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The Orange Dashboard Paradox

December 2, 2010 by
Filed under: Risk Management

Fancy dashboards that show the state of affairs in one glance; the dream of every corporate senior manager. Well, this is quite possible in financial reporting. Not so easy in risk . . .

Why is that? . . .
<>Consolidating risks
When you want to see a corporate overview of the financial status of the company, it's quite straightforward: you simply add up the numbers. Well, I have to pay respect to the accountants that add up these numbers, because it can be complex with IFRS, US GAAP regulations, intercompany bookings, changing currency rates and so on. But let's be honest: in the end of the day, it's adding up numbers. The discussion is not about the data, but the interpretation of the rules.

There are people that believe that the same is possible for risks. This is somewhat true for risks in the past (incidents and losses), as long as they are quantified (i.e. have a hard dollar value). But risk management is fundamentally about predicting the future, and our models aren't particularly strong here, as recent history has shown us. There are several problems; first of all, risk is not just about numbers. Many risks cannot easily be quantified, and require qualitative judgments. Adding them up is less than obvious. Secondly, a low (say: financial) risk in all entities may well consolidate into a very low risk at corporate level. Another risk with a reputational dimension, low in all entities, may on the other hand add up to a serious issue at corporate level. Then thirdly, and perhaps most challenging: there is a psychological effect. When adding up risks, because of the complex factors mentioned before, who is going to take the responsibility to be on the easy side? People have the tendency to be on the safe side.

So, net effect is that a corporate risk dashboard soon becomes an orange dashboard. There is always something. Now what? The lesson learned here is to understand this paradox wholeheartedly, and be careful with consolidation. The more you consolidate, the less information is left.

Tags: BWise, Risk, Risk Management

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