Ways companies always mismanage risk (6)
- Relying on historical data
- Focusing on narrow measures
- Overlooking knowable risks
- Overlooking concealed risks
- Failing to communicate
- Not managing in real time
Ways to overlook knowable risks
- risks outside the normal risk class
- risks incurred by hedging
- market concentration risks
- value assumption risks
You understand your causal model and can predict the outcome of your decision with reasonable certainty
Conventional capital-budgeting tools
You understand your causal model and can predict a range of possible outcomes
Quantitive multiple scenario tools
You don’t understand your causal model, but you can predict a range of outcomes
Case-based decision analysis
You don’t understand your causal model and you can’t predict a range of outcomes
Case-based decision analysis
You understand your causal model but cannot predict outcomes
Qualitative scenario analysis supplemented with case-based decision analysis
Causal model
Strong understanding of what critical success factors and economic conditions, in what combination, will lead to a successful outcome
Conventional capital-budgeting tools
Use cashflows to make decisions (discounted cash flow, expected rate of return, NPV models)
Quantitative multiple scenario tools
Specify possible outcomes and their probability (Monte Carlo, decision analysis, real options)
Qualitative scenario analysis tools
Develop a set of qualitative scenarios of how the present may evolve into the future and identifies the consequences
Case-based decision analysis
Provides an approach to aggregating and synthesizing information from past experiences and examples
Limitations to use of information markets (2)
- Information and prediction makets can only be used when executives are able to specify a range of possible outcomes
- Information may leak out
Alternatives to information markets (2)
- Incentives estimates
- Similarity-based forecasting
Risk
Known probability distribution for the event
Ambiguity
Not clear what events and probabilities are relevant
Utility
Weighted average of the utility in each possible state
Assumptions of game theory (4)
- All actors behave rationally & try to win
- All actors are interdependent
- All actors are aware of their interdependence
- All actors know all moves that are possible
Dominant strategy
- Outperforms all other strategies regardless of rival’s actions
- Might nog be highest possible pay-off, but you always win
Dominated strategy
Always lose regardless of what the actor does
Equilibrium
Each actor gets best possible payoff given the rivals’ responses
Tit for that
- Always start with cooperation
- If rival attacks, you counterattack, then try cooperation again
- Responses should be proportional
Conditions that hinder cooperation (3)
- Large number of competitors
- Substantial differences between actors
- Lack of transparency
