CORPORATE GOVERNANCE

QUIZ 2&3

HAMZA IHSAN
SP17-BBA-007
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Contents
EXECUTIVE SUMMARY...........................................................................................................................................2
RISK MANAGEMENT AND CORPORATE GOVERNANCE...............................................................................3
INTRODUCTION:........................................................................................................................................................3
Relationship between the two:..................................................................................................................................4
Effects of risk management on corporate governance:...........................................................................................4
Summary:................................................................................................................................................................... 5
REFERENCES :............................................................................................................................................................5
Bibliography..................................................................................................................................................................... 5
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EXECUTIVE SUMMARY

Risk management is an important factor in corporate governance nowadays. It plays a vital role in
deciding the fate of any corporation. Risk management has always been in the lime light for the the impact it
has on the success of a corporation. A corporation is said to be successful if its risk management skills are up
to the mark and it is familiar with the term ‘calculated risk’. This document is about risk management and
corporate governance. It discusses in great detail both corporate governance and risk management. It also
points out the relation between the two. It sheds light on the processes and steps with which a corporation
can guarantee its success in today’s corporate world. This document gives the reader a true representation
of the impact risk management has or would have on the success of an organization. It emphasizes the
abiding by of corporate law in true letter and spirit for the accomplishment of goals a corporation or an
organization seeks to achieve. Risk management is a core aspect of corporate governance which has been
proved to play a vital role in any organization’s development. Corporate governance is incomplete if the
topic of risk management is excluded. It is therefore a corporation’s first priority to devise a plan for the
accomplishment of a perfect balance of risk management.
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RISK MANAGEMENT AND CORPORATE GOVERNANCE

INTRODUCTION:
Risk evaluation and risk management instruments are difficult to use and monitor. Understanding
them often requires a good grasp of mathematics and statistics. It is, consequently, not clear that audit-
committee members without specialized training would be up to monitoring the in-and-outs of coverage and
even speculations presented to them, often in rapid and very summary fashion. For example, at the meeting
of the Enron audit committee on February 12 th, 2001, nine important points were included on the agenda,
two of which were linked to risk evaluation and risk management.

The meeting lasted eighty-five minutes! Even if the committee was composed of leading experts in
management and university research (the list of points discussed and of the committee members present is
discussed in Healy and Palepu, 2003), it is unlikely that all these items were explored in depth, particularly
those linked to transactions which could have appeared suspicious or tinged with conflict-of-interest
concerns. It is now a well-known fact that risk management issues can give rise to conflicts of interest
between corporate executives and shareholders, notably when executives are remunerated with their firm’s
stock options (Smith and Stulz, 1985).

Take the example of the risk management of gold mines, which, for several years, has been a topic of
detailed study (Tufano, 1996; Dionne and Garand, 2003). The principal random variable linked to the
financial risk of firms in this industry is the selling price of an ounce of gold. There are three questions
which are asked by the executives of the mining corporations and they are as follows :

1. Should we hedge the selling price against future fluctuations.

2. If the answer is yes, then the question arises in what proportion.
3. And most importantly what instruments should we use.

It is now established that one of the main goal of risk management is to maximize the firm’s value or
shares. But risk management can also serve to maximize the well-being of executives and this second
objective can be in conflict with the first, especially when the executives in question are remunerated to a
significant degree with stock options. This type of conflict can produce problems of governance. Indeed,
Tufano (1996) has observed that, in the North American gold mining industry, executives remunerated in
stock options undertake fewer risk management activities that those who are not (also see Dionne and Triki,
2003, who obtained similar results with an update of data and different econometric specifications, as well as
Rogers, 2002, for the same conclusion drawn from another data base).

This finding can be explained by the fact that the value of executives’ options will increase with the
volatility of shares or with the volatility of the firm’s value. Even if managers are risk averse with respect to
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their own wealth, they are risk-leaning (have convex preferences) towards the firm’s value when they hold
stock options in the firm they manage. This is what explains their decisions to engage in fewer risk
management activities, since such activities would reduce the volatility of the firm’s value and, thus, the
value of their options.

