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The widely publicized legal or financial difficulties of such highly-visible corporations as Enron, WorldCom, Xerox and a number of other large firms caused shareholders and regulators to demand that all companies manage risk more effectively. As executives and boards of directors scramble to meet new regulatory mandates, the spotlight is on applying financial and operational risk management tools. Although these are important from a compliance point of view, we believe that the main cause of some of the most noteworthy corporate debacles wasn't vulnerability to financial or operational threats. Rather, it was the absence of the effective management of strategic risks.
For example, according to prosecutors, criminal schemes hatched by top executives sank Enron. While the courts work their way through the charges, we ask a larger question: why would senior executives be in a position where cooking the books seemed the most attractive way out of a crisis? And why would a board be unaware that the company was at risk of finding itself in a corner so tight that executives would decide law breaking was their best recourse?
The root problem is the inability to properly articulate and evaluate strategic risks by corporate leadership - both top management and the board. In Enron's case, the plan to become a market maker in newly deregulated commodities rested upon critical assumptions about the future - for example, that their aggressive strategies to profit from deregulation would flourish. But risks such as those pertaining to the continuation of a trend in government policy - in this case, deregulation - are of a type that cannot be addressed by the tools designed to cope exclusively with financial or operational risk. Illegal actions and cover-ups are inexcusable, and any failures of financial and operational risk management mechanisms are of grave concern, but it is imperative that we also recognize the ultimate importance of...