May 26, 2020
Published: Journal of Accountancy
Risk appetite plays an important role in organizational success and should be considered carefully by leaders as they make strategic decisions.
The Committee of Sponsoring Organizations of the Treadway Commission (COSO) has published new guidance on risk appetite focusing on how organizations can promote risk appetite as a key factor in decision-making.
“Risk appetite is a fundamental part of setting strategy and objectives, providing context as the organization pursues a given level of performance,” COSO Chairman Paul Sobel said in a news release. “What is important is to recognize that the choice of strategies and objectives requires an understanding of the appetite for risk. While most often an organization can adjust to take on more risk, there may be times where it needs to adjust the appetite, or perhaps even strategy, to accommodate a shifting business environment such as the one we are currently experiencing.”
The guidance includes six key things to remember about risk appetite:
- Risk appetite is not a separate framework. It’s not a stand-alone activity, but it should be integral to managing risk as well as organizational action and communication.
- Risk appetite and risk tolerance differ. Though related, they are different ideas.
- Risk appetite applies to more than the financial services industry. It can help all organizations understand and manage performance more effectively.
- Risk appetite is at the heart of decision-making. It also is important in determining that a decision is even necessary.
- Risk appetite is much more than a metric. Although it is often treated as part of an approach where each metric is assigned a target appetite, a better, forward-looking application ties appetite and strategy together for future action.
- Risk appetite helps increase transparency. It can raise awareness of the risks the organization is willing to assume as well as the risks it aims to limit.
“Organizations take risk to succeed,” report co-author Frank Martens of Pacific Rim Risk Management Services said in a news release. “But risk can’t go unchecked. Setting and understanding risk appetite is an important element of corporate governance, strategic planning, and decision-making. Determining appetite through a performance lens requires deep discussions that affect management and boards and, to be effective, permeate an organization’s culture. In this way, appetite reflects the mission and vision and integrates with strategy and objectives with the end goal of adding value.”
COSO is a joint initiative of five private-sector organizations, including the AICPA, dedicated to providing thought leadership on enterprise risk management, internal control, and fraud deterrence. For more information, visit coso.org.