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Validating management assumptions is probably the single most important value a risk manager can bring to his / her company. As companies and markets are becoming more interdependent, an issue in one industry or country may have a flow on effect on the global supply chain. The business environment is becoming more volatile. Unfortunately, many companies have been slow to adjust for such volatility. We have noticed an alarming trend to match the models to the desired outcomes to keep shareholders happy and justify bonus payments. Risk management needs to be vigilant to this often unethical behaviour. These topics were very well disclosed in the Professor Patrick McNutt’s book Strategic code – patterns and prediction of behaviour.
Management assumptions about interest rates, FX, market growth, customer behaviour and new technologies are quickly becoming outdated or overly optimistic. Risk managers play a vital role in verifying those assumptions to ensure they remain current and realistic.
Scenario analysis, stress testing and Monte-Carlo simulations help risk managers test current business plans and financial models to verify and validate assumptions made by management. Some risk managers use game theory principles and behavioural psychology to help management look at the strategic risks from different angles.
HERE IS A QUICK CHECKLIST TO TURN THIS SECTION INTO ACTIONS
| ☐ | Perform sensitivity analysis to identify critical management assumptions made in planning, budgeting, investment analysis or project management |
| ☐ | Establish reliable external or internal sources of information to validate management assumptions |
| ☐ | Perform Monte-Carlo simulations to show how volatility affects objectives / decisions and whether management assumptions are realistic |
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