Corporate governance can be described as the control system that is designed for the purpose of evaluating the company's operations and the potential conflicts of interests between various stakeholders of the organization. The achievement of the significant goals of corporate governance requires the use of a board of directors as one of the vital mechanisms. The board of directors plays a critical role in corporate governance because their main role is to represent the interests of the stakeholders of the organization. Moreover, the main objective of the board of directors is to capitalize on the value of the company or the value of the company's shares. For these board directors, effective risk management is crucial regardless of whether the company is in the main market, second tier market, or other markets. Therefore, risk management is regarded as a relevant aspect for all parties in the corporate and financial world.
Risk Management and Corporate Governance:
Many firms have developed and established structures, policies, and processes that support the process of governance because it's either a requirement by law or a necessity for the organization's decision-making process. In most cases, the corporate governance process incorporates the creation of boards and committees as well as management and reporting processes (Blanchard & Dionne, 2003). In certain cases, other companies have established more than the basic corporate governance requirements since they have focused on mechanisms and processes that enable them to enhance the quality of relationships with stakeholders, boards, management team.
In the past few years, good corporate governance has emerged as a critical factor for the productivity and success of organizations. This is largely because good corporate governance goes beyond the basic requirements of the needs of organizations in the creation of a governance structure and decision-making processes. In attempts to establish good corporate governance structures, policies, and practices, there has been an increased focus on risk management. Actually, some organizations have established complex and institutionalized means to ensure that risk is effectively identified and analyzed. However, despite of the importance of risk management in good corporate governance, some organizations have minimal or no risk management capacity.
The establishment of effective risk management mechanisms requires the proper investment several resources such as time despite of the status of the organization's risk profile i.e. whether it's relatively simple or benign. Risk management is vital for good corporate governance since risks occur in various forms, without warning, and with severe consequences. An example of such risks is the recent global financial crisis that has a huge impact on companies across every business sector. This is despite of the fact that the main risks during this period were created in the financial services sector and industry (Adamson, 2011).
Companies and organizations across all business sectors have been developing and establishing risk management processes and policies to enhance the identification and analysis of risks. The emphasis on improvement of risk identification and analysis is largely because it's impossible to eliminate risks completely. The multi-faceted forms of risk management that have been created by several companies are increasingly becoming an important component of good corporate governance.
In the context of corporate governance, risk management policies have involved the use of mathematics and statistics since risk analysis and management instruments are complex to utilize and evaluate. This is evident in the fact that organizations only hire members of an audit committee who have undergone specialized training. Risk management is critical in corporate governance because risk management issues can contribute to the emergence of conflicts of interests between corporate stakeholders and executives.
Importance of Risk Management in Today's Corporate Environment:
With the increased focus on good corporate governance structures and policies, risk management has become a crucial element in today's corporate environment because of several reasons including:
Identification of Risk Exposure:
Risk management is significant in the contemporary corporate environment because it focuses on identification, evaluation, and control of the organization's exposure to various risks. For instance, in financial literature, risk management is basically described as policies, structures and practices that focus on identifying and managing a company's exposure to financial risks. In this case, financial risk is regarded as the unpredictability in cash flows and market values that are caused by unexpected changes in prices, exchange rates, and interest rates (Kaen, n.d.). The critical role of risk management in identifying and managing risk exposure is crucial in today's corporate environment because of the increased occurrences of risks in various forms.
Creation of Value to Stakeholders:
In the past few years, there has been an increase in the frequency of corporate scandals that have mainly involved corporate executives. These scandals have mainly occurs because of the conflict of interests between an organization's main stakeholders. Risk management has developed to become an important aspect for many organizations because it promotes the creation of value to an organization's stakeholders. In most cases, effective risk management creates value for the company's owners and ensures that the firm's managers control the company in the best interest of its shareholders. Poor risk management practices usually result in losses of the wealth of shareholders, the loss of the firm's reputation, and other undesirable consequences.
Uncertainties about the Future:
Today's corporate environment is relatively dynamic with the future remaining uncertain to a huge extent. As a result of these numerous uncertainties in the future, fate is normally allowed to play a considerable part in the results that are achieved by several organizations. Nonetheless, there has been a decline in the role of fate in companies' results in past few years due to effective risk management policies and practices. Risk management has proven to be critical in today's corporate environment because it enables organizations to predict and deal with future uncertainties. This is largely through the help of the probability theory and the critical analysis of the environment that enable companies to identify and deal with several risks that could impact their businesses ("Why is Risk Management Important?" 2005).
Recommendations for Effective Risk Management Plan:
An effective risk management plan is geared towards lessening several risks that are linked with the efficient achievement of any specific goal and objective of an organization. Since risks usually occur in different forms, an organization's risk management plan may be ineffective if the wrong plan is used. Consequently, the main objective of risk management is to develop and establish an approach that is structured in dealing with uncertainties, particularly those that are associated with threats.
An effective risk management uses various different strategies in order to address risks in an efficient way. This is largely because the effective risk management plan can either avoid the risk completely or transfer the risk to another group. Therefore, the risk management plan can be designed in ways that it decreases the impact of risks if they occur. There are some recommendations for a public corporation to implement an effective risk management plan.
First, the organization should ensure that they have identified or have the capability of detecting new risks. Since the impacts of many risks are usually negative, the public corporation should be able to identify the risk since it can impact its goals and objectives. The process of identifying risks is followed by quantifying the identified risks, which is a fundamental step in the process. The process of quantifying the identified risks basically involves figuring out the probability of the risk to occur. The possibility of the risks to occur can be classified into high, medium, or low categories depending on experience, judgment, and perception of the future. Actually, the culmination of quantifying the identified risks is attaining a risk rating by merging its impact and possibility to occur.
Third, the corporation should allocate its resources properly when developing the effective risk management plan. The proper allocation of resources is…