Overview :
Management Risk arises from the activity of managing an organisation, be it a Company pursuing a profit — wealth maximisation motive or a non profit organisation pursuing social welfare and charitable objects. The risk that every organisation has is that of an ineffective, non-performing, underperforming or reckless management that destroys rather than build.
This is because management is in charge of governance. It is management that provides the vision, mission, direction and strategy which take the organisation forward in pursuit of its goals and objectives. A management that either for reasons of incompetency, ineffectiveness or self interest sacrifices and sabotages the entity’s objectives is detrimental to the interests of stakeholders. These give rise to ‘management risks’.
The definition of management risk provided in ‘Investopedia’ sums up the term very well.
‘Management risk refers to the chance that Company managers will put their own interests ahead of the interest of the Company and shareholders. Management risk also applies to investment managers, whose decisions and actions may divert from the investors’ wishes or reduce the value of an investment portfolio. The risk therefore is that either the management is ineffective, inefficient and/or incompetent, or fails to handle a situation, or has its own personal self interest which is conflicting with the objectives of the Company and its stakeholders. An additional risk is that of management turning against its own company by colluding with one of the interested groups and committing frauds and misappropriation to the detriment of the company and the larger body of stakeholders’. Examples of the above abound in the multitude of mega scams often described as management frauds or scams, worldwide. Some of the classic recent examples are of WorldCom and Enron abroad and Satyam and Maytas in India
In these cases, the management acted in a manner detrimental to the interests of the Company and destroyed shareholder wealth and confidence in the system and the economy.
The sub-prime crisis which shook the world’s financial market is a striking example of ‘self interest’ of financial managers. Hence, dealing with management risk requires a good management life cycle.
Some of the risk mitigating steps are :
- selection of the CEO and members of his team based on professionalism and devoid of favouritism.
- continuous monitoring of business performance.
- periodic review of procedures to ensure transparency.
- periodic review whether internal controls and ethical practices are being adhered to by the CEO and his team.
- developing a succession plan for the CEO and his entire top management team.
- remuneration and reward system. The need for this is highlighted; even G 20 is discussing the level of managerial remuneration in financial industry.
In addition to this there should exist in the top team a system of checks and balances against dictatorial tendencies.
The example of this month’s case study on management risk is that of a company operating in the food processing industry that manufactures and markets jams, fruit juices, fruit concentrates and pulp in India and overseas under the brand name ‘Madhur’, ‘Meetha’ and ‘Rasbhari.
The Company has its factory in Uttar Pradesh which is about 50 years old. The Company initially had operations restricted to the State of Uttar Pradesh. It has expanded over the last 10 years to cover the whole of India.
About two years back a new professional management team has been inducted who have been pushing for modernisation, expansion overseas, greater market penetration by appointing franchisees and having captive bottling/canning plants to service the growing market. The large resources required for this, are proposed to be raised through a public issue. The management team wishes to go in for financial reengineering in order to show the investors the golden future that awaits the company post modernisation and public issue.
The owner/promoter who wish to proceed with caution, as well as the existing bankers are wary of the plan, as they do not want to lose control of the situation and prefer continuing the entity as a private limited company.
The Company management is torn between two options and there are the old guard who want status quo and the new entrants who wish to go public and modernise.
Outline the management risks in the given situation and suggest an approach to the case.
Solution to the case study :
The Company owners and stakeholders have three options before them. The first is to continue the status quo. This may not be such a good option given that the factory is already over 50 years old and without modernisation and expansion the company as it stands will not be able to face competition and survive in the market. Competitors are bound to emerge who will fast overtake the company which will lose out even its home ground to them in the course of time.
The other choice is to modernise and expand the factory and business by raising public funds through an IPO and going in for a big bang expansion by appointing franchisees and using captive bottling units.
A third choice is also possible where the company will put in a place a modernisation program, which will be gradual and will be funded by internal accruals. This will ensure that control is retained by the existing promoters and management and at the same time enable the organisation to meet its objectives.
The first option which eventually involves doing nothing is potentially disastrous and has to be ruled out. The second option is risky in terms of losing control and also magnifying management risks. However, the rewards also will be substantial, if it goes through smoothly.
The third option is a viable via media if the existing management is not sure if it can manage and handle the higher level of management risks posed by going public.
To conclude, depending on the strengths of the existing promoter / owners and their ability to control and manage the professional management team on the parameters hereinabove enumerated, they should choose between the second option of going public and the third option of moderate expansion along with inducting strong management to oversee both in-house franchise operations.
