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September 24, 2008
Reflections about KM in the current financial world
Reflections about KM (Knowledge Management) in the current financial world
This time I want to present a KM point of view related to the financial crisis. The experience is part of the learning process and knowledge development. The reflection is about experiences and the causes of the current issues in the market that could be analyzed in a KM setting in order to reduce the “risk” of new failures. Two possible optics to analyze this phenomenon are: the company operation and the
user perception and reaction.
The company operation
The issue of a consolidated management practice for risk and knowledge is a controversial one. On the one hand, the two disciplines and practices are considered to be independent with many technical components which are not possible to use jointly. On the other hand, the practice shows that the processes in both disciplines have many points in common which can be used to gain synergy in the firm.
Bowman (1980) describes the paradox of having a negative association between corporate return and risk when there is a positive relationship, from the portfolio point of view, between return and risk. The meaning is that companies with lower risk and higher return have a higher share price, reducing the return for the owner or buyer of the stocks This result has inspired many different articles in order to understand whether the better the organization´s knowledge, the better the risk. The risk will have consequences for the investor’s decision depending on the return appetite. In the final analysis, I think that the integration of KM and RM could contribute to the creation of a more competitive and sustainable advantage, because:
1. Strategy requires information interpretation in order to produce knowledge so as to control the enterprise’s risks.
2. The strategy formulation process and the purpose of wealth growth need to be analyzed under a framework of uncertainty, trends, and complexity. The control of result variance is an important strategic goal.
3. Good results in a company require the combination of a clear business definition, understanding of risk, and the development of people’s capacity for productivity improvement.
4. There is a need for understanding of integrated knowledge and risk assessment tools that can introduce a more efficient and effective management. Understanding that is represented by the analysis of:
• Drivers of the strategic goals
• Time horizons in strategic plans
• Level of comfort with the results
• Level of comfort with the KM and RM practices
• Value of an integral view of Risk and Knowledge Management
• Existence of independent Risk and Knowledge Management technological tools
• Existence of joint structure for Risk and Knowledge Management
5. The knowledge practice is based on merging people, technology, general processes and leadership with creation, storage, retrieval, transfer and application of knowledge. This merge looks for the identification, classification, transference, hedging, planning and evaluation of enterprise risk.
Thus, the big question that I have is: can we identify and show that failures are related to the five points above (KM and RM ties) and to learn from the conclusions in order to avoid deeper crises. Please, reflect about the comments that I have below for some of historical difficulties/failures that can have roots in a lack of managing the knowledge processes (Simons,1999):
• Expansion: In American Express in 1987 the growth affected the operations. There was fast expansion, faster than the capacity. The knowledge support was minimal to manage Optima a newly introduced product.
• Culture: The Banker Trust expansion reduced the quality of the product presentation to the clients; the reason was: cultural pressures. There was a lack of information flow and the products were not well understood. The culture of avoiding bad news reduced the possibility of finding solutions to errors.
• Controls: Barings Bank’s failure is related to the lack of early warning systems and the relation of a work environment of rewards and recognition based on a short term performance view, with internal competition, which contributed to the bad results.
• Lack of Understanding of what is happening: the complexity increment, transaction are created, lack of control, deficient information management and cost as the only important driver to manage are points reducing the capability of reacting in difficult and opportune times. This complexity and the cost of knowledge show the need for managing the understanding and use of information rather than the information itself (Sutcliffe and Weber, 2003).
• Reduced communication of business values in an understandable way which people can embrace. Possibly the identification of off-limits actions was not clear. And the need of stimulation of a learning system in order to review processes and to discuss the results and adequate diagnostic control systems
• A mix of many things. The cases of Lehman Brothers, Merrill Lynch, AIG, Societe Generale, UBS, Fanny Mae, Freddie Mac can be a combination of many things but at least some are clearer than others. For example, diminishing the value of specialization of the organization, growth of businesses that are related but that have different dynamics and can affect the main business (AIG and the derivative trading subsidiary), managing a leverage level that was not acceptable, possible short term performance interests and no long term strategic consolidation, management influenced by their performance evaluation parameters, controls and bad use of knowledge, reduced observation of the interrelationships among organizations; for example, Lehman Brothers and UBS, needed the understanding of a mortgage market with a dynamic that required some adjustments,
In conclusion, these examples show that the five points could show that the integration of KM and RM could deal with avoiding failures in risk management as Marshal et al (1996) identified as: dysfunctional culture, unmanaged organizational knowledge and ineffective controls.
