Back to school on risk

It is time for business schools to re-evaluate and fundamentally re-calibrate their coverage of risk. While admirable progress has been achieved in recent years in terms of creating more specialised courses and degree programs, these offerings largely replicate the pitfalls that existed before.

Risk is still sitting in functional silos such as finance and supply chain management; it is still used as a vehicle for celebrating modeling skills that are mainly helpful in a world where the future tends to be a repetition of the past. Business schools should move on and, by doing so, should become more visible and impactful innovators of the risk management profession. We are proposing five specific actions that can put business schools on a different and more effective footing when it comes to the coverage of risk. They are ordered from modest to more radical moves.

Do a better job with the basics

Too many business school graduates still depart with their degree in hand and the gospel of modern portfolio theory and CAPM in their minds. They should much rather learn that total risk and tails of a distribution matter, and that the real world is notoriously non-Gaussian. Hence, they should be educated as knowledgeable doubters of conventional methodologies, which will also make them better educated collaborators of corporate risk managers.

Teach traditional risk management frameworks properly (as well as their limitations)

There exists a striking rigor gap between risk management methodologies taught in quantitative finance classes and the non-technical narratives at times communicated in other areas (more focused on corporate risk management). Students training to become risk managers should generally have a good understanding of advanced statistical concepts such as semi-variance, skewness and kurtosis; they should be familiar with a broad range of statistical distributions and their practical uses. In fact, it should become part of the standard repertoire of compulsory finance classes to discuss the limitations of NPV modelling by extending the analysis to Corporate VAR and Cash-Flow@Risk with the help of Monte Carlo simulation.

This will ensure that business school graduates are more broadly familiar with decision-making based on confidence intervals rather than expected outcomes and without compartmentalising business risks into separate silos. It will also become a perfect vehicle for explaining the limitations of quantitative risk modeling, e.g. by exploring the practical difficulties of determining correlations between risk factors.

Pay more attention to the soft factors of risk management

Business school curricula generally glance over the soft factors of corporate risk management that are known to shape its effectiveness on a day-to-day basis, risk appetite and risk culture. The former requires the conversion of global risk management objectives, generally couched in financial terms, into operational targets that can be disaggregated to reach all corners of a corporate organisation. The latter deals with educating corporate actors so that they properly align their roles as risk owners and risk managers with other performance KPIs. The omission so far can be explained by the absence of a ‘one size fits all’ blueprint that asks for non-conventional pedagogy to help students navigate to workable solutions.

Transition from RISK to VUCA

Traditional risk management offers a schematic logic that amalgamates a population of risk factor distributions into a performance-linked ERM system. Random movements of the volatility structure (the V in VUCA) and difficulties in handling the complexities (the C) of how the different risk factors relate to each other are obvious challenges to address in this context.

In our view, more real-world (‘dirty’) casework is needed to illustrate the difficulties of addressing these issues to business school students. Lifting the discussion intellectually out of the hygienic classroom laboratory will also facilitate the development of a ‘wayfinding’ logic that leaves the world of probability behind (the U for uncertainty) and highlights the prevalence of ambiguities (the A) that may make it difficult to differentiate between threats and opportunities.

By combining these four perspectives, business school students are prepared for professional roles as risk managers that can comfortably move beyond existing compliance frameworks to help their companies cope (and ideally benefit) from disruptions big and small.

Develop frameworks that help companies to understand and improve their resilience

Conceptually, we are still in the early stages of operationalising the concept of resilience as an alternative approach to risk management. The key ingredient is to make adaptability a core business competence, which helps companies to move from the identification of potential vulnerabilities to capitalising from market dynamics. The real options methodology seems to be fit for purpose, but is generally considered too much of a methodological black box. What will be needed instead is a set of operational measurements feeding into a leadership narrative that, for one, communicates the normalcy of change and, second, provides risk managers with handrails to deliver on performance expectations.

The authors are Ulrich Hommel, Professor of Finance at EBS Business School, Germany, who holds the Chair for Corporate Finance and Higher Education Finance there. Ben Woods, chief operating officer for Helikon Strategies and doctoral candidate at EBS Business School. The views are the authors and do not represent the official position of IRM.

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