Enterprise Risk Management for Agricultural Cooperatives

1
Enterprise Risk Management for Agricultural
Cooperatives

• Timothy J. Richards
• Power Professor of Agribusiness
• Morrison School of Agribusiness
• Arizona State University

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ERM What is it?

• Enterprise Risk Management is a systematic and
  integrated approach to the management of the
  total risks that a company faces Dickinson
  (2001)

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The Emergence of ERM

• High-profile corporate failures Enron?
• Rise of importance of corporate governance
• Shareholder activism and value-focus
• Convergence of insurance and finance
• Sophistication of loss-prevention, control
• Mergers and risk assumption

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Importance for Cooperatives

• Volatile Markets
• Single-Commodity Focus
• Single-Region Orientation
• One Part of Value Chain
• Limited Capital Reserves
• Low Margins
• Risk Averse Membership
• Member Commitment Important

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The 6-Step ERM Process

• Risk Management Objectives
• Risk Identification
• Risk Measurement
• Risk Response
• Risk Integration
• Risk Infrastructure

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Risk Management Objectives

• Efficient Capital Allocation?
• Prevent Earnings Shocks?
• Increase Cross-Functional Understanding?
• Competitive Advantage?
• Avoid Catastrophic Risks?
• Allocation of Internal Resources?
• Regulatory Compliance?

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Risk Objectives

• Develop metrics to measure success
• Share price for publicly traded company
• Earnings volatility
• Return on assets / local savings
• Increased financial flexibility
• Liquidity ratios
• Solvency ratios
• Efficiency ratios
• Member commitment / retention rates

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Risk Identification

• Growers
• Production Risk
• Price Risk
• Processors
• Competitive Risk
• Government / Policy Risk
• Financial Risk
• Operational Failure
• Human Failure

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Risk Identification

• Need for enterprise-wide risk sensitivity
• Process of risk identification must be
• Dynamic
• Continual
• Quantitative where possible
• Risks should be ranked by their
• Magnitude ( of income)
• Probability
• Expected loss is key measure of importance

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Risk Measurement

• Measures
• Value at Risk (VaR) and Earnings at Risk (EaR)
• Industry Benchmarks
• Internal Performance Benchmarks
• EVA (Economic Value Added)
• RAROC (Risk Adjusted Return on Capital)
• Methods
• Statistical Methods simulation, _at_Risk, Factor
• Qualitative Assessment guess, concensus

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Risk Measurement

• Tools must be rigorous, but understandable
• Measurement must include risk attitudes
• Risk loving?
• Risk averse?

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Intangibles

• Value of a Brand
• Goodwill
• Reputation
• Human Capital

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Risk Response

• Risk Avoidance
• Risk averse strategy
• Opportunity cost of forgone investments
• Risk Acceptance
• Self-insurance
• Capital reserves necessary

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Risk Response

• Risk Mitigation / Control
• Strategy part of strategic plan
• People incentives to reduce risk
• Process include means to reduce risk
• Systems dynamic feedback and reengineer
• Risk Transfer
• Financial market transactions
• Insurance integrate insurable / uninsurable

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Risk Response

• Use Combination of Methods
• Creative Use of Transfer Opportunities
• Over the counter market
• Structured derivative products
• Integrate insurance and derivatives

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Risk Integration

• Recognize Firm as Portfolio of Risks
• Implications of Portfolio
• Natural hedges, eg. price and yield
• Inconsistencies, eg underweight low probability
• Trading opportunities?
• Develop Enterprise-wide Sensitivity to Risk
• Risk as Source of Competitive Advantage

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Risk Infrastructure

• Senior-Level Executive CRO
• Accountability
• Integration
• Authority
• Preserve Autonomy, Flexibility, Value
• Link to Business Processes
• Part of Strategic Plan
• Flow of Information

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Risk Infrastructure

• Risk Management Committee
• Cross functional committee
• Business units and treasury
• CEO / CFO / Treasurer / CRO members
• Vertical information flow

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Ways to Implement ERM

• Coop as Portfolio of Business Ventures
• Understand Sources of Risk
• Hire Consultants?
• Enterprise Diversification
• Financial Risk Management Products
• Swaps
• Weather Derivatives

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Case Study UGG

• New World in 1990s
• Growth in non-board trade
• Changes to rail distribution system
• Publicly traded shareholder obligation
• Built Strategic Risk Management Project
• Developed integrated financing approach
• Combined insurable and non-insurable risk
• Sold risks to Swiss Re

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Conclusion

• Cooperatives are vulnerable to risk
• Risk should be defined at enterprise level
• Systematic approach to managing risk
• Build cross-functional risk systems
• Minimize risk as organization objective