Value-driven ERM: Managing Risk in Real-Economy Companies
For non-financial companies in the real economy, the need for effective enterprise risk management has become more urgent than ever. In the face of worldwide economic downturn, turbulent markets, and pressure from regulators and rating agencies, boards are demanding it, and many CEOs are searching for the right model.
By Carl Spetzler and John Celona
Strategic Decisions Group
November 2008
Until recently, financial firms would have been held up as the gold standard for risk management. Certainly, they employ hundreds of highly-trained, hard-working staff in their risk management departments. They have extensive analysis, models, procedures, and attention from the top of the organization. However, the financial services approach to risk management is inadequate for real-economy companies – and not only because the meltdown on Wall Street calls it into question. More fundamentally, Wall Street, with an investor mindset, identifies risk with the volatility of a stock, which can of course be bought or sold in a second by investors.
For the CEO of a real-economy company, the daily volatility of the stock price provides only a small input to the understanding of enterprise risk. Rather, risk must be conceived in terms of big swings in value that take place due to major events or over months and years, not hours and days. Real companies may buy and divest businesses, but they simply cannot get into or out of their businesses on a moment’s notice. The real measure is not a “spot” price or today’s market capitalization, but the intrinsic enterprise value, which depends on the systems – economic, commercial, organizational, regulatory, business portfolio, operational, and many others – that underlie that value.
