- Perhaps 10% or more of the meaning of a message is lost each time it is passed along. If risk appetite and corporate objectives are only developed at the board level, by the time they reach customer-facing or market-facing risk-originators who are several layers down the hierarchy, they are likely to have been badly distorted and to contain more incorrect information than correct information.
- When issues arise and need to be addressed through a corporate change, communication up the hierarchy similarly suffers a fate of distortion. For example, as customer preferences change or as the realization of a risk emerges but is not yet fully realized, by the time such a message reaches senior management, it may be mostly incorrect or it may be too late to deal with it.
In complex organizations, there is a challenge in understanding appropriate levels of risk to take and in ensuring that those risks are understood, are aligned with corporate tolerance levels and that risk-taking is properly incented.
- How much risk can a business unit or product line take?
- Are incentive and other compensation policies driving a focus on the best return on this risk-taking capacity?
- Should there be an independent risk oversight of all activities?
- How can we focus group efforts on a common outcome?
Similar in concept to the Carver Governance Model, each successive layer of management defines policies and objectives to a level of detail at which it is comfortable that the next layer of the organization can make any reasonable interpretation of the policies.
Further, the capacity for risk taking, as one of those policies, is defined through the allocation of Risk Capital (defined below) which becomes a common property of that next level of management.
As the Carver model or any other form of distributive governance has the capacity to isolate groups in their thinking (group think), each higher level of management and other stakeholders will have representation within the govrnening committee of the lower level so that outside information can flow into the group and so that group information can flow out to the organization.
See work of Shann Turnbull in this area for its application to the Board of Directors and envision a similar application at each level to which risk capital is allocated (mini-boards at each level)
Defined as the capacity for risk-taking, it is similar to the amount of risk that each successive unit within the company could take risk on its own as a standalone. In effect, each subdivision of the organization becomes an entrepreneurial venture, responsible for the raising of its risk capital (through business plans and lobbying) and for the return to the organization on that capital.
- Greater ownership of outcomes by smaller and smaller subsets of the organization
- Smaller individual risks taken, none of which would have the capacity to take down the entire organization, thus building resiliency
- Better investment return on risk capital
- Lower perceived risk of the organization by external parties
In short, the three factors that matter for the valuation of the organization (size of cash flows, duration of cash flows and rate of risk at which to discount those cash flows back to today) all improve, greatly improving the value of the organization.
Step two: force each line to do the same thing, down to a level at which it make no more sense to divide (might be to a loan originator, for example, or to a factory or branch office)
Step three: establish incentive plans based on the value of those final subdivisions and a method for determining, in advance, what that value is (avoid overly metric-based approaches that might distort behaviors, see Darley's Law)
Step four: establish stakeholder groups that will integrate with each successively smaller subdivision during its strategic planning and evaluation process
There are numerous texts that have also had an influence, too numerous to list here.