Risk Management Reports

July, 2005
Volume 32, No. 7
 
The Crippling Effects of Fear

Franklin D. Roosevelt famously addressed a nation in the throes of the Great Depression when he took office in 1933: "We have nothing to fear but fear itself." It was the first step in bringing the United States out of economic chaos. But today, I see many signs repeating that crippling fear of seventy years ago. Are we too easily frightened, too ready to see potential discouraging downside events, too anxious about the future to grasp the opportunities that lie ahead? We are starting to play defensive ball, which, as almost all sports analysts will tell you, is how to lose the game.

Three examples illustrate this malaise. The first happened at a May quarterly meeting for investors run by two stockbroker friends. As a preface to their remarks about the predicted trends in the markets over the next three months, they posted a list of their "fears." Here they are, and most will acknowledge that they are real and important:

  • Slowing economic growth in the United States
  • Weakening US dollar
  • Rising interest rates
  • Inflation, especially in the United States
  • Declining consumer confidence
  • The international housing bubble
  • Energy prices
  • Geopolitical uncertainty
  • The deficit in the United States
  • Global economic conditions
  • Increasing protectionism in Europe and the United States
  • Terrorism

I don´t deny that these are valid concerns, but a realistic analysis of each "fear" shows positive counterparts! This is exactly what I have been preaching for so many years: an unexpected event has both positive and negative consequences; we cripple our creativity if we look only at the downsides.

Consider these options:

  • Slowing economic growth in the United States: but this growth may be steadier and more predictable, thus enhancing investment.
  • Weakening US dollar: but this will encourage others to buy goods and services from the United States.
  • Rising interest rates: this will attract more external investors to US securities.
  • Inflation, especially in the United States: economists tell us that modest inflation is desirable; it has been low for some years.
  • Declining consumer confidence: but this may stimulate a needed increase in personal savings.
  • The international housing bubble: bubbles need to be deflated, even burst, thus enhancing future economic growth.
  • Energy prices: high prices will stimulate a serious search for alternative energy sources, helping the climate, political dependencies, costs, etc.
  • Geopolitical uncertainty: geopolitics is always uncertain! What´s new?
  • The deficit in the United States: our growing awareness means that we will do something serious about the deficit.
  • Global economic conditions: as with geopolitics, these are always volatile.
  • Increasing protectionism in Europe and the United States: a minor backward step in the long march toward freer global trade.
  • Terrorism: the actual frequency of terrorist events is sharply reduced from the years 1970-1990: global attention is producing results!

I do not propose a Pollyannaish response to these fears. I do suggest that a more balanced view of the potential unexpected events of the future will allow us both to take advantage of new opportunities and to reduce the effects of negative events. This is the goal of risk management: to enhance our native resiliency.

The second illustration was also local. Periodically the Defense Department in the United States is asked to review its holdings of military bases and similar property in line with its changing mission. This inevitably leads to the shutdown of some facilities, many of which have been economic mainstays to their communities. Even though the process is insulated against political pressures, it creates the usual outcry when the periodic shutdown list is published. This spring the submarine base in Groton, Connecticut, close to where I live, was on the list. The first headline was "Region Shocked, Angered by Possibility of Shutdown," with every politician screaming bloody murder. Should we have been surprised? Hardly, as this base appeared on a prior shutdown list and as submarines now play a reduced role in current military plans. Every commentator described in horrific terms the economic pain the region might experience and argued that we should be spared (even as these same politicians demand that government cut its expenditures to reduce the deficit!) In other words, cut costs, but not in my backyard! It took almost a month before some saner observers noted that the property in question was prime waterside real estate, always in demand, and that some creative and imaginative thinking might just produce new businesses that would more than replace the lost sub base income to the region. In other words, the proposed shutdown could be an opportunity for all of us! Here again the driving force of fear obscured the other side of the equation. Yes, it is a very human reaction but good risk management requires immediate consideration of the balance.

My third illustration is the negative reaction to the Sarbanes-Oxley law in the United States (and comparable regulations in other countries). Compliance will cost considerable money and the regulatory burden will be heaviest on the smaller public firms. I´ve already noted in RMR the degree to which the accounting profession, both internal audit and external accounting, has focused on compliance almost to the exclusion of any balanced view of risk management. All this discourages managers from taking any risks. Yes, there will be benefits, including a slow but sure re-establishment of trust in public companies and the figures that they publish, but at what cost? If these laws and regulations, and our reaction to them, dampening risk taking and creating new "defensive management," we are likely to become a horde of lemmings, reluctant to do anything different or "risky" for fear of legal retribution or public opinion retribution.

The solution to these three examples is to swim against the prevailing tide of disillusionment and fear. Be contrary! When considering an action decision, list both favorable and unfavorable unexpected outcomes. A balanced analysis of risk is our proper course. But, while being contrary, don´t jump off the cliff just because all the lemmings are running away from it!

Innovation is the driving force behind value creation and competitive advantage, but you can´t innovate and grow unless you are willing to take risks. Yet in the current regulatory and tort environment, companies are more focused on risk reduction than ever before. They´re practicing defensive management by reducing R & D and other investments that Wall Street might punish for being too focused on the long-term or that could lead to regulatory challenges or litigation.

Deborah Wince-Smith, "Innovate at Your Own Risk," Harvard Business Review, May 2005

Copyright 2005, by H. Felix Kloman and Seawrack Press, Inc.

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