Growing Web of Risks in Today's Business World

As many companies look to better understand the complex risks within their organization, recent events are pointing to the increasing need to understand the even more complex risks posed by partner organizations. Richard Thaler, professor of economics and behavioral science at the University of Chicago, provided his view in the New York Times this week.

AS the oil spill in the Gulf of Mexico follows on the heels of the financial crisis, we can discern a toxic recipe for catastrophe. The ingredients include risks that are erroneously thought to be vanishingly small, complex technology that isn’t fully grasped by either top management or regulators, and tricky relationships among companies that are not sure how much they can count on their partners.

For the financial crisis, it has become clear that many chief executives and corporate directors were not aware of the risks taken by their trading desks and partners. Recent accusations against Goldman Sachs suggest the potential for conflicts of interest among banks, investors, hedge funds and rating agencies. And it is clear that regulators like the Securities and Exchange Commission, an agency staffed primarily with lawyers, are not well positioned to monitor the arcane trading strategies that helped produce the crisis.

The story of the oil crisis is still being written, but it seems clear that BP underestimated the risk of an accident. Tony Hayward, its C.E.O., called this kind of event a “one-in-a-million chance.” And while there is no way to know for sure, of course, whether BP was just extraordinarily unlucky, there is much evidence that people in general are not good at estimating the true chances of rare events, especially when human error may be involved. There was another major blow-out in the gulf 31 years ago by the Mexican rig Ixtoc I. So was this really a one-in-a-million risk?

In the current spill, the problems of assessing risk were complicated by the teamwork required among BP; Transocean, which owned the rig; and Halliburton, which had provided services like concrete work. “Of the 126 people present on the day of the explosion, only eight were employees of BP,”reported Ian Urbina in The New York Times. “The interests of the workers did not always align.”

Certainly, before a company can fully understand the growing web of internal and external risks inherent in their business activities, the company must have a disciplined approach to risk management. A strong enterprise risk management program can help in this regard. If your company is looking to implement or improve its enterprise risk management program, Wheelhouse Advisors can help. Visit www.WheelhouseAdvisors.com to learn more.