Measuring behaviour behind closed doors

Finance expert Kaouthar Lajili weighs in on the link between corporate governance mechanisms and risk disclosure behaviour.

by Susan Hickman

It isn’t easy to measure risk, says Telfer School of Management professor Kaouthar Lajili. An expert in business economics and finance, Lajili has focused her research since coming to the University of Ottawa in 2000 on global enterprise risk management. Whether a company is involved in mining, manufacturing, technology or finance, it has to manage risk related to environmental regulations, market volatility, currency exchange, safety issues, loss of key employees and technical failure, to name just some. 

“How do you manage this risk?” asks Lajili, whose research examines the impact of a company’s risk tolerance and its governance characteristics, that is, its executive compensation, incentives, ownership structure, management style and the makeup of its board of directors. “Governance and risk are intertwined, and in this age of globalization and breathless advances in information technology, managers have to respond to threats and opportunities within a turbulent framework.”

During a study of the Toronto Stock Exchange, Lajili and a colleague examined close to 300 companies in different sectors. They concluded that the information disclosed by companies is oft en vague and not very useful. “They’re not telling us whether they are risk takers or how they manage risk.” While every company disclosed a certain amount of information in their annual reports, Lajili noticed that, “in terms of investment, the information was boilerplate. Almost 80% of it was qualitative, mostly general, nothing new.”

Currently, Lajili is leading a three-year project to compare the disclosure behaviour of companies in Canada, the United States, the United Kingdom and Germany to determine the connection between risk disclosure attributes, company specific characteristics and the potential impact on stock prices.

“We are focusing mainly on manufacturing and trying to relate the risk disclosure intensity to certain fi rm attributes, such as the size of the company and business risk proxies. Results so far show little forward-looking or quantitative risk information. The United States has the highest volume of risk disclosures across the board.” Lajili’s research team will try to determine whether disclosure should be mandatory and why red flags weren’t raised by the excessive risk-taking of some American companies during the recent financial crisis. “We are leaning towards keeping it voluntary, which will allow good risk-managing companies to differentiate themselves,” she notes.

In a second project with another colleague, Lajili is examining North America’s gold mining sector. “Gold mining companies are exposed to many risks, and we are considering developing a scorecard of risk tolerance for them. We are trying to gauge their risk appetite by building a risk matrix and then relating it to their risk-management efforts.”

For the sake of the investor, Lajili is keen to see more transparency and clear information on the risks companies take. “Risk isn’t bad. Good rewards are driven by taking risks. But there is a threshold, a maximum level you cannot exceed. As a shareholder, I would want to know whether a company is taking a good calculated risk or taking us downhill.” Lajili’s aim is to find a method for determining a company’s risk appetite. “It’s becoming more and more important to know what is going on inside a company. If you are an employee and you know a company is mismanaging, you can act on that information instead of losing your pension or your job. If you are a shareholder, you can avoid losing everything,” she explains. “It’s tough in these times of uncertainty, and in a financial crisis, you need to know how a company is managing its risks,” adds Lajili.

In the future, Lajili foresees greater regulation to control the irrational human factor. “There will always be a need for regulation, but you can’t make it too tight. You have to find the trade-off between regulation and a market that works efficiently with a good flow of information.” She notes, “Information is at the heart of risk management, and how one risk impacts another is important. Internal controls and more transparency are needed in order to succeed.”

Lajili admits there is much room for improvement in the field of risk management research and practice. She suggests companies could provide a risk road map for their stakeholders, similar to how airlines inform their passengers of aircraft safety procedures. Tough financial times, Lajili declares, call for this kind of clarity and disclosure. 

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