Enterprise Risk Management for Agricultural Cooperatives

1. Enterprise Risk Management for Agricultural Cooperatives Timothy J. Richards Power Professor of Agribusiness Morrison School of Agribusiness Arizona State University

2. ERM: What is it? • “Enterprise Risk Management is a systematic and integrated approach to the management of the total risks that a company faces” – Dickinson (2001)

3. The Emergence of ERM • High-profile corporate failures: Enron? • Rise of importance of corporate governance • Shareholder activism and value-focus • Convergence of insurance and finance • Sophistication of loss-prevention, control • Mergers and risk assumption

4. Importance for Cooperatives • Volatile Markets • Single-Commodity Focus • Single-Region Orientation • One Part of Value Chain • Limited Capital Reserves • Low Margins • Risk Averse Membership • Member Commitment Important

5. The 6-Step ERM Process • Risk Management Objectives • Risk Identification • Risk Measurement • Risk Response • Risk Integration • Risk Infrastructure

6. Risk Management Objectives • Efficient Capital Allocation? • Prevent Earnings Shocks? • Increase Cross-Functional Understanding? • Competitive Advantage? • Avoid Catastrophic Risks? • Allocation of Internal Resources? • Regulatory Compliance?

7. Risk Objectives • Develop metrics to measure success: • Share price for publicly traded company • Earnings volatility • Return on assets / local savings • Increased financial flexibility: • Liquidity ratios • Solvency ratios • Efficiency ratios • Member commitment / retention rates

8. Risk Identification • Growers: • Production Risk • Price Risk • Processors: • Competitive Risk • Government / Policy Risk • Financial Risk • Operational Failure • Human Failure

9. Risk Identification • Need for enterprise-wide risk sensitivity • Process of risk identification must be: • Dynamic • Continual • Quantitative where possible • Risks should be ranked by their: • Magnitude (% of income) • Probability • Expected loss is key measure of importance

10. Risk Measurement • Measures: • Value at Risk (VaR) and Earnings at Risk (EaR) • Industry Benchmarks • Internal Performance Benchmarks • EVA (Economic Value Added) • RAROC (Risk Adjusted Return on Capital) • Methods: • Statistical Methods: simulation, @Risk, Factor • Qualitative Assessment: guess, concensus

11. Risk Measurement • Tools must be rigorous, but understandable • Measurement must include risk attitudes: • Risk loving? • Risk averse?

12. Intangibles • Value of a Brand • Goodwill • Reputation • Human Capital

13. Risk Response • Risk Avoidance • Risk averse strategy • Opportunity cost of forgone investments • Risk Acceptance • Self-insurance • Capital reserves necessary

14. Risk Response • Risk Mitigation / Control • Strategy – part of strategic plan • People – incentives to reduce risk • Process – include means to reduce risk • Systems – dynamic feedback and reengineer • Risk Transfer • Financial – market transactions • Insurance – integrate insurable / uninsurable

15. Risk Response • Use Combination of Methods • Creative Use of Transfer Opportunities • Over the counter market • Structured derivative products • Integrate insurance and derivatives

16. Risk Integration • Recognize Firm as Portfolio of Risks • Implications of Portfolio • Natural hedges, eg. price and yield • Inconsistencies, eg underweight low probability • Trading opportunities? • Develop Enterprise-wide Sensitivity to Risk • Risk as Source of Competitive Advantage

17. Risk Infrastructure • Senior-Level Executive: CRO • Accountability • Integration • Authority • Preserve Autonomy, Flexibility, Value • Link to Business Processes • Part of Strategic Plan • Flow of Information

18. Risk Infrastructure • Risk Management Committee: • Cross functional committee • Business units and treasury • CEO / CFO / Treasurer / CRO members • Vertical information flow

19. Ways to Implement ERM • Coop as Portfolio of Business Ventures • Understand Sources of Risk • Hire Consultants? • Enterprise Diversification • Financial Risk Management Products • Swaps • Weather Derivatives

20. Case Study: UGG • New World in 1990s: • Growth in non-board trade • Changes to rail distribution system • Publicly traded – shareholder obligation • Built “Strategic Risk Management Project” • Developed integrated financing approach: • Combined insurable and non-insurable risk • Sold risks to Swiss Re

21. Conclusion • Cooperatives are vulnerable to risk • Risk should be defined at enterprise level • Systematic approach to managing risk • Build cross-functional risk systems • Minimize risk as organization objective