In this video, examine the upside and downside of risks corporations face, and look at the purpose of risk management.
- Businesses make money because they take risks, but if they take on too much risk, they could go out of business. A great example of this was the energy company Enron. It was worth billions of dollars, but the company took on too much risk and one day, the company was gone. There is an important balance that corporations have to strike between upside and downside risks, and this is one of the core foundations of corporate financial risk management. Managing risks is important for making a business successful and stable.
In this video, we're going to talk about how and why risks are important for businesses. Upside risks present opportunities for profits but downside risks present the potential for losses. Effective risk management is important for helping companies capture both the upside opportunities and limit downside risks. In the same way that a prospector in the gold rush era would have bought a pickax to mine for gold, there was risk involved. Maybe at the end of the day, he would have found gold, or maybe at the end of the day, he would just have a pickax.
Any modern business functions under similar conditions. Businesses take risks all the time to try to capture margin, build their business, drive profits and achieve growth, and yet, if that prospector took everything he had and spent it on that pickax, there isn't much risk management there. If he doesn't find gold quickly, he could find himself in a very bad place. Maybe a better strategy would have been to risk a little bit, but not everything.
For a corporation, sometimes it's all or nothing, but there should be a good understanding of the risks involved. Knowing the downside risks is a critical first step. You need to know what's at stake. By and large, entrepreneurs are known as a risk-taking class. Most risk a little at first, until there's evidence that a business can be built, something known as proof of concept. And a proof of concept is when you first prove something can work. A great example of this was when the Wright Brothers tested their first plane in Kitty Hawk, North Carolina.
That plane wasn't the Concord trying to break the sound barrier, or one of Top Gun F-14s, it was a wooden plane they were just trying to get off the ground for a few seconds. Now that short time off the ground provided proof that the concept of flight could work, or the proof of concept. But even if a business is careful, and risks are taken slowly, there are internal and external factors that can threaten to upend almost any business. There's a joke people like to tell about CEOs, and I've seen it shown in a few different ways, but in each case, the presentation is similar.
The peak goal for most CEOs is to go to Davos, a winter meeting of global leaders, politicians and cultural icons, in the Swiss Alps, each January, and while that may be the top goal, the first goal is more fundamental, just don't get fired. For a corporation, the internal and external risks people talk about are not usually focused on finding gold nuggets or going to Davos, they're about going out of business. When people talk about corporate risk, they're focused on the negative risks that need to be avoided.
Of course, sometimes there is the potential to turn downside risks into upside opportunities, and we'll dig into those in other videos. But normally, when people talk about corporate risk, know that they are talking about minimizing, mitigating, eliminating, offsetting or otherwise reducing negative risks that could make a company lose money or go out of business. The way companies do this, the structured way they protect themselves from downside risks is called risk management.
So, whether you're a modern-day prospector, an entrepreneur dreaming of flying, a CEO dreaming of Davos, or anyone in between, know that along with the upside risks for your company, there are downside risks that require proper risk management.
Jason Schenker of Prestige Economics discusses nine types of corporate risk, including financial and nonfinancial risks. He explains the difference between direct risks that companies face constantly, as well as indirect risks that usually come from vendors, competitors, and counterparties. Then he covers how risks are typically resolved, either by elimination (divestiture or acquisition), transfer (hedging or insuring), offset (creating a natural hedge), or ownership (keeping the exposure). Finally, he reviews how corporations can actively measure and monitor risk by appointing dedicated risk managers, officers, and committees.
- Understanding risk in corporations
- Risk management process
- Nine different types of corporate risks
- Financial market risks
- Direct and indirect risks
- Risk management solutions
- How corporations actively manage risk