Risk Management and Corporate Governance: Interconnections in Law, Accounting and Tax by Marijn Van Daelen (Editor), Christoph Van Der Elst (Editor)
After the recent financial crisis more and more pension and other funds are adjusting their portfolios for risk. This book offers a fascinating look at the juxtaposition of corporate governance and risk analysis. Bob Tricker has often proclaimed the 19th century the entrepreneur’s, 20th century management’s, and 21st that of governance. It could also be the century when risk and probability finally enter everyday consciousness and is finally taught in grade school.
The law of probabilities defined by Fermat and Pascal in 1654 started us down the road. Authors represented in this small volume bring us up-to-date regarding how far we have come on the journey from passive prisoners of providence to attempting to measure and manage all possible events.
In the 17th century the Dutch East India Company was forced by shareowners to publish balance sheet statements and profit and loss statements. Today, shareowners call on Starbucks to “Adopt a Comprehensive Recycling Strategy for Beverage Containers.” Talk about drilling down. The London city directory mentioned 11 accountants in 1799; we’ve come a long way. The authors provide a brief tour of history, which includes a wide variety of risk models, such as Value at Risk (VAR), Risk Adjusted Return On Capital (RAROC) and Economic Value Added (EVA), as well as many more complex views, including the Committee of Sponsoring Organizations (COSO) cube, its make-up and evolution.
Inadequate or imprudent loan policies played a part in 79% of collapsed savings and loans during that crisis; inadequate supervision by the board in 49% of cases, according to the GAO. The 2008 financial crisis once again highlighted the importance of how companies manage risk. The challenge is for regulators to get the right balance between high-level principles and detailed accounting rules.
The chapter on risk management from a business perspective gives a quick run down and description of documents from the Securities Act of 1933 to the 2008 Combined Code. Although providing better coverage of the UK than the US, the frameworks discussed have universal relevance. The chapter on risk management in financial law provides brief case studies, useful in explaining concepts such as securitization, credit default swaps, etc.
There’s also a chapter on taxes, which discusses the concepts of fair share by country and horizontal supervision. Perhaps the most relevant chapter is the last one, which discusses the race to reduce and control excessive risk-taking through the interconnections in law, accounting and tax. In this chapter, the authors move from a discussion of the birth of regulated markets and reporting to stakeholders, through to the corporate governance movement and the codification of internal controls and risk management, putting it all together with a map of the risk management landscape.
Although we can’t avoid risk-taking behavior altogether, we can heighten our awareness of risks and respond by reducing, sharing or accepting them in line with our risk profile. Whereas oversight in the past has almost wholly been with management, there is a real shift to emphasize the role of the board’s audit committee. Shareowners are also getting more and more into the act, examining and voting on compensation packages that can play a critical role in how incentives may drive risk.