JOIN THE CONVERSATION 010117 440 pm Countering the Biggest Risk of All Page 1

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01/01/17 4:40 pm Countering the Biggest Risk of All Page 1 of 2 MANAGING UNCERTAINTY Countering the Biggest Risk of All by Adrian Slywotzky and John Drzik FROM THE APRIL 2005 ISSUE W hatever your business, consider for a moment the remarkable turnaround over the past decade in the U.S. banking industry. In the early 1990s, the industry—rocked by the Latin American debt crisis, a major real estate bust, and economic recession—suffered massive loan losses, erratic earnings, and the highest rate of bank failures since the Depression. A decade later, as much of the economy reeled from the dot-com bust and another recession, banks were generally flourishing. The number of bad loans was down, earnings were relatively stable, and the banking industry was outperforming the market as a whole. The turnaround occurred in large part because banks were able to develop new tools and techniques to counter risk, in the process giving birth to an entirely new discipline of financial risk management. Sophisticated credit-scoring measures reduced banks’ credit losses. New forms of options, futures, and counterparty agreements allowed banks to redistribute their financial risks. In fact, banking regulations now require companies to employ financial models that quantify their market risks.
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01/01/17 4:40 pm Countering the Biggest Risk of All Page 2 of 2 A Hazardous Environment One measure of the increased strategic risks companies face is the sharp drop in the percentage of the 3,000 S&P-rated stocks receiving a high quality rating (based on S&P’s assessment of a company’s ability to achieve long-term, stable earnings growth) and the increase in the percentage of stocks receiving a low quality rating. High-quality stocks include those rated A+, A, and A-. Low-quality stocks include those rated B, B-, C, and D. (B+ stocks are omitted.) We cite this example because the risks that plagued banks 15 years ago are emblematic of the challenges that companies across all industries increasingly face today. What if these companies could also employ tools and techniques that would provide some protection against a broad set of high-stakes risks? These looming threats form a category we call strategic risk —that is, the array of external events and trends that can devastate a company’s growth trajectory and shareholder value. The evidence of strategic risk is becoming ever more apparent. In the past 20 years, there has been a dramatic decrease in the number of stocks receiving a high quality rating by Standard & Poor’s and a dramatic increase in the number of low-quality stocks. (See the exhibit “A Hazardous Environment.”) And our own analysis indicates that from 1993 through 2003, more than one-third of Fortune 1,000 companies—only a fraction of which were in volatile high-technology industries—lost at least 60% of their value in a single year.
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