Accounting for good practices: why effective risk management matters

Andrew Leck

THE global attitude towards risk management has changed irrevocably in the last three years.

Yet, despite the increasingly stringent regulatory controls and development of sophisticated financial modelling, at the end of the day, risk management must address the human factor.

People ultimately make decisions based on the best available information, but more crucial is how that information is delivered, who it is delivered to, and whether and how it is acted upon which ultimately defines how well risk is managed.

The Association of Chartered Certified Accountants (ACCA) recently compiled a study, ‘Rules for Risk Management: Culture, Behaviour and the Role of Accountants’, which is revealing in the attitude of its members because it shows what actually happens within organisations where advice is given by risk assessment professionals, how ethics come into play – or flies out the window – and what risk management should and shouldn’t look like in practice.

The study canvassed over 2,000 ACCA members from 109 countries. Respondents included CFOs, finance directors, financial controllers and financial accountants from all types and sizes of organisation.

One of the study’s key findings is that, while a lot is being done already, accountants feel they can do a lot more to improve ethical behaviour, to identify or drive a superior decision-making culture, to instil a more integrated approach to risk management within the organisations they work and to control and minimise dysfunctional behaviour among key decision-makers.

The results revealed overwhelming support for a series of six decision-making practices and behaviours which should form the basis for achieving best practice in risk management; these are: questioning proposals regardless of the seniority of those that originated them; recognising uncertainties, and measuring and managing them; making unbiased decisions irrespective of personal interests; acting ethically and encouraging an ethical culture; acting legally and challenging a failure to do so; and thinking carefully while using applicable quantitative techniques.

Participants judged that decision-making based on these good practices will always be significantly superior to that based simply on consensus, on short term self-interest, on unsubstantiated opinion, or simply following orders without question – behaviours which many believe were at the root cause of the financial crisis.

The study also shows how important an organisation’s “culture” is in creating a positive impact. There is a statistical link between instances of good risk management and a reduction in people’s experiences of ‘dysfunctional’ behaviour. And this is particularly true where ethical behaviour has been actively encouraged rather than just assumed.

In their starkest definition, dysfunctional behaviours often stem from fear or greed. They typically include: allowing personal bias to affect risk decisions; permitting political power battles to influence decisions; excessively weighting the value of beliefs over evidence-backed information; or letting an unbalanced focus on subjectively selected priorities determine outcomes.

While many chief executives and boards would, no doubt, argue vigorously that such negative traits do not exist or are not endemic within their firms, just fewer than 1 per cent of respondents in the ACCA study believed that dysfunctional behaviours did not happen in their organisation.

However, the results also found no link between the size of an organisation and how often risk management practices were being used. This could help remove some negative stereotypes about small businesses, which may assist small businesses seeking new sources of finance. Contrary to many perceptions, risk management is alive and well in the SME sector.

This then begs the question: are accountants merely instruments of the chief executive, using tight budgetary control to enforce strategy based on nothing more than conviction, are they there to report whatever profit figure the chief executive would like to report, or are they more interested in promoting honesty, objectivity and thoughtful use of evidence?

There is an argument among some commentators that says risk management has been largely ineffectual because companies’ internal systems tend to be wholly focused around numbers, while companies are in actual fact people-based. The ACCA study supports this view.

Accountants understand risk. They embrace the norms of risk management and they show overwhelming support for several effective risk management tools. They value the support they provide to decision–makers as a means to help them manage risk. They have a clear view that the contribution of accountants to the culture of decision-making should encourage honesty and objectivity, but not baseless conviction, consensus, and advocacy over evidence.

They understand that it is better, from this point of view, to explain a range of possible outcomes from a course of action than to detail just the most likely outcome. This is the essence of risk management.

Current guidance and regulation on risk management has been pushing for some time to have risk management more closely integrated within management, while compliance is suggesting that companies don’t just simply gather data but also take a more robust approach to its management. Organisations need to be able to identify potential risks so that they can avoid them or limit their impact when they materialise.

Here, accountants have the opportunity to exert a much greater positive influence; it’s simply a question of how they use it.

Accountants are already risk people, they understand risk and they understand risk management. They value the support they can provide to decision-makers by presenting risk management as part of every-day business decision-making. They can do more and they want to do more. Business should not miss this opportunity to embrace that.

Andrew Leck is head of ACCA UK