Establishing Your Company’s Risk Appetite

The Committee of Sponsoring Organizations of the Treadway Commission (COSO) recently published new guidance on how companies can promote “risk appetite” as part of decision-making. It’s especially relevant in today’s uncertain marketplace.

The COSO guidance, “Risk Appetite — Critical to Success: Using Risk Appetite to Thrive in a Changing Word,” explains that management must learn to anticipate and understand their risk when change happens. It defines risk appetite as, “The types and amount of risk, on a broad level, an organization is willing to accept in pursuit of value.”

This definition is intentionally broad to apply across an organization. It may differ within various parts of your organization to remain relevant in changing business conditions. When establishing your appetite for risk, the goal is to enhance long-term growth and innovation.

“Risk appetite is a fundamental part of setting strategy and objectives, providing context as the organization pursues a given level of performance,” said COSO Chairman Paul Sobel. He stressed the importance of recognizing that the choice of strategies and objectives requires an understanding of the appetite for risk.

In volatile times — like during the COVID-19 pandemic or when facing regulatory uncertainty from a contentious upcoming election — a business may need to alter it to take advantage of growth opportunities as market conditions evolve.

COSO lists six things to remember when establishing your company’s appetite for risk:

Risk appetite applies through the development of strategy and objective-setting. It focuses on the overall goals of the business. Risk tolerance, on the other hand, applies to the execution of strategy and focuses on objectives and variation from plan.

To be effective, your company’s risk appetite should permeate its culture. To get the message out across the organization, management should consider creating an appetite statement that includes measurable benchmarks. For example, you might say, “ABC Co. isn’t comfortable accepting more than a 10% probability that it will incur losses of more than $200,000 in pursuit of emerging market opportunities.”

The choice of language and length of an appetite statement will vary by organization. Some statements require several sentences to balance brevity with clarity.

Taking risks is essential to growing your business. However, risks can’t go unchecked. Setting and understanding risk appetite is an important element of corporate governance, strategic planning, and decision-making. We can help you better understand and apply this concept, communicate it to stakeholders, and monitor progress. Contact us today for help.