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Management risk is a business risk associated with poor management practices. If the management of a company is not competent or is more interested in generating profits for itself than shareholders, it can make bad decisions that result in losses for the company and the shareholders. In calculating management risk, people consider the success of a company under competent management, in contrast with what might happen if company managers make poor or self-interested choices.
Managers of a company can make bad decisions for a number of reasons. Simple incompetence can be one cause of management risk if a company has managers who are not experienced or skilled enough to administer the company properly. Management can also be corrupt, inefficient, too conservative, or can underperform in other ways. Management prone to taking risks can also be a detriment to the company if the risks taken are not well considered in advance, and the company suffers losses as a result.
One of the most perilous forms of management risk is when company management stops acting in the best interests of the company and its shareholders. This is illegal, as company managers are required to think about the interests of the company when making decisions, but sometimes the prospect of easy money is too appealing to resist. This can create a so-called “Leprechaun leader” situation, which is when management moves funds to hidden accounts so the depth of the mismanagement is difficult to determine until managers in question have moved on and taken their "pot of gold" with them.
Companies want to find managers who will make sound choices when called upon to make management decisions, walking the line between managing with prudence and taking calculated risks. When evaluating management risk, companies can look at the history of the management's performance, the company's current position, and the experience and qualifications of individual members of management. This must be considered when making changes to management in order to avoid situations in which unreasonably high risk is created.
It can be difficult to predict what the outcome of a series of decisions could have been after the fact. This makes it hard to determine how much money companies lose as a result of poor management and bad decisions. Self-interested decisions may be banned under the law for people heading up public companies, but once those decisions are made, it can be challenging to determine how much should be awarded to people who lost money as a result of those decisions. This is especially difficult when people have moved on and successfully concealed their ill-gotten gains.