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Corporate Governance and Risk Management

7 important questions on Corporate Governance and Risk Management

What is SOX (Sarbanes-Oxley Act of 2002)?

A response to series of accounting and management scandals. Placing primary responsibility of accuracy in financial statements to CEO and CFO. They have to make sure that financial statements don't contain untrue statements or omit any material fact. Moreover, they bear responsibility for design, establishing and maintaining disclosure controls and procedures (assess annually). There should also be a critical audit committee consisting of financial experts.

What are main corporate governance concerns?

- Stakeholder priority (controlling tail risk, but also downside risk for other stakeholders)
- Board composition (independence, engagement and expertise)
- Board risk oversight (educating board, risk responsibilities and empowerment)
- Risk appetite (willingness to take risk, enterprise-wide risk limits
- Compensation (deferred payment to long-term, less bonuses)

What is the relation between corporate governance and risk management?

Agency risk, can cause a conflict of interest for management in boosting returns while assuming risks, and the interests of the company's long-term stakeholders. Powerful and charismatic CEO should be prevented. Therefore the board and management committee increasingly look to the CRO to integrate corporate governance responsibilities with the existing risk function's. Basel requires CRO's to report and have direct access to the board without impediments.

What other levers does the board has to ensure proper risk management?

Establish strong ethical standards and work to ensure that it understands the degree to which management follows them. Consider performance metrics and compensation strategy, by risk-adjusted performance. Board members should demonstrate healthy skepticism and require information from a cross section of knowledgeable and reliable sources (as CEO, directors, auditors). It must make sure that risk management is functioning properly.

What has changed since 2008? More educated board members on risk issues, also those who are in risk committees to have technical sophistication. Clearly separate audit and risk committees.

What are different mechanisms for transmitting risk governance?

Important role for risk- and audit committees to ratify the key policies and associated procedures of the bank's risk management activities. They help to set limits that flow down through the bank's executive officers and business divisions.

What about a risk management committee?

Independently reviewing the identification, measurement and controlling of risks, including adequate policy guidelines and systems. It usually has the delegated authority from the board to approve individual credits above a certain limit, which it will report to the board. Any other special cases that require attention from the board.

What about a compensation committee?

Stock ownership can also encourage risk-taking, as shareholders'gain are not limited on the upside, while their losses are capped on the downside. Compensation schemes used to be structured like a call option! Nowadays it is more aligned with long-term interest of shareholders and other stakeholders, as well as based on a risk-adjusted return on capital. No guaranteed bonuses anymore and exposure to downside.

EU regulators have adopted a cap on bankers' bonuses at one times their salary. Twice, only if shareholders voted with 2/3 majority.

The question on the page originate from the summary of the following study material:

Part 1: Foundations of Risk Management

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Corporate Governance and Risk Management

7 important questions on Corporate Governance and Risk Management

What is SOX (Sarbanes-Oxley Act of 2002)?

What are main corporate governance concerns?

What is the relation between corporate governance and risk management?

What other levers does the board has to ensure proper risk management?

What are different mechanisms for transmitting risk governance?

What about a risk management committee?

What about a compensation committee?

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