Concentration of Power Risk

 

Guest Post from Max J. Rudolph, FSA CERA CFA MAAA

Rudolph Financial Consulting

A risk that we never talk about has become the elephant in the room. Some would call this ego risk, but at most institutions decision making occurs primarily at only the highest levels. It has been a year since I wrote a financial essay titled Does Your Company Need a Chief Skeptical Officer? I don’t think it has gotten any better. This is not due to poor goal setting. These senior officers believe they are doing what is best for their firm. Unfortunately, all of us tend to fall in love with our best ideas. We see that when we invest, where we hold losers far too long. When a manager has worked hard for a long period of time to develop an opportunity it can gain such momentum that it can’t be stopped no matter how poor the idea or the timing for the idea is. Many companies continued to write loans that previously had been securitized while liquidity in this market dried up. Others threw good money after bad on commercial real estate properties while existing properties were sitting vacant. There are very few companies that have instilled this skepticism in their risk culture. Berkshire Hathaway is one, where both Warren Buffett and Charlie Munger are comfortable in their own views and are encouraged to say what they think to each other. It will be interesting to see if this culture extends to the next generation of leaders at this highly successful firm. One way to ensure this is to practice consistent pricing discipline. When an opportunity comes about, the same financial analysis should always occur. This will include setting risk appetite, hurdle rates, and capital. It will not include having the CEO override the discussion.

There is no momentum to create this type of culture. Perhaps it should be developed at the board level with independent ERM experts providing the process and bringing in specific topic experts to anonymously consider these risks.

Warning: The information provided in this Post is the opinion of Max Rudolph and is provided for general information only. It should not be considered investment advice. Information from a variety of sources should be reviewed and considered before decisions are made by the individual investor. My opinions may have already changed, so you don’t want to rely on them. Good luck!

©2009 Rudolph Financial Consulting, LLC

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