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Mark Beasley

Audit Committee Involvement in Risk Management Oversight

Embracing emerging expectations for risk management leadership.

January 7, 2008
by Mark Beasley, PhD

The volume and complexity of risks facing enterprises across most industries is at an all-time high. What’s more, boards of directors and senior executives are increasingly expected to manage the portfolio of risks for their enterprises. Many boards are now directing executive management of organizations to embrace enterprise risk management (ERM) to develop a stronger top-down holistic view of enterprise-wide risks. In most cases the board is delegating oversight of management’s risk processes to an already challenged audit committee.

Drivers of Risks

The profile of risks affecting enterprises today is vastly different than risks impacting enterprises a decade ago. Because of changes in technology, globalization, the nature of business transactions and risk drivers, such as the recent sub-prime lending meltdown, the challenge facing audit committees and boards to effectively oversee numerous complex risk drivers can be daunting.

Editor Note: Meet Mark Beasley at the upcoming AICPA conference, The Audit Committee’s Role in Risk Oversight: Taking a Strategic View of the Enterprise, March 27-28 in New York, NY.

Enterprise Risk Management

To meet these challenges, many boards and senior executives are changing the way they think about managing risks throughout their businesses. While businesses have managed risks for centuries, the traditional approach to risk management has been to assign risk oversight responsibilities to certain business functions, such as legal or IT, where risks are managed in isolation by that function. Such an approach is often described as a “silo” or “stove pipe” approach (see Figure 1). Unfortunately this approach fails to recognize the reality that individual categories or “silos” often interact with other silos. As a result, one function may be lobbing risks unknowingly to other functions within the same organization. Furthermore, traditional risk management approaches often fail to develop a common way of thinking about “risks,” leaving the interpretation of what constitutes a risk and what level of risk is acceptable to each silo leader. And for some, risk management is left to ad hoc, gut-level knowledge and management of key categories of known risks.

Figure 1 - Traditional Risk Management Approach

"Silo" or "Stove-Pipe" Risk Management

Leading best practices now call for a move from an ad hoc approach-to-risk management to one that leads to a more structured enterprise-wide view of risks affecting the enterprise. This new approach is the enterprise risk management or ERM. Embracing ERM involves a shift in processes and culture by strengthening communication, training and awareness, and building processes to track risks so that individual risk silo managers view risks through an enterprise lens and help build an enterprise-wide analysis of risks for senior executive and board review.

Several conceptual frameworks have been developed in leading the implementation of ERM. In 2004, the Committee of Sponsoring Organizations of the Treadway Commission (COSO) issued its Enterprise Risk Management — Integrated Framework with this definition of ERM:

Enterprise risk management is a process, effected by the entity’s board of directors, management, and other personnel, applied in strategy setting and across the enterprise, designed to identify potential events that may affect the entity, and manage risk to be within the risk appetite, to provide reasonable assurance regarding the achievement of objectives (Committee of Sponsoring Organizations of the Treadway Commission (COSO), Enterprise Risk Management — Integrated Framework, September 2004, New York, NY).

This definition emphasizes several key concepts. First, ERM must be driven from the top of the organization, including board involvement. Second, ERM is meant to be value-adding, and thus risk analyses should be integrated with strategy planning. Third, the goal of ERM is not risk reduction. Rather, it is designed so that risks are effectively managed by creating an enterprise-wide view of risks in which organizational objectives are more likely to be achieved for value preservation and enhancement (see Figure 2).

Figure 2 - ERM Brings Risks Together

Role of the Board and Audit Committees

The board of directors and its audit committee play a critical role in ERM by establishing the right environment or tone-at-the-top. Given the board’s responsibilities for representing the interests of shareholders, it plays a vital role in overseeing management’s approach to ERM. Without their oversight, ERM may not be embraced by senior management.

External drivers are encouraging boards to oversee management’s ERM practices by assigning explicit responsibilities to audit committees for risk oversight. The New York Stock Exchange’s (NYSE) Final Corporate Governance Rules require audit committees to discuss policies with respect to risk assessment and risk management. While acknowledging that an entity’s senior executive team has the job of assessing and managing the entity’s exposure to risk, the NYSE rules call for the audit committee to discuss guidelines and policies to govern the process by which this is accomplished and to discuss the entity’s major financial risk exposures. Standard & Poor’s recently announced plans to expand its evaluation of an enterprise’s ERM processes as part of their debt rating analysis and scoring (Standard & Poor’s, Criteria: Request for Comment: Enterprise Risk Management Analysis for Credit Ratings of Nonfinancial Companies, November 2007, New York, NY). A key element of S&P’s ERM evaluation focuses on the entity’s risk management culture and governance, which includes an analysis of the board and audit committee’s role in risk oversight. Moody’s and Fitch perform similar considerations as well. Thus, the board and audit committee’s involvement in ERM oversight is becoming a critical component of effective governance.

Developing Audit Committee Processes

Despite the incredible demands now placed on audit committees, those who serve on these committees are examining how their processes need to be enhanced to meet these increasing expectations for audit committee oversight of risk management activities. They are seeking best practices and training to identify their role in overseeing management’s risk procedures, including their review and approval of key risk policies, risk authorities and risk tolerances. Audit committees are also exploring methods for evaluating management’s infrastructure, including personnel competencies and technologies and communications, to ensure that risk information they receive is providing the appropriate top-down, enterprise view of risks.

As audit committee involvement in ERM oversight evolves, more of those who serve are beginning to realize the benefits of better risk intelligence for them in their governance roles. Many are learning that ERM is producing better risk insights that help the board in its strategic oversight by identifying events. In addition, better risk intelligence means both audit committees and the full board are better informed. In the end, the increase in audit committee and board risk management oversight is strengthening the board’s ability to protect and enhance stakeholder value.

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Dr. Mark S. Beasley, is the Deloitte Professor of Enterprise Risk Management and Director of the ERM Initiative in the College of Management at North Carolina State University in Raleigh, NC. The ERM Initiative provides thought leadership on enterprise risk management, with an emphasis on the role of ERM in strategy and governance. Beasley serves on the COSO Board representing the American Accounting Association and is a frequent speaker on ERM and governance at national and international conferences.