Relationship between the two:

A theoretical counterargument has recently been presented in the literature by Carpenter (2000).
According to this author, holding options has two consequences for the wealth of executives. The first is the
one reported above: The wealth of managers will increase with the volatility of options because the value of
the latter will increase accordingly. The second argument is that the value of the options portfolio will drop
when shares fall in value because the probability of exercising the options will also decline. We thus have an
ambiguous relationship between holding options and risk management, but the empirical results mentioned
above seem to confirm the dominance of convexity of preferences among managers and the source of
conflict of interests between executives and shareholders.

Finally, another study shows that firms most active in hedging against risks are those that have the
largest number of external directors on their board (Barochoric et al., 2001); however, these authors did not
check whether or not these directors were independent.

These results call into question the composition of risk management committee appointed by boards,
since more than a few directors may also hold the stock options of firms on whose boards they sit. This is a
key question, since general risk management policies must be approved and monitored by the board of
directors. In our opinion, the risk management committee should also be composed of competent and
independent directors and, above all, of directors who hold no options to purchase the firm’s shares! It is not
obvious that simply regulating the composition of the audit committee will suffice to curtail potential
conflicts of interest linked to risk evaluation and risk management, especially in firms with a committee
dedicated to these tasks.

Effects of risk management on corporate governance:

Risk-taking drives corporations to push ahead and make steep gains. When risks pay off, profitability
makes shareholders and stakeholders happy. Technology has created greater global interconnectivity, which
is an asset for most businesses. Consequently, interconnectivity makes the perspective of risk-taking
extremely complex. The changing landscape of risk is creating a global conversation about how principles
for corporate governance need to evolve to respond more appropriately to the relationship with risk
management.

The world’s corporations are keeping a keen eye on how large corporations are managing and
responding to risk failures so they can avoid the same mistakes. They’re learning that companies tend to
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underestimate the cost of risk failures internally, as well as externally. In many cases, corporations are also
underestimating the cost of time that managers need to address damage control.

Banks and other financial institutions have long set the standards for good corporate governance
principles. While the world has much to learn from their strategies and missteps, the governance principles
they’ve established don’t necessarily translate well for all types of businesses. As the conversation
continues, corporations are trending toward wanting to take a broader-based approach toward corporate
governance principles to suit more diverse situations.

Summary:
This document is about the risk management involved in corporate governance. It gives an insight
into the role of risk in corporations and its affects arising from both bad and good risk management
measures. This document provides the relationship between risk management and corporate governance and
explains how these two are interlinked.

Risk management plays a very crucial part in today’s corporate environment. Things could have
completely opposite results if risk management is not done properly. For the purpose of risk management all
the rules of corporate governance must be followed. If a corporation abides by the rules of corporate
governance in true letter and spirit only then would it be able to manage its risk and bring about its positive
impacts on the organization.

For instance when the financial crisis of 2008 hit the world a lot of changes came in the financial
world very swiftly and many things have changed since then. Technological advancements have also paved
a way for new advancements but corporate governance has still not been able to bring change to itself
according to the demands of the current corporate structure. Corporations need to remember that their main
goal should be to create an optimal level value for their customers and shareholders. Corporations should
only focus on the supervision of their firm’s ability and efforts to maximize its risk management.

REFERENCES :

[CITATION Nic \l 1033 ]

Bibliography
Price, N. J. (n.d.). Relationship Between Risk Management and Corporate Governance. From Diligent Insights:
https://insights.diligent.com/risk-oversight/relationship-between-risk-management-and-corporate-
governance#:~:text=Relationship%20Between%20Risk%20Management%20and%20Corporate
%20Governance,-February%2021st%2C%202018&text=Risk%2Dtaking%20drives%20corporati