Friday, December 12, 2008

Stages of Risk Management

Phil made this point and it's worth covering here. He broke risk management into three stages:
  1. Counting: This is simply adding up resources, expenditures and what not. What does the firm posses?
  2. Accounting: This is simply making some sense of what it is they posses, in a systematic way. It is a measure of value.
  3. Accountability: This is generally defined as responsibility, liability, etc. It goes beyond accounting for what happened and implies that someone or some group is ultimately responsible for some set of actions.
With the recent problems in financial and credit markets, and now with our auto companies, it is clear that firms at most get to stage 2. Perhaps a CEO or two gets fired or demoted to a $1 salary, but there is no real accountability. Earlier in the financial crisis there was considerable uncertainty as to what banks even had on their balance sheets, which indicates a failure at point 1, which is a very bad sign. Resilient companies understand all three points and are able to adapt to shocks and may even prosper from them. Companies that do not get to stage 3 have little hope and it is becoming clear that the taxpayers are now the ones that must bear the burden.

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