In order to answer the question it is essential to define the terms used.  In short, both business and risk need to be defined to avoid misunderstandings from inception.

For the purposes of this discussion, ‘ business’ refers to any commercial, professional and industrial activity generally, as in “business continues to evolve as markets change”, as applied to companies, public sector bodies and not-for-profit organisations such as charities.

Risk can be defined as the potential harm that may arise from some present process or some future event, which is seen as undesirable.  Usually the probability of that event and some assessment of its expected harm must be combined into a credible outcome which combines the set of risk, regret and reward probabilities into an expected value for that outcome.  In mathematical terms risk is often expressed by the following formula; risk = probability x hazard.  It follows that this question seeks to answer whether business’ appetite for risk, as expressed in the formula, has increased or decreased over a period of time, say the last decade.

As a way to expand an organisation’s capital and reduce the risk of personal liability, the limited company concept has continued to expand rapidly as evidenced by markets for fledgling companies such as AIM.  Within the last decade, in the UK, professional partnerships have been permitted to embrace the limited liability concept to mitigate the risk of full personal liability.  Effectively partners of these firms have become more risk averse, have capped their liability and passed the risk back to their clients.

The ultimate determinant of an organisation’s strength be it a company or a public body is the strength of its covenant with its ultimate guarantor.  Public bodies’ risks do not reside in the conventional loss of worth but are dependant on adequate funding provision from central government’s taxation revenues.  When the balance of political interest moves in a different direction, public bodies find severe difficulties, as is currently the case, with the National Health Service.

In profit generating businesses, it has often been said that profit is the reward for risk.  Thus, it should follow that, in a free market, the greater the risk the greater the profit.  This is however not always the case, since there will always be new entrants to a profitable market negating the early advantage gained by the initial monopolistic or niche businesses.

Increasing layers of regulatory compliance have been added to reduce the risks borne by a variety of stakeholders.  Society’s understanding and recognition of stakeholders has expanded beyond the initial shareholder investor and now, for limited companies, encompasses its shareholders, creditors, employees and immediate neighbours, through environmental concerns, as well as its pensioners.

The risks of failing to meet the often conflicting demands of all interested stakeholders have increased dramatically as the definition of stakeholders has broadened, giving rise to increased risk and exposure to litigation.  Class actions, a recent American import, have heightened the risks whereby one stakeholder can sue on behalf of all.  The compensation culture has become engrained in our thinking with the attendant risk that legal action, often pursued on a contingency basis by the lawyers, is always present.  On this analysis, the risk of being sued is always present for all organisations, save the few that are exempt by statute such as the Crown.

Behavioural psychologists have identified the two principal drivers behind individuals’ motivation.  These are broadly defined as being the pursuit of pleasure and the avoidance of pain.  Repeated studies have shown that, given the choice, the vast majority seeks to avoid pain.  By nature we are risk averse and, since people control organisations, their inherent characteristics dominate the organisation’s behaviour tending to lean towards averting risk. There is therefore an underlying tension in all organisations between profit maximisation on the one hand and risk limitation on the other.

Not-for-profit bodies and Public Bodies are evaluated in terms of alleviating some suffering or executing core objectives.  Various Key Performance Indicators are now used to try to measure their effectiveness.  In a cynical media dominated era these organisations are as threatened as limited companies if they fall short of targets, which are often, manipulated to give the illusion of success.  For example, rather than admit it is failing, a school will exclude its less able pupils from GCSE examinations in order to boost its league ranking. Undoubtedly failing schools, their staff and governors are now at greater risk than they were because of the visibility accorded by their results.  Pension Fund Trustees and School Governors are in the vanguard of those who are at risk of personal litigation since they are often lacking in the detailed knowledge now required for these roles.  Consequently fewer people put their names forward with the clear inference being that they are becoming more risk averse.

Financial disasters such as the Maxwell, Barings, BCCI, WorldCom and Enron scandals have served to tighten financial, fiscal and regulatory controls across western markets.  Compliance costs have risen significantly driven in part by EU harmonisation, the imposition of global accounting standards and protective legislation such as the US “Sarbox” legislation. When new regulations appear so do new crimes such as insider trading.  As compliance regulations multiply, the risk of non-compliance expands.

Auditors now have a tome of checklists to cover all disclosure requirements of a PLC audit. Ironically, the resultant accounts are now unintelligible to most shareholders and are generated for the sophisticated financial journalist.  This is an example of risk aversion (the drive for greater disclosure) generating more risk for the investor who now has to rely on the analyst’s view.

Within the last decade all businesses’ perception of risk has been shaken to the core as a result of globalisation, accelerated by the communications revolution largely caused by the explosion of the Internet.  All businesses now operate in a global village, a fact recently acknowledged by HMRC, which is looking at ways to retain its current tax base because of concerns about the migration of businesses offshore.

A large reduction in the UK’s tax take, represents a major risk to a nation in which more than half the population works for the state, as broadly defined.

We have all become more risk averse as evidenced by the demand for LLPs for professional practices and the plethora of personal and product liability insurance policies offered to individuals and businesses alike.  Increasing regulation serves to reinforce a risk averse culture but in its implementation has succeeded in creating greater risk.

Accounting Standard setters, in trying to reduce risk and introduce clarity, have generated greater confusion than existed previously.  FRS 17, accounting for pensions, is an example of this.  Companies with pension deficits now report these liabilities in their accounts with the result that the liability fluctuates at the whim of the market on a specific date.  Moreover Actuaries have recently declined to give mortality data yet these assumptions are critical to the calculation.  A drive for transparency has generated opacity, leaving Directors liable if, after having approved and paid a dividend, it subsequently transpires that there was a deficit on reserves.

In conclusion whether business is becoming more risky or more risk averse is somewhat academic since they are opposite sides of the same coin.  When businesses seek to become risk averse they transfer risk to others and vice versa.

The inexorable advance of the “pool of risk” will grow as economies continue to expand. In short, one business’ adoption of risk aversion methods will become another’s risk.

Article contributed by Nigel Colin, Tennants Consolidated - nigel.collin@tg-tcl.com