A question of risk
The Revolutionary Organization
The most important organizational structure the world has ever seen is not the nation-state, or any religious institution, the monarchy, or any political party, movement or philosophy. Nor is it the city, town or community, or even the family. The most important organizational structure the world has ever seen is in fact the company.
So argue John Micklethwait and Adrian Wooldridge in The Company: A Short History of a Revolutionary Idea (2003). As the authors show, the company is the basis of prosperity, the engine of economic growth, the sine qua non of economic development. Its place in the history of the West is unrivaled; its centrality to the future of the rest of the world is crucial. To quote Nicholas Murray Butler, one of the great sages of the Progressive Era, “The limited liability corporation is the greatest single discovery of modern times.”
Companies have proved enormously powerful – reconfiguring geography, warfare, the arts, science, all fields of endeavor. They are the reason why the West prospered while once great civilizations in China and the Islamic world fell behind. Today most people in the West work for companies, which also produce the bulk of the world’s products.
The three big ideas behind the development of the modern company are as follows:
* It could be an “artificial person,” with the same ability to do business as a real person.
* It could issue tradable shares to any number of investors.
* These investors could have limited liability; that is, they could lose only the money they had committed to the firm – creditors have no recourse to the company’s owners.
Thus do companies increase the pool of capital available for productive investment. And thus does the company – in organizational structure and in concept – unleash creativity, innovation, inventiveness, and perhaps most importantly, productive risk-taking.
The Revolutionary Idea
“The revolutionary idea that separates modern from ancient times is the mastery of risk: the notion that the future is more than the whim of the gods and that men and women are not passive before nature.” So writes Peter Bernstein in Against the Gods: The Remarkable Story of Risk (1996).
Bernstein’s argument is that an understanding of risk is at the very heart of progress: “When investors buy stocks, surgeons perform operations, engineers design bridges, entrepreneurs launch new businesses, astronauts explore the heavens and politicians run for office, risk is their inescapable partner.” These are calculated risks, of course, and how risk is best calculated is Bernstein’s central theme.
Since we cannot know what is safe unless we are willing to find out what is unsafe, the only way to reduce risk in the long-term is to take risk in the short-term. Risk management, the main focus of Bernstein’s book, is the process, both analytical and subjective, of understanding, measuring and predicting risk. In this sense risk is a choice, rather than a fate. Risk management transforms risk from something to be avoided or faced armed only with bravery, into a set of opportunities open to choice (options) and direction (maneuverability).
Interestingly, after discussing statistics, utility theory, probability theory, financial risk analysis, business forecasting, game theory, insurance, derivatives, chaos theory and neural networks, Bernstein concedes that quantitative analysis is not always accurate or even appropriate. Risk management, in the end, is as much art as science, and must include, even integrate, subjective belief.
Why It’s Time to Take a Risk
The irrational exuberance of the 1990s has been replaced by an irrational lethargy, entrepreneurial bravado with marked apprehension. Wherever you look, the forces of retrenchment are on the march. But as Gary Hamel, chairman of management consultancy Strategos, writes in Business 2.0, you can’t move forward when you’re cutting back: “The trick in tough times is to downsize your cost base without downsizing your future.”
During the past two years, capital investment has declined about 11%, more than during the 1990-91 recession and almost as much as during the recession of 1981-82. Billions of dollars are disappearing from balance sheets as companies write down the value of poorly conceived acquisitions, struggling venture divisions, and unsold inventory. The hiring slump is persisting, with more than 1.5 million jobs lost since the start of the 2001 recession. And among venture capitalists, 70% of current cash goes to fix problems at existing companies rather than to fund fresh ideas.
But timidity is not a strategy, writes Hamel, and innovation is still the engine of growth. Besides, resources are cheap, the competition is paralyzed, and tight money is a blessing (forcing the discovery or invention of cost-effective solutions).
Cutting costs is seldom a winning strategy in the long run. According to a Mercer Management study, of 116 companies that aggressively cut costs in the 1990-91 recession, only 29% managed to grow both profits and sales in the 1994-99 expansion, compared with their peers. Furthermore, momentum can be crucial coming out of a downturn. According to Accenture Consulting, companies that emerged from the 1990-91 recession with high returns on capital maintained their lead over other companies through the decade.
