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The Dimensions of Risk Management - Corporate Governance : The umbrella in action

By Michael Vincent

26 December, 2006

In theory managers of listed companies are appointed by the shareholders and are accountable to the shareholders for their actions.  This is called "agency" or in other words the management of the company are agents acting in the best interests of the owners or shareholders.  If management fails to act in that best interest they can be classified as an "off-balance sheet liability."

The above describes a very narrow definition of corporate governance, that is the ability of the owners to ensure the managers act in accordance with the guidelines of the company and have accountability sheeted home.  Accordingly shareholders have a series of problems to overcome, chief amongst these are:

Therefore we can define corporate governance as a set of methods to ensure that investors get a return on their money, (Shleifer and Vishny 1997).  This served well whilst the shareholder was the focus of value creation; however recently, (indeed a couple of months ago in this column) the focus has started to shift from the shareholder to the stakeholder.  This change of focus has lead to a newer and more appropriate definition.

"A firm has many stakeholders other than its shareholders: employees, customers, suppliers and neighbours, whose welfare must be taken into account.  Corporate governance would refer then to the design of institutions to make managers internalise the welfare of stakeholders in the firm." (Tirole 1999).

The UK is setting a pathway of corporate governance being the skeleton of the management of risk to be fleshed out from the basic guidelines as discussed in the Cadbury and the Turnbull reports.  Our view would be that corporate governance is an aspect of good risk management as it will give an ethos to the management of a company and create an expectation of good performance based on acceptance of accountability.  However corporate governance is still only a function within the umbrella of risk; sitting at the heart of that umbrella is the acceptance of the management of risk as an integrated aspect of good management practice that encompasses a whole range of prudential issues.

Governance is basically a business process and is not only critical but also fundamental to each stage of the risk management process within an organisation.  In the framework of the management of risk within the firm correct governance ensures independence of the process from the risk taking activities entered into in the pursuit of business success.

Accordingly a proper governance process for a firm would provide the correct organisation support for the research, design, implementation, operation and validation of the company's risk policy.

Governance processes will by nature integrate the principles of risk management and the strategic flow on of decision-making.  It will demonstrate externally the functioning of policies, procedures, internal controls and reporting lines, in other words the working relationship structure within the firm.  Workflows, process maps and organisational charts will be necessary to demonstrate the levels of responsibility and accountability.

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