ERM Chapter 11 Flashcards
Name five categories of company stakeholder.
- Principal - contribute capital and/or expect a return e.g. shareholders/debtholders, customers, government, insurance market, financial market.
- Agency - paid by principals to perform a specific role on their behalf e.g. directors, pension scheme trustees/administrators, managers, employees, auditors, investment managers.
- Controlling - supervise the principals or their agents e.g. professional bodies, regulators, industry bodies, government.
- Advisory - advise the principals or their agents e.g. actuaries, lawyers, credit rating agencies, investment advisors, shareholder service providers.
- Incidental - affected by the behaviour and actions of the principal or their agents e.g. creditors, suppliers and other business partners, general public, media.
Outline shareholders role in ERM.
Shareholders seek a good return on their investments considering the inherent degree of risk. They have a strong interest in protecting against any events that could cause a collapse in the share price, but equally may seek value creation through risk-taking.
Depending on the strategy of the investor, some may prefer short-term gain whilst others may prefer long-term gain.
They are reliant on directors and auditors to safeguard their investment, and have relatively limited power until problems become significant. Many shareholders are turning to shareholder service providers, and by subcontracting their responsibilities to these organisations they become more influential and vocal on controversial matters.
Outline the role of shareholder services/proxy advisors and explain the concerns that might be raised about their role.
These institutions act on behalf of shareholders to:
- express considered views on the company e.g. on corporate governance, board composition and remuneration
- (optionally) manage their proxy voting
Concerns include:
- having power, but no responsibility, thus having influence on a high proportion of voters but no interest in the outcome of the vote.
- potential conflict of interest - some firms provide consulting and other services to the companies on which they are making voting recommendations.
- ‘tick-box’ methodology, where a common template is applied to all firms with little consideration given to the qualitative aspects of the individual circumstances of each company.
Outline the interests of customers and policyholders.
Seek both good value for money and security of the company in order that it provides the products and services expected. Individually customers are very weak, but collectively they have greater power, particularly when supported by customer advocacy groups (although often after an adverse event).
What are the key aspects of customer management?
Acquiring new customers - improvements in attracting and retaining the right customers can significantly increase the value of a business. High customer turnover rates are common, and it is cheaper to retain an existing customer than recruit a new one, so retention is important. Long-term customers are particularly valuable as they are more likely to purchase larger quantities, be less price-sensitive and more likely to recommend the company to other potential customers.
Retaining customer loyalty - dissatisfied customers will go elsewhere and may also dissuade potential customers from purchasing. It is not sufficient merely to satisfy a customer, some may still go elsewhere. Companies need to perform sufficiently well to retain the customer’s loyalty.
Knowing your customer - customer surveys, feedback and data mining are all useful ways of learning about a company’s customers and hence improve retention. However, privacy may be an issue.
Effective crisis management - a crisis generally damages reputation, however if handled well it may enhance reputation. Contingency plans should be in place before a crisis occurs. When a crisis does occur, a company should not try to cover it up, should act swiftly to resolve it, should keep stakeholders informed, and focus on the long-term future of the business.
Outline the interests of directors.
Have a need to balance the needs of other stakeholders with their own personal goals, which may be influenced by remuneration. They have a significant duty of care w.r.t. RM and must therefore ensure they fully understand the business and are able and willing to challenge management decisions.
Directors need to ensure the company remains compliant with all relevant regulation. Some are purely responsible for safeguarding the interests of shareholders, whilst others also hold roles within the firm (executive directors) and so can be considered to some extent as employees.
Give an example of an interest of NED that conflicts with shareholders.
e.g. the need to maintain their directorship and remuneration.
Outline the role of employees in ERM.
Employees have a key role in ERM as part of the day-to-day process throughout the whole organisation. The continued profitability and security of the company are directly related to the security of the individual’s job and benefits.
Give examples of the types of employees that might present a higher agency risk.
The risk perspective of employees should be similar to that of shareholders, as they act as agents. However, the further down the employee is, the more likely they are to act on their own rather than in the interests of the anonymous shareholders.
Members of unions may present additional operational risk due to the possibility of strikes and demanding of standardised wage arrangements.
‘Free agents’ (those that are self-employed or could be if they wished so) are less likely to align their interests with those of the company.
What are the key aspects of employee management?
Recruitment - companies need to identify and recruit the right individuals. Cash compensation is important, but other incentives and benefits such as pensions can make a substantial difference.
Staff retention, promoting and training - employee turnover can be costly, as skills and knowledge are lost , and employees may go to competitors, strengthening their positions. Morale, retention and productivity can be improved by career development programmes and continual training. It is important that employees feel valued and achievements are recognised.
Dismissal and resignations - large-scale redundancies adversely affect morale and can lead to voluntary resignations of highly-valued employees. In some circumstances a managed programme of dismissals, e.g. up or out, can increase employee motivation. Exit interviews are a valuable way of finding out why employees are leaving.
Aligning interests - there are two key groups of employees for which it is particularly important to align interests with those of shareholders:
- CRF, led by the CRO, who assess the level of risk across the organisation and enforce RM policies
- the pricing teams, who are instrumental in ensuring the profitability of the company.
Outline the role of regulators.
Regulators need to ensure that companies comply with relevant regulatory standards and aim to protect the stability of companies. Getting the right balance is important - sufficient controls to protect stakeholders, particularly customers and policyholders, but not so restrictive that the market is constrained and cannot operate freely and efficiently.
There is also a need for an appropriate intervention process, which assures issues are dealt with in good time but also allow opportunity for correction and improvement, thus hopefully avoiding closing down operations unnecessarily.
Outline the role of governments.
Set regulations and legislation, and intervene more dramatically when companies get into trouble. They may act as a lender of last resort or, in more extreme circumstances could force nationalisation of a company which would otherwise fail e.g. Fannie Mae and Freddie Mac in the USA.
List four key risks faced by governments.
- Insufficient tax revenues
- Inappropriate insolvencies - in particular the failure of strategically important organisations.
- Regulatory arbitrage
- Electoral losses
Outline the role of professional advisers.
External auditors perform annual reviews of accounts, and this should include assessments of the inherent risks and the ways in which those risks are managed. They have a duty to report openly and honestly on the state of the company on behalf of shareholders and regulators. The effectiveness of risk assessment may depend on the degree of disclosure and the extent to which issues are hidden by management.
Other professional advisers may be asked from time to time to investigate and report on specific matters, to provide assurance to various stakeholders. They bring independent technical expertise and industry benchmarking information.
List three key risks faced by professional advisers.
- Reputational risk
- Risk of litigation
- Conflict of interest e.g. the same accounting firm providing both audit services and more lucrative consulting services to the same client.
