THE BIGGEST challenge in performance management today is the increased attention that needs to be paid to the risk-reward trade-off. Companies have been ignoring the risk side of performance management for too long – a lot of attention has traditionally been paid to performance measurement and monitoring (ie, the reward side of the equation), but all performance is essentially linked to risk. Risk is intrinsic to doing business.
The recent financial and economic crisis has shown that a failure to integrate performance and risk management can leave businesses struggling in the face of uncertainty. For example, at some banks the group risk management function was alerted to potential subprime losses long before the senior management appreciated the severity of the problem. Often, it was not until a presentation was made to the Chairman that included both performance and risk aspects that the size of the problems became known to the board.
The resulting legislation and codes of conduct have significantly increased the scope of directors’ responsibilities. But because of this, companies’ efforts in the area of performance and risk management at board level focus far too much on documentation and procedures to meet regulatory requirements and not enough on how to obtain and integrate performance and risk information for more effective decision making.
One way to link performance and risk reporting to the board is by integrating risk-adjusted performance measures (“key risk indicators”) in a company’s balanced scorecard. Another way is through scenario planning and budgeting, where senior managers have to come up with draft performance objectives, think over potential threats to realisation of those objectives and then fine-tune their plans accordingly. That way the board is in a better position to “stress test” the strategic plans that are being proposed to them for approval.
The research grant we were recently awarded by CIMA will allow us to document the state of affairs and analyse the different approaches companies use with respect to integration of performance and risk at board level. I expect the research to highlight that risk-enhanced performance reporting should be incorporated within the company’s normal performance management and governance processes, rather than treating risk management as a separate exercise to meet regulatory requirements.
At the very least, I hope that we will be able to create awareness of the problem that some boards may be sub-optimally informed about risk and how it affects company performance.
Professor Regine Slagmulder is associate professor of accounting and control at Vlerick Leuven Gent Management School