FRM Notes 2011 Unit IVB Corporate Governance and Risk Management

FRM Notes 2011 Unit IVB Corporate Governance and Risk Management

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Version: January 7, 2010 FIN 7400: Financial Risk Management IV. IMPLEMENTING A RISK MANAGEMENT PROGRAM B. Corporate Governance and Risk Management The Role of Risk Management in Corporate Governance Corporate governance describes the relationship between shareholders, senior management, and the board of directors. We often talk of good corporate governance as characterizing a firm in which the board of directors puts the shareholders interests first and is able to get management to act in the best interests of the shareholders. Corporate governance has garnered much attention lately, a result of a number of highly publicized scandals involving senior management and board members of companies such as Enron, WorldCom, Tyco, etc. As a result, many institutional investors are increasingly active in asserting their influence over the companies whose shares they own. This process, often called shareholder activism , has become a major topic in the corporate world. The U. S. government has also gotten involved with the passage in 2002 of the Public Company Accounting Reform and Investor Protection Act , known as Sarbanes-Oxley Act or SOX. A good summary of SOX is at http://www.aicpa.org/info/sarbanes_oxley_summary.htm . In general, the act is designed to improve corporate governance. We should emphasize that it is not clear that SOX has actually improved corporate governance. Companies are spending millions of dollars on SOX compliance. (BP has estimated it will spend $100 million.) But whether it has worked or not, SOX is a fact of life for corporations. And if nothing else, SOX has forced companies to take a close look at their overall operations, with a sharp reminder that senior management and the board are ultimately responsible. Risk management is one of many activities of a company that falls under the umbrella of responsibility of senior management and the board of directors. The material in this section deals with the issues that must be addressed at the highest level of the firm to implement an effective risk management system. The overriding theme is that good risk management is part of good corporate governance. It took banks and corporations a number of years and painful lessons to realize that risk management needed to be done. In the year 1994 in particular, there were a tremendous number of high (and some low) profile firms as well as some non-profit organizations that suffered large losses due to bad or no risk management. In some cases these losses were enough to cause bankruptcy; in other cases, there were more of just an embarrassment. In some cases, the firms appeared to know what they were doing and in Unit IVB Notes Page 1 of 8 D. M. Chance, LSU
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Version: January 7, 2010 FIN 7400: Financial Risk Management others, they clearly did not. In many cases, they were involved in highly leveraged transactions with the appearance of taking bets. Most of these cases did not involve dealers, but rather, end users. The dealers, however, were culpable in that they sold the
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FRM Notes 2011 Unit IVB Corporate Governance and Risk Management

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