User perception and reaction
Knowledge can be considered a factor to reduce risk (Dickinson 2001). Knowledge transfer can be influenced adversely by the existence of knowledge silos, and business units can require education in how to transfer experiences, taking into consideration that the pace of change can reduce the value of experience in some specific fields. The point is how to understand the user reaction in the face of a crisis and how to develop contingencies barriers to avoid chain reactions.
Some researchers have studied the relationship between knowledge, innovation and share price. They have found that the knowledge-based enterprise obtains firm value based on human capital, research and development, patents and technological assets. Similarly, financial ratios have been examined and it has been found that intangible assets add value to increase equity and to produce better equity ratios.
There are several examples of the identification of the relationships between the investor’s psychology and the perception of risk. Some of these analyses are related to perception of risk and how it can affect decisions, and in turn can be affected by knowledge and information about reputation, business longevity and perception of organization competitiveness. Some authors conclude that the stock return is associated with three elements: energy, perceived brand relevance and financial performance measures. However, we do not have a lot of knowledge about the ways to manage crises even if we know that they are coming.
In summary, the reflections to think about are related to and arise from the internal operations of the financial institutions and the observation of the users of the financial system. Users that have fears, knowledge, chain reactions and trust lost when a company has troubles.. Probably this opens a chapter in Risk Knowledge Management that is Crisis Knowledge Management in order to manage a critical situation.
References:
• Bowman E (1980) A risk/return paradox for strategic management Sloan Management Review Vol 21 pp 17-31
• Dickinson G. 2001, “Enterprise Risk Management: Its Origins and Conceptual Foundation”, The Geneva Papers on Risk and Insurance, Vol. 26, No. 3, pp 360-366
• Marshal, Chris and Prusak, Larry, “Financial Risk and need for superior knowledge management”, California Management Review, Vol 38 No. 3 spring 1996, pp 77-101
• Simmons, Robert, “How Risky is Your Company”, Harvard Business Review, May-June 1999, pp 85-94
• Sutcliffe, Kathleen and Weber, Klaus,” The High Cost of Accurate Knowledge", Harvard Business Review, May 2003, pp 74-82
Research space
This section is an open field of research. Risk management in a more individualistic world: This time the analysis can be how to deal with a more individualistic world for managing risk when our exposures are growing in different markets, products, sectors and cultures. Is there any plan to bring the experiences in many different scenarios in order to use them for a better development of the branches, subsidiaries or even headquarters?
This is contrary to the issue of the lost privacy as well. What could be the effect of the privacy lost if we are more individualistic but belonging to more social networks? Could the social networking create more risk issues and risk exposure in areas that we are not aware of yet.
Your model and my model!!!
The music metaphor. For many years I have heard that a person in charge of the organization should be described as an orchestra director, managing different resources to perform a musical piece. My understanding is that the simile stopped at the level of resources management. What about the concepts to follow melody, harmony, tune etc? Sounds have to be organized and noise has to be filtered in order to produce music. In an orchestra the concepts are the bases for music production; the performers and instruments are the means to produce music. The director of the orchestra works mainly with concepts to guide the performers.
The simile between manager-leader and orchestra director is complete if the consolidation of concepts is the basis of management. In management we need to produce music and control the noise (risk). Concepts such as: rhythm, melody, song, symphony, concerto, harmony, tocata, preludes... and so on. These are concepts used to manage the orchestra and to produce music according the expectations and compositions; it is required knowledge and creativity to guide the group. All of them are under a world of risk (noise) that is based on the listener and its judgement.
Mathematical Circle:
The question here is how knowledge management has a relationship to risk if we see a mathematical world? Well the point to present is that the knowledge from different disciplines can be used in problem solving from different areas. Something that has been great was to use Brownian Motion, part of the Physics tool, to describe financial behaviour. However, we do not have a lot of examples where many applications are at the same time based on the same principles. For example, are the Fibonnaci numbers, the Golden Ratio, Fractals and Mandelbrot models related? Read about Elliot and think about what Mandelbrot said “The geometry that describes the shape of coastlines and the patterns of galaxies also elucidates how stock prices soar and plummet”. What do you think about it? It seems that multi-fractals describe the prices and applications where can be possible. Fractals are pattern descriptions, geometric representation-shapes where the parts are exact copies of the whole but on a smaller scale.
Thank you
Eduardo Rodriguez
Principal
eduardo.rodriguez@iqanalytics.com
www.iqanalytics.com
Posted by edrota at September 24, 2008 11:26 PM
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