“Some changes are foreseen and some are not, the laws of some are tolerably accurately known, of others hardly at all; and the variation in foreknowledge makes it clearly indispensable to separate its effects from those of change as such if any real understanding of the elements of the situation is to be attained.”
Quote from, Professor J.B. Clark’s Dynamic Theory of distribution by Frank H. Knight,” Risk, Uncertainty, and Profit”
Human activity whether in business or life involves decision making in order to accomplish the personal or business outcomes we seek. However, we may underestimate the process of decision making in how we think about risk management.
Recently McKinsey & Co. published an article on Human Risk based on research they conducted by partners, Alexis Krivkovich and Cindy Levy. The McKinsey study looked at how companies have responded to the financial crisis and the changes made to strengthen corporate culture. The McKinsey data identified characteristics of a strong risk culture.
Key characteristics for a strong risk culture:
- Responsive and pro-active risk management function
- Acknowledge risk and plan accordingly
- Encourage transparent communications about risk
- Encourage a healthy respect for risk and internal controls
- Be patient as the culture changes
- Build consensus on culture
- Create a sustainable process
It would be hard to argue with any of these findings and most would argue that the characteristics are self-evident by risk professionals. The study while instructive leaves several questions unanswered. What does this have to do with Human Risk? How does the firm begin to make the desired change to adopt these characteristics? The study also doesn’t tell us if the firms with these characteristics are the exception or what percentage of adoption each of the firms made in implementing each characteristic successfully?
In the 19th century, when the early thinking of risk and uncertainty was being formalized risk-taking was separated from entrepreneurial endeavors. Only capitalist were considered to take risks while business owners made profits. Today’s definition of risk is broader and in many respects more complex and confused. It is the nature of risk taking or how we become risk takers or risk averse that allows us to deal with Human Risk.
Modern business leaders must make a variety of trade-offs regarding the risks they will assume or tolerate in achieving today’s fast paced and conflicting goals. In today’s economic environment where resources are limited and failure is not tolerated human risk becomes very personal.
As a result of ground breaking work done by behavioral psychologists and economists we understand that how we choose between risky ventures is a result of professional expertise as well as biases and heuristics that can lead us astray. Decision making under uncertain conditions is the key human risk that must be better understood and incorporated into risk practice.
New technology has begun to address the issue of uncertainty using data analytics the harder challenge for risk professionals is to consider how to include decision risk into their practice.
As Professor Clark predicted at the turn of the 20th century, “Some changes are foreseen and some are not, the laws of some are tolerably accurately known, of others hardly at all; and the variation in foreknowledge makes it clearly indispensable to separate its effects from those of change as such if any real understanding of the elements of the situation is to be attained.”