Research Paper on Risk Management

Introduction

Risk management is one of the critical functions within an organization. It helps in the identification, assessment, and reduction of risks thereby preventing financial losses. This analysis compares the risk management approach proposed by Dr. James Kallman to those of Ryan Baxter, well renowned experts in risk management.

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Dr. Kallman (2008), explains that organizations can use four techniques to manage risk; transfer, avoid, reduce, or accept. In his article "Risk Management Solutions" Dr. Kallman argues that the first decision any firm has to make is whether to avoid or accept a given risk. Every opportunity a firm has is associated with risks or threats that can lead to financial losses. An organization should conduct a cost-benefit analysis of each decision to determine the possible losses (Kallman & Maric, 2004). Tools such as decision trees, among other techniques can be used to evaluate decisions. If the potential loss is larger than the firm's risk appetite, the best risk management strategy is avoidance. However, if the potential loss is within its risk appetite, the firm should accept the risk (Kallman, 2008). Once the firm has decided to engage in the activity, the next decision is whether to spend resources to control the risks or not. If the risks are within the firm's risk tolerance, then acceptance is the best strategy. For instance, if the probability of loss or the standard deviation is too low, there is no need to spend resources on mitigating risk. When the probability of loss is high, the company should spend resources to mitigate the risk. In this case, risk transfer and risk reduction are the appropriate strategies.

Risk transfer involves sharing or shifting the burden to a third party. Risk transfer strategies include insurance as well as contractual transfers. Contractual transfers decrease the likelihood that one would incur losses. Risk reduction strategies include retention and transfer programs, loss prevention, and gain enhancement projects. According to Kallman (2008), effective operations management can help reduce risk. For instance, a manufacturing company can outsource the transportation of its products to a logistics firm.

Ryan Baxter, et al (2013) recommends that organizations should adopt the COSO framework in all functions and departments to enhance the effectiveness of risk management. COSO has five components including the control environment, risk assessment, control activities, information and communication, and monitoring. Organizations that adopt the framework can identify and manage risk effectively. Baxter, et al (2013) analyses the entire risk management system of which the risk management strategies are part. Baxter's recommendations relate to those of Dr. Kallman. The risk assessment component of COSO deals with the identification and analysis of risk, which is the first step Dr. Kallman recommends.

I agree with the recommendations of Dr. Kallman and Baxter. Risk management cannot be effective if it is isolated in an organization. Thus, it is essential to establish the COSO framework and integrate it into all functional units. Although Dr. Kall outlines the four strategies of risk management, he explains situations when each strategy is suitable. This is true since not all risks require mitigation measures. An organization can retain some risks while others can only be transferred. For instance, a firm can manage foreign currency exposures through hedging, but the risk of damage to property is too high to retain. Such can only be transferred through insurance.

Other Factors to Consider

Firms have different strategies for managing risks, including risk identification, assessment, and mitigation. The suitability of these strategies varies from one firm to another. An organization has to consider several factors such as cost, nature of the organization, level of risk, external influences, among other factors.

Cost: Risk management is aimed at increasing the value of the firm. Thus, the cost of the risk management strategy adopted should not exceed the potential benefits (Horcher, 2013). Some of the risk management technology solutions are too expensive for small firms.

Nature and level of risk: Different organizations face different levels and types of risks. For instance, a local retail store does not face a significant foreign exchange risk, unlike a multinational firm. Besides, firms in the same industry can have varying levels of exposures. Thus, a firm must use risk management strategies that are suitable for the risk it faces. The local store would not waste its efforts and resources in managing foreign currency risk while the multinational firm would focus its risk management strategy on mitigating foreign exchange exposures.

Size of the organization: Lager organizations require more complex risk management systems that enable the integration of different functional units as well as branches (Horcher, 2013). Besides, the level of risk involved is usually higher in larger organizations than in smaller organizations.

Level of automation and technical support required: A firm must select risk management approaches that it has sufficient automation and skilled workforce required to operate. A risk management technology cannot benefit a business if the business lacks the necessary skills and resources required to operate it effectively.

Regulatory and other external influences: Firms must take into account the effect of its enterprise risk management systems on compliance with the relevant regulations. For instance, banks have to comply with Basel III regulations when establishing and managing risk information systems as well as technology infrastructure.

References

Baxter, R., Bedard, J., Hoitash, R., & Yezegel, A. (2013). Enterprise Risk Management Program Quality: Determinants, Value Relevance, and the Financial Crisis. Contemporary Accounting Research, 30(4), 1264-1295. doi: 10.1111/j.1911-3846.2012.01194.x

Horcher, K. (2013). Essentials of financial risk management. Hoboken, N.J.: Wiley.

Kallman, J. (2008). Risk Management Solutions. Risk Management Magazine, (101).

Kallman, J., & Maric, R. (2004). A Refined Risk Management Paradigm. Risk Management, 6(3), 57-68. doi: 10.1057/palgrave.rm.8240190