Four steps companies can take to better manage operational risk

After corporate accounting scandals grabbed the headlines in the early 2000's, most companies established the necessary financial management discipline to avoid such disasters. But from investors' perspective, the issue of financial performance risk is far from being fully addressed.

Expanded investor scrutiny now includes all forms of capital contributing to value creation, from products to people. This requires much broader corporate performance reporting, and failure to comply can result in significant risks to long-term financial performance.

These risks are particularly evident in asset-intensive industries such as energy, chemical and manufacturing with their higher rates of operational risk. In some areas, such as declining injury rates in U.S. industry, companies are performing well. Yet catastrophic events, like the Fukushima Daiichi nuclear disaster, still have the potential to adversely affect entire industries and economies.

It's only a matter of time until these major events trigger reforms similar to those following the accounting scandals of the early 2000's. Companies should take proactive steps to better manage operational risk now.

These four steps can help businesses establish an enterprise-level system to do precisely that:

First, companies should articulate policies and procedures for reaching non-financial performance objectives from all bases of capital - financial, manufactured, human, intellectual, social and natural. As non-financial disclosure guidelines and regulations are a newer phenomenon than their financial counterparts, it's unsurprising many companies are inexperienced with the practice.

Second, corporations must standardize risk-management practices.

Proactive risk management is imperative across all company management systems, yet senior management often lacks knowledge of potential hazards. This can result in skewed risk comparisons and improperly informed decisions. The situation becomes more complicated when this information is used to assess the relative importance of different risk types throughout the company.

Standardized risk-assessment methodologies and a holistic view of the company's risk profile allow management to more effectively mitigate critical risks.

Third is the establishment of a hierarchy of controls.

The hierarchy of controls is an effectiveness rating system used to select the most feasible and effective control for hazards, matching highest level of control to the level of risk exposure. The hierarchy runs from highly effective risk reduction through design, to simple administrative controls, which should generally be used only until long-term strategies can be enacted.

Fourth is the development and establishment of a system of checks and balances.

When it comes to checks and balances, ensuring policies and procedures are in place is not enough. Their institutionalization must also be enforced. Diligent monitoring of their performance is integral to reducing risks.

The world in which all corporations operate is becoming increasingly sophisticated. As investors and other stakeholders become more interested in the risks and financial and operational fundamentals that drive business performance, comprehensive enterprise-level risk-management strategies are becoming critical to sustained, long-term financial returns.

Jeff Ladner is senior director, operational excellence and risk management for IHS
Posted 18 February 2015