Management Risk: Understanding the Risks and Mitigation Strategies
What Is Management Risk? Management risk refers to the risk—financial, ethical, or otherwise—associated with ineffective, destructive, or underperforming management. It can impact investors holding stock in a company or the risks associated with managing an investment fund.
Key Takeaways
- Management risk involves the financial, ethical, or performance-related risks associated with ineffective management.
- It is a concern for investors holding stock in a company and for the management of investment funds.
- Directors of publicly traded stocks have an obligation to act in the best interest of shareholders.
- Portfolio managers have fiduciary responsibilities and breach of these obligations can create risks for shareholders.
Company Management Risk
- Numerous rules, regulations, and market practices aim to protect shareholders of publicly traded companies against management risks.
- The Sarbanes-Oxley Act of 2002 increased the importance of transparency and investor relations for public companies.
- Publicly traded companies have dedicated investor relations departments responsible for managing investor events and communicating compliance.
Fund Management Fiduciary Responsibilities
- Investment funds are subject to fiduciary responsibilities and must comply with the Investment Company Act of 1940.
- The Act includes provisions such as the requirement for a board of directors overseeing fund activities and investments.
- Style drift, caused by investment decisions shifting away from the fund’s objective, can pose risks for investors.
Fraudulent Activities
- Managers who act outside their obligations may face legal actions.
- Noteworthy corporate scandals like Enron, Worldcom, Tyco, and Xerox led to the enactment of the Sarbanes-Oxley Act.
- Fraudulent activities can also apply to investment managers who deviate from their legal authority in managing investor funds.
- Registered funds with established boards of directors and oversight processes offer better protection against fraudulent activities compared to hedge funds, privately managed funds, and offshore funds.
Additional Resources: Websites and Online Resources:
- Securities and Exchange Commission (SEC) – https://www.sec.gov/
- Financial Industry Regulatory Authority (FINRA) – http://www.finra.org/
Books:
- “Corporate Governance Matters: A Closer Look at Organizational Choices and Their Consequences” by David Larcker and Brian Tayan
- “The Risk Management Process: Business Strategy and Tactics” by Christopher L. Culp
Academic Journals and Research Papers:
- “Management Risk and Performance: Evidence from the Hedge Fund Industry” by Stephen Brown, William Goetzmann, Bing Liang, and Christopher Schwarz
- “Management Risk, Equity Ownership, and the Cross-Section of Expected Returns” by Jonathan Berk, Richard Stanton, and Josef Zechner
Reports and Studies:
- “Sarbanes-Oxley Act of 2002: Summary of Key Provisions” – U.S. Securities and Exchange Commission
- “Investment Company Act of 1940: Summary and Explanation” – U.S. Securities and Exchange Commission
Professional Organizations and Associations:
- National Association of Corporate Directors (NACD) – https://www.nacdonline.org/
- CFA Institute – https://www.cfainstitute.org/
These resources provide authoritative information and valuable insights for readers seeking further information on management risk and its implications in corporate and investment contexts.
Websites and Online Resources:
- Investopedia – “Management Risk Definition” – Read more
- Securities and Exchange Commission (SEC) – “Investor.gov” – Visit website
Books:
- “The Handbook of Corporate Financial Risk Management” by Stanley Myint and Fabrice Famery – Buy on Amazon
- “Investment Management: Meeting the Noble Challenges of Funding Pensions, Deficits, and Growth” by Roger M. Edelen, Ronald N. Kahn, and Stephen J. Brown – Buy on Amazon
Academic Journals and Research Papers:
- “Management Risk and Firm Value: Evidence from CEO Turnovers” by Qianqian Du and Hong Liu – Read more
- “Management Risk, Incentives, and Financial Reporting Quality” by Katherine Gunny and Jonathan Lewellen – Read more
Reports and Studies:
- Deloitte – “Managing Risks and Creating Value with Enterprise Risk Management” – Read more
- International Monetary Fund (IMF) – “Global Financial Stability Report: Lower for Longer” – Read more
Professional Organizations and Associations:
- CFA Institute – “Risk Management” – Visit website
- Global Association of Risk Professionals (GARP) – “Risk Management Resources” – Visit website