Risk management's place in an organisation : a tradeoff between independence and co-ordination

This paper investigates the question of how risk management should be embedded in a firm's hierarchy. We take an innovative approach to this question by combining the well-known capital asset pricing framework with game-theoretic thinking. We discover the conditions under which risk information adds value to an investment decision. Furthermore, we provide a theory for the integration of risk management - the provider of risk information - into an organisation based on private information and differences in preferences. A simple model analyses when a principal will choose to allow a business manager to acquire additional risk expertise to improve estimation of a project's risk characteristics. In return, the organisation's decision making will benefit from the co-ordination of private information about the project's return and risk. However, the business manager could use the private information to implement favoured projects to the detriment of the organisation. The paper derives the prerequisites under which it is advantageous for the organisation to provide the business manager with additional private information as to a project's risk characteristics so as to foster co-ordination even if the principal's and the business manager's interests are not perfectly aligned. These findings have a number of implications for the organisation of risk management. -- Risk Management ; Organisation ; Private Information ; Co-ordination