Boards have always had a core function: managing risk. But this year’s pandemic has put that responsibility into the spotlight. In an environment where risks can change rapidly and it’s crucial for boards to get into a learning phase and understand how current developments in the world are altering the risk landscape and long-term trends that could impact their business.
To achieve this, they must be able to evaluate the risks of new and existing projects objectively. It is possible to identify potential problems using a simple red-amber-green evaluation, but it can be difficult for boards to gain a precise understanding of risks. Boards can benefit from using quantitative techniques to help facilitate communication between the board and management, and help the board to better understand management’s risk appetite.
More sophisticated tools, such as ones derived from options pricing (the mathematical technique employed to calculate the theoretical cost of an equity option), can be very beneficial in helping assess the risk and prioritize issues that may arise. For instance, they could assist in identifying the extent to which a project is at risk from oil price risk or credit risk, and reveal how risk-taking has been controlled.
The board should also use its knowledge of the risk profile of a business to inform strategic planning, as it reviews and monitors internal controls. It should also ensure that all committees of the board – including audit, compliance and strategy have the same common understanding of the company’s risk profile.
