Risk management and the decision process : critical concepts for board members and top executives

Abstract

AIMS OF THE RESEARCH: To explore the decision making processes of top management, CEO's and boards of directors - to gain ne~ insights into the causes of management decision failures, management risk and decision process weaknessess. To identify important factors that play a pivotal role in effective decision making in business situations. To draw up a frame~ork for effective decision making based on the correlations between decision theory and empirical findings amongst senior executives and board members. To find ways how management can minimize the risk of decision failure in complex problems, what questions they have to ask themselves about the way in which they make decisions, what decision risks they have to be aware of at each stage of the decision process and how they can gain from available decision theory. The aim is to improve the decision process to obtain better overall quality of decisions produced by kno~ledgeable senior managers and board members. This will provide a framework for effective third generation risk management.

EXECUTIVE SUMMARY OF THE RESEARCH FINDINGS Board members and top executives rely on experience and personal knowledge to analyse complex problems and do not consciously involve concepts from decision theory (see section 8.5). They describe these phenomena in their organisations, but they have not formally done a decision process analysis to minimise decision risk. Current risk management practises in modern financial institutions focus mainly on risk classification techniques and structural mechanisms (see section 15) to control risks, with little or no attention to decision process dynamics. The Board of Directors and Top Management are generally very good at identifying corporate risks, economic risks and financial risks, but they have great difficulty in identifying internal decision process risks within the management hierarchy/system or amongst themselves. Introspective analysis of their own decision process dynamics can help to improve this. A step by step analysis of the decision process in the board and top management team as described in section 18.2 is proposed as a further contribution to improve the quality of decision making in financial institutions. Structural changes to boards like those introduced by Cadbury improved second generation risk management practices. This research proposes that further advances can be made by third generation risk management improvements in the decision process dynamics. We teach decision makers about economic and financial analysis and derivatives and risk management, but the fundamentals of decision science and the human decision process seem to be ignored. To prevent the financial failures that so often destroy shareholder value, we need to focus on decision science and financial decision process analysis Analysis of the decision process dynamics is proposed as a way to reduce the number of decision failures in large financial institutions and other organisations. By increasing the a~areness and kno~ledge of board members and top executives about the potential causes of decision failure, their own ability to identify and prevent these will be improved. New risk management structures and recent changes to board structures have contributed greatly to corporate governance but could not prevent many of the financial failures. Combining these structural improvements with an additional focus on decision process analysis can increase our ability to manage risk successfully.