2. Encourage a cross-functional, cross-unit perspective to circumvent new risks. In large organizations with different operating units, it is important to understand how support functions and units interact with each other and with outside parties. Ad hoc sessions should embrace a cross-functional, cross-unit view. For example, do multiple operating units source from the same supplier? If so, is business continuity risk exposure monitored over time on an enterprise-wide basis? If not, how should that be done?
3. Keep it fresh. While emerging risks may be identified through established committees, monitoring processes, and forward-looking key risk indicators, a constantly changing business environment necessitates shaking things up to encourage people to think out-of-the-box to avoid being constrained by rules and conventions. To illustrate, providing the latest information on market developments—perhaps sourced from the organization’s various intelligence-gathering functions—grounds the dialogue in business realities, keeps the assessment evergreen, and can elicit new insights into possible emerging risks. In addition, encouraging longer-term thinking—say, over a 10-year time horizon—can unleash dialogue that results in envisioning very different risks to the business. Considering risks over a longer time horizon is often a key distinction between organizations actively working toward alleviating sustainability risks, for example, and those who give lip service to such issues due to short termism.
4. Pay attention to the execution of the strategy. The 2009 NACD Blue Ribbon Commission report points out that boards need to pay attention to the risk that management may fail to execute the approved strategy either due to unwillingness or a lack of capabilities to execute it. In 2019 Governance Outlook: Projections on Emerging Board Matters, NACD survey data show that nearly 70 percent of directors believe that their boards must strengthen their understanding of the risks and opportunities affecting company performance. Accordingly, organizations should supplement the traditional retrospective metrics used to monitor performance with anticipatory and forward-looking indicators and trending metrics linked to the most critical risks to executing the strategy.
5. Watch out for “gray rhinos.” In 2018, the NACD Blue Ribbon Commission issued a report on board oversight of disruptive risks and the importance of adaptive governance as a framework for overseeing such risks. Ad hoc sessions can be used to consider possible disruptive risk events that are high impact, high velocity, and high persistence so that focused efforts are undertaken to develop and improve response plans. Apart from the so-called “black swans” (the risks that no one sees coming), these “gray rhinos”—defined by James C. Lam as “probable, high-impact trends [that are] clearly observable but often ignored”—can be just as threatening if they are disregarded until it is too late. Some examples of gray rhinos include the bursting of the housing bubble in 2008 and the impact of digital technologies on business models.
6. Expect the board to play a part in recognizing emerging risks. The 2009 NACD Blue Ribbon Commission report states that the board is positioned to provide a value-added perspective on emerging risks because it is “inherently less insular than a management team might be on [an] issue.” Boards should be resourceful in looking to external sources beyond management for insights on topics that matter. These sources may include industry developments, technological advances, investor feedback, benchmarking against competitors, and changes in the regulatory environment, among others. As there is no formal playbook for the board to follow when taking this initiative, such a collective effort by individual directors amounts to adhocracy at its finest.
In summary, the board should foster a risk-savvy culture that encourages management to look out far enough, monitor what matters both internally and externally, and devote efforts to assess the implications of change on the business. Effective adhocracy supports this culture by augmenting the formal processes management has put in place.
NACD: Tools and resources to help guide you in unpredictable times.