Risk Management Blog - ClearRisk

Examining Strategic Risk – What is it – Why Should We Care? Part 2

Posted by Craig Rowe on Wed, Oct 14, 2009 @ 16:10 PM

One of the reasons for the lack of academic research about strategic risk is the confusion as to what is ‘strategic risk’. Many of the early ERM adopters are at a preliminary assessment in which they treat enterprise risk management as an extension of their audit of regulatory compliance processes. Other organizations are at a more advanced stage, in which they quantify risks and link them to shareholder and risk-transfer decisions.

Even among more advanced practitioners the focus of enterprise risk management rarely includes more than financial, hazard, and operational risks. It is relatively rare to have an organization focusing on its strategic risks as part of its ERM practices. The result is that organizations may be focusing on the wrong risks, instead of the strategic risks that can be a much more serious cause of value destruction (see for example the work of Slywotzky and Drzik 2005 in the Harvard Business Review).

It is important to note that financial risk has been the focus of much of the management literature and is the most developed when examining strategic risk. Financial risk is primarily quantitative with emphasis on the risk return relationship; the academic research manifesting this focus on quantitative analysis.

Also there has been a plethora of research on the managerial perspectives on risk and risk taking particularly within financial management. Significant work has also been done at the organizational level where most of the management literature has emerged from Bowman’s (1980) work on the notion of risk/return.

Specifically the academic research on the concept of strategic risk has focused on the issue or Bowman’s Paradox which stated there is a negative relationship between risk and return in most industry sectors. This is contrary to conventional thinking which has that higher risks are positively correlated with higher returns in the aggregate.

This creates a dilemma about organizations trying to manage strategic risks.

Bowman argued that an organization’s attitudes towards risk may influence its risk taking. Firms who do not perform well in the aggregate often take greater and less justifiable risks (Bowman 1982).

This finding pointed to the need for a comprehensive strategy and understanding of the individual organizationals factors in the development of an approach to risk.

However, the result of Bowman’s and others work has been to place an emphasis of strategic risk within a financial contest which has focused and shaped the management literature. The focus has been on quantitative research on financial risk management issues which may have a strategic impact upon the organization. There has been little consideration of the non-financial strategic risks facing an organization. Some of these non-financial risks may be considered ‘soft’ or un-quantifiable, such as reputation, which means that a qualitative approach may be the most appropriate method for further research and management.

Essentially how do you manage that which is difficult to measure?

For more on strategic risk, check out Examining Strategic Risk – What is it – Why Should We Care? Part 1

References:

Bowman, E.H. (1982). Risk seeking by troubled firms. Sloan Management Review, 23(4), 33-42.

Slywotzky, A.J.; Drzik, J. (2005). Countering the Biggest Risk of All. Harvard Business Review, (April), 78-88.

Topics: strategic risk, what is strategic risk, planning risk management, why strategic risk is important