Many legendary companies made their names during economic downturns, including Ford, Wal-Mart, Federal Express, Microsoft, Compaq, Intel, and JetBlue. Today, meanwhile, IBM, Dell, Pfizer and UPS expand through times of slow growth, so as to be better positioned for the inevitable return of faster growth.
How to Take Risks in a Time of Anxiety
Not all risks are alike, writes Leigh Buchanan in Inc. magazine. There are “intrusion” risks (risks of ungovernable disruptions by God or man), and “decision” risks (those affected directly by our choices and actions). We can’t do much about intrusion risks, but decision risks are actually getting easier to govern, thanks in part to the intensified attention risk is getting from software developers, political economists, psychologists and others.
A number of strategies have emerged for assessing risks in order to make better decisions, writes Buchanan. All of them take this as their premise: that risk is ultimately a byproduct of uncertainty, and the best weapon against uncertainty is knowledge. The knowledge required to judge wisely falls into four categories:
* Decision makers should know their own personal biases, and how those biases might influence their judgment. Because people are so influenced by context, the best way to at least approximate objectivity is to ask a question in as many ways as possible. Psychologists call this altering the “frame.” It means decision makers consider multiple assumptions about the present, their points of comparison, and the nature of their motivation.
* Decision makers should know the statistical probability of success and the magnitude of potential failure. Probability modeling is a common technique in large companies that is starting to filter downstream. Popular modeling tools include Monte Carlo simulation, and decision trees.
* Decision makers should overcome groupthink by consulting a wide range of experts. Diversification as a risk-management tool works for stock portfolios, revenue streams, and also, it appears, expert opinion.
* Decision makers should know if their companies have organizational Achilles’ heels that might imperil a desirable outcome. All companies need to map and weight their risks, involving as many employees as possible in the assessment process, and update those risk plans often.
Echoing Bernstein, author of Against the Gods (see above), Buchanan concludes that risk management tools, techniques and models are not always accurate or appropriate. Ultimately, the goal isn’t to get “the right answer” (because often there won’t be one), but to gain a fundamental understanding of how risk works, and to use that understanding to make good decisions. When all else fails, intuition and improvisation must prevail.
Criminalizing Risk
Politicians are punishing Wall Street to avenge a stock market gone sour, writes Neil Weinberg in Forbes. The new rules, passed in response to the infamous misdeeds of a few – Enron, Arthur Andersen, WorldCom, Global Crossing, Tyco – will make life tougher for all 15,000 publicly held firms m the US. Main Street and small investors will be among the unintended victims, he contends.
The Sarbanes-Oxley Act will force public companies to underwrite more expensive audits and revamp financial controls, even if they believe the costs outweigh any benefit. Their foreign operations must comply with the same standards. The bill is so arcane that the day after it passed the general counsel of the securities & Exchange Commission presented Oxley with 20 pages of questions, asking what lawmakers were trying to do.
Robert Elliott, head of the American Institute of Certified Public Accountants, is quoted as saying, “It’s the criminalization of risk-taking, which is the same as criminalizing capitalism.” Writes Weinberg:
The regulatory onslaught already is wreaking unintended consequences on the US economy. Dozens of public firms are going private. Foreign companies are shunning US markets and raising cash in London, instead. Executives, fearful of the mounting threat of litigation and criminal prosecution, are passing up the sort of promising ventures they were hired to pursue.
George Melloan, writing in the Wall Street Journal, is more sanguine about both the short-term and long-term future. Indulging in a rosy scenario for the US economy, he cites improved corporate cash flows, earnings and profits; continued improvements in productivity; high total employment despite recent job losses; the beneficial trade and investment effects of a less-than-super-strong dollar; the decline in crude oil prices; the expected tax cut to be enacted this year; and the return of investor and consumer confidence.
He concedes that Sarbanes-Oxley and other regulatory measures may have done more harm to business confidence, and the ability of companies to adapt to changing circumstances, than has been readily apparent. But all and all, it appears, the resilience of American business will again prevail.
Copyright FutureScan May 2003
Provided by ProQuest Information and Learning Company. All rights Reserved.
