Business Risk and Simulation Modelling in Practice - Rees Michael

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or political biases are common in many real-life decision situations, often resulting in optimistic scenarios being presented as a base case, or risks being ignored, for many reasons:

      • The benefits and cost may not have unequal or asymmetric impacts on different entities or people. For example, project implementation may allow (or require) one department to expand significantly, but may require another to be restructured.

      • “Ignorance is bliss.” In some cases, there can be a lack of a willingness to even consider the existence of risks. There are certainly contexts in which this reluctance may be justified (in terms of serving a general good): this would most typically apply where the fundamental stability of a system depends on the confidence of others and credibility of actions, and especially where any lack of confidence can become detrimental or self-fulfilling. In such cases, the admission that certain risks are present can be taboo or not helpful. For example:

      • A banking regulator may be reluctant to disclose which institutions are most at risk from bankruptcy in the event of a severe economic downturn. The loss of confidence that may result could produce a run on the bank, in a self-fulfilling cycle (in which depositors withdraw their money due to perceived weakness, which then does weaken the institution in reality, and also may have a knock-on effect at other institutions).

      • A central bank (such as the European Central Bank) may be unwilling to publicly admit that certain risks even exist (for example, the risk of a currency break-up, or of one country leaving the eurozone).

      • Generally, some potential credit (or refinancing) events may be self-fulfilling. For example, a rumour (even if initially false) that a company has insufficient short-term funds to pay its suppliers may lead to an unwillingness on the part of banks to lend to that company, thus potentially turning the rumour into reality.

      • A pilot needing to conduct an emergency landing of an aeroplane will no doubt try to reassure the passengers and crew that this is a well-rehearsed procedure, and not focus on the risks of doing so. Any panic within the passengers could ultimately be detrimental and hinder the preparations for evacuation of the aircraft, for example.

      • Accountability and incentives. In some cases, there may be a benefit (or perceived benefit) to a specific party of underestimating or ignoring risks. For example:

      • In negotiations (whether about contracts, mergers and acquisitions or with suppliers), the general increased information and transparency that is associated with admitting specific risks exist could be detrimental (to the party doing so).

      • Many publicly quoted companies are required to make a disclosure of risks in their filing with stock market regulators. Generally, companies are reluctant to provide the information in any more detail than is mandated, in order not to be perceived as having a business that is more risky than competitors; a first-mover in such disclosure may end up with a consequential drop in share price. Therefore, such disclosures most typically are made at a very high level, are rather legalistic in nature and generally do not allow external analysts to truly understand or model risks in the business in practice.

      • “Don't worry, be happy” (or “We are too busy to (definitely) spend time considering things that may never happen!” or “You are always so pessimistic!”). In a similar way to the “ignorance is bliss” concept, since identified risks are only potential, and may never happen, there is often an incentive to deny that such risks exist, or that they are not material, or to insist that they can be dealt with on an ad hoc basis as they arise. In particular, due to implementation time and other factors, it is often the case that accountability is only considered at much later points in time (perhaps several years); by which time the truly accountable person has generally moved to a different role, been promoted, or retired. In addition, defenders of such positions will be able to construct arguments that the adverse events could not have been foreseen, or were someone else's responsibility, or were due to non-controllable factors in the external environment, and so on. Thus, it is often perceived as being more beneficial to deny the existence of a problem, or claim that any issues would in any case be resolvable as they arise. For example:

      • A senior manager or politician may insist that a project is still on track despite some indications to the contrary, although the reality of the poor outcome is only likely to be finally seen in several years or decades.

      • A manager might not admit that there is a chance of longer-term targets being missed or objectives not being met (until such things happen).

      • A project manager might not want to accept that there is a risk of a project being delivered late, or over budget, or not achieving its objectives (until the events that provoke it actually occur).

      • Management might not want to state that due to a deterioration in business conditions there is a risk that employees will be made redundant (until it actually happens).

      • A service company bidding for a contract against an established competitor may claim that they can provide a far superior level of service at a lower cost (implicitly ignoring the risks that this might not be achievable). Once the business has been secured, then “unexpected” items start to occur, by which time it is too late to reverse the contract award. Unless the negotiated contracts have clear service-level agreements and penalty clause elements that are adequate to compensate for non-delivery on promises, such deliberate “low balling” tactics by potential suppliers may be rational; on the other hand, if one bids low and is contractually obliged to keep to that figure, then a range of significant difficulties could arise, so that such tactics may not be sensible.

      • Often clauses may exist in contracts that would only apply in exceptional circumstances (such as if consequential damages may be sued for if a party to the contract delivers a performance that is materially below expectations). During contract negotiations, one or other party to the contract may insist that the clause should stay in the contract, whilst maintaining that it would never be enforced, because such circumstances could not happen.

      Specific examples that relate to some of the above points (and occurred during the time at which this book was in the early stages of its writing) could be observed in relation to the 2012 Olympic Games in London:

      • The Games were delivered for an expenditure of approximately £9bn. The original cost estimate submitted to the International Olympic Committee was around £2bn, at a time when London and Paris were in competition to host the games. Shortly after the games were awarded to London in July 2005, the budget estimate was revised to closer to £10bn, resulting (after the Games) in many media reports stating that they were “delivered within budget”. Some of the budget changes were stated as being due to heightened security needs following a major terrorist attack that occurred in London shortly after the bid was awarded (killing over 50 people). Of course, one can debate such reasons in the context of the above points. For example, the potential terrorist threat was already quite clear following the Madrid train bombings of 11 March 2004 (which killed nearly 200 people), the invasion of Iraq in 2003, and the attacks in the United States of 11 September 2001, to name a few examples; security had also been a highly visible concern during the 2004 Athens Olympics. An external observer may hypothesise that perhaps a combination of factors each played a role to some extent, including the potential that the original bid was biased downwards, or that the original cost budget had been estimated highly inaccurately. In any case, one can see the difficulty associated with assigning definitive responsibility in retrospect, and hence the challenge in ensuring that appropriate decisions are taken in the first place.

      • A private company had been contracted by the UK government to provide the security staff for the Games; this required the recruitment and training of large numbers of staff. Despite apparently having provided repeated reassurances that the recruitment process for the staff was on track for many months, at the last minute (in the weeks and days before the Games) it was announced that there was a significant shortfall in the required staff, so that several thousand soldiers from the UK Armed Forces were required to step in. An external observer may hypothesise that the private company (implicitly by its actions) did not perceive a net benefit to accepting or communicating the existence of the risk of non-delivery until the problem became essentially unsolvable by normal means.

      Cognitive

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