Many people talk and write as if risk and reward were the true trade-offs in a capitalist system. It certainly makes risk management important if that were true.
But unfortunately for us risk managers, and fortunately for business managers, choosing among risky alternatives is not the best choice for business success.
In fact, the natural tendency of capitalism is directly away from risk and towards Competitive Advantage. If a business can find a competitive advantage, their first choice forever after is to strengthen that advantage and to reduce their risk.
A business with a total competitive advantage, also called a monopoly, is crazy to then take any risk. Economists call their income a rent. The income from risk taking is called a risk premium. All businesses prefer rents to risk premiums under that definition.
So the risk managers who talk all of the time about the risk and reward continuum and about the efficient frontier of risk taking are talking nonsense to any business person who knows the story of any of the most successful businesses. The most successful businesses all made fortunes for their founders by collecting rents.
What we should be talking about is the Rent / Risk continuum. If you want to be really successful, you need to find a way to collect rents. If you want to get mediocre returns, then you can go out and take risks.
Many years ago, Riskviews was producing risk reports for return on risk capital for an insurer. The insurer had some fee for service business. This business did not fit into the risk reward framework.
Investment Banks had at one time been mostly fee for services businesses. Then for a time, they decided that they could make more money taking risks. It turns out that they were largely wrong. The “profits” that they were recording on their risk taking were risk premiums for taking very large risks that were “in the dark“. According to Taleb, they were being massively underpaid for those large but infrequent risks.
Some reinsurers that make their business taking on large amounts of catastrophe risks can be shown to be taking a significant amount of their value from the “default put” that is created because they collect premiums for all expected claims under their reinsurance contracts, but they do not intend to pay off on the largest catastrophes because they will have defaulted.
Risk taking is a questionable way to make profits.
So risk managers need to work to identify rents and properly reflect the superior place that rents should have in business goals. Risk managers should be slow to claim that any risk taking behavior will make a profit and not just mistaken accounting of risks that are waiting in the dark and growing stronger to take back all of the so called profits from risk taking.