Risk Management and Corporate Governance

Ana Bulgaru,Corporate Governance

2013

Content1. Corporate Governance2. Risk Management

2.1. Risk Types2.2. Risk Management processes2.3. Internal Controls

3. Dealing with Risk – Approaches3.1. Risk adjusted value3.2. Probabilistic approaches3.3. Value at Risk (VAR)3.4. Real Options

4. Risk management – Associations5. Case Study: New Star Financial vs Lehman

Brother 5.1. NewStar Financial 5.2. Lehmen Brothers

6. Conclusions 7. References

1.Corporate GovernanceCorporate Governance

DOING

THE

RIGHT

THINGS

AND

DOING

THINGS

RIGHT

2.Risk management

Principles

2.1Risk Types

2.2. Risk Management process

Internal Controls:

• COSO- Control environment- Risk assessment- Control activities- Information and communication- Monitoring

• Turnbull Guidance- Strategy- People- Detail- Tasks- Drivers

Dealing with risk – ApproachesRisk adjusted value.

Downside risk

• Risk adjusted discount Rate : calculate present value at a discount rate.- Cost of equity = Risk Free Rate + Beta + Risk Premium- Cost of Capital = Cost of Equity (Equity/Debt + Equity) + Cost of Borrowing (1+t)

(Debt/(Debt + Equity))

• Certainty equivalents: calculate the present value of an uncertain expected CF using a risk free rate

-

Dealing with risk – Approaches Probabilistic approaches.

Downside risk• Sensitivity analysis• Scenario analysis• Decision Tree• Simulation Analysis

Discrete/Continuous

Correlated/Independent

Sequential/Concurrent

Risk Approach

Discrete Independent Sequential Decision TreeDiscrete Correlated Concurrent Scenario AnalysisContinuous Either Either Simulations

Dealing with risk – Approaches Value at risk (VAR).

Downside risk• Variance covariance matrix• Historical data simulation • Monte Carlo Simulation

Real Option. Upside risk• Option to expand • Option to abandon • Option to delay or wait

Risk Management - Associations

Case Study: NewStar Financial vs Lehman BrothersSuccess story: NewStar Financial

NSF story:• Focused on risk management• Discuss and deliver

• Founded in 2004.• Buying and distributing risk• Capitalyze on opportunities• Market value of $863 million.

Success story: NewStar FinancialReasons.

• Appropriate stuffing• Individual credit selection (clearly defined approach)• Constant portfolio monitoring• Regular communication• Use of risk appetite

Impact:

• Assets of 2.28 billion in June 2013• Continuity• Client trust• Risk management sharing experience

Success story: NewStar FinancialRecomandation.

• Keep working in the same efficiency

Case Study: vs Lehman BrothersFailure story: Lehman Brothers• Founded in 1850• The fourth largest investment bank in US.• Doing business in: investment banking, equity and fixed-income sales

and trading, research, investment management, private equity, and private banking.

LB story:• End of mortgage boom in 2007• Invested $15 Mln in Archstone-Smith Trust (real-etate)• Largest bankruptcy in US having a worldwide impact.• Collapsed in 2008,• Debts: $613 billion

Failure story: Lehman Brothers.Reasons.

• Unmeasured risk of mortgage investments.• Bad communication between managers and CEO• English Authority for Financial Services didn’t approve the transactions with Barklay• Largest bankruptcy in US

Impact:

• American Government did not refused to “save”.• Worldwide impact on investment market.• Dow-Jones index lost 504 points.• American government invested over 62 MLD in other banks to keep the

balance later.

Failure story: Lehman Brothers.Recomandations.

• Plan and analyze better the risks associated with the business.• Avoid being exposed to risk hazard,• Improve communication• Create clear guidelines for risk management• Create/improve the department(s) responsible for internal control.

Conclusions:

• Risk management -> key important in corporate governance.

• Focus on healthy risk management can drive considerable profits

• Wrong (ignoring) the risk management can lead to bankruptcy.

• Best approach: “Learn from other’s mistakes”!

• Risk management journey is never complete.

• Is impossible to avoid all risks but a good management should be able to deal with it through various tools.

Reverences.• http://www.garp.org/media/991488/theroleofriskgovernanceineffectiveriskmanagem

ent_tunji_adesida_071312.pdf

• “RISK MANAGEMENT & CORPORATE GOVERNANCE” by Richard Anderson & Associates http://www.oecd.org/daf/ca/corporategovernanceprinciples/42670210.pdf

• “RISK MANAGEMENT: A CORPORATE GOVERNANCE MANUAL” by Aswath Damoradan, 2010, http://people.stern.nyu.edu/adamodar/pdfiles/papers/RiskManual.pdf

• “ Corporate Governance and Management of Risk (M_o_R)” by John Fisher, Unconfuseu, 2010, http://www.best-management-practice.com/gempdf/Corporate_Governance_and_Management_of_Risk.pdf

• DSM, Oct, 2013, https://www.dsm.com/corporate/about/corporate-governance/risk-management.html

• “ International Finance Corporation, June, 2012, http://www.ifc.org/wps/wcm/connect/9ff11a804c40464698dddaf12db12449/RiskGovJuly2012.pdf?MOD=AJPERES

• “Cum a contribuit Richard Fuld la daramarea Lehman Brothers, un imperiu pe care l-a construit de la zero” , 16 nov. 2008, Ciprian Botea, http://www.zf.ro/business-international/cum-a-contribuit-richard-fuld-la-daramarea-lehman-brothers-un-imperiu-pe-care-l-a-construit-de-la-zero-3505638

• http://www.conference-board.org/retrievefile.cfm?filename=TCB%20DN-V3N2-11.pdf&type=subsite