Ignore risk management at your peril

Catastrophic events such as the Fukushima nuclear power plant accident, triggered by Japan’s recent earthquake and tsunami and the 2010 Deepwater Horizon oil spill in the Gulf of Mexico have led to concern about safety in the energy sector.

Yet, as these and other disasters have shown, a clear lack of preparation and risk management remains an issue for many companies operating in the energy sector. Understanding this fact is crucial, and business schools have an obvious role to play in explaining the facts, reflecting on how best to promote efficient risk management within complex organisations and ultimately adapting their training and development programmes to prepare better for future disasters.

Risk management is a hot topic, particularly within global corporations where the concept of enterprise risk management (ERM) is widely understood and integrated. This is partly due to stricter regulations on risk control, such as those imposed by the Sarbanes-Oxley legislation in the US. So why isn’t adherence to these regulations reflected in performance?

In reality, companies are often more concerned with compliance – that is, protecting the personal liability of managers – than with effective risk management. Risk management starts with paperwork, writing procedures, the building of “risk maps” and design of control systems, but there is far more work to be done. Unfortunately, efforts frequently do not seem to extend much further than the initial groundwork.

For risk management to work, companies must create the necessary incentives to ensure employees adopt the right attitude towards risk. Communication and training are not enough if employees are left with contradictory objectives or have rewards directly linked to financial indicators that do not integrate risk performance. As obvious as this advice may seem, it is in reality not the practice of many companies today.

Globalisation and deregulation have resulted in increasing uncertainty, forcing companies to acquire “strategic agility”. Flexibility and mobility of human capital are today the imperatives in increasing proactive behaviour and fostering the ability of firms to take advantage of unanticipated opportunities. As a result employees have become more individualistic: they understand it is now essential to focus on their own employability and transferability of skills. Fostering individualism goes against information sharing and co-operation – precisely what is needed to handle risk.

Outsourcing, a key aspect of globalisation and the root of major organisational changes, is now recognised as an aggravating factor of companies’ ability to manage risk well. The practice results in the direct segmentation of processes and in information asymmetry, diluting risk along the value chain and making risk control more difficult.

What can business schools do to help? Risk management is covered by most schools, at least as an elective or component of particular programmes, but this is not sufficient. While it is right to include all the tools well-trained managers need to master to be prepared to handle risk, as business educators we must help energy sector leaders address the “human element” – how people react on the ground in response to problems arising and in relation to their individual interests.

Schools need to reflect on this mismatch between individual and organisational perspectives. Joint research, with organisations working with academia to identify the deterrents of effective risk management, can also add constructively to the development of incentives for staff in relation to risk and safety. Accidents and disasters will never be eradicated, but unless business schools integrate ERM across all of their work to educate and develop leaders and work more closely with companies to address risk, how those unforeseen events are handled will not improve. Current debate is focusing on the rights and wrongs of nuclear energy, but the core issue is risk management.

Patrick Gougeon is director of the executive master in energy management and the London campus, ESCP Europe.