Leadership and Risk Culture - Ivey Business Journal

It is only slightly arguable, but many believe that the ability to manage risk is the crucible of a leader?s effectiveness. Failure to manage risk and to develop a risk-focused culture will sink the company and the CEO. Citing two recent, highly visible cases, these Ivey professors describe how the leaders of TD Bank Group and Maple Leaf Foods designed and implemented a strong risk management ethos and strategy in their companies.

In an increasingly volatile world there is arguably no more important role for senior leaders than to prepare their organizations for risk ? taking it, avoiding it and managing it.? This was apparent before, during and after the 2008 financial crisis. Some organizations were ill prepared to manage the risks they had built up over the previous decade of dramatically expanded leverage. They either failed or were badly damaged by the financial markets meltdown and subsequent recession. Others had recognized the risks and had either avoided them or developed robust coping structures, systems, processes and cultures that allowed them to survive or even prosper when the immediate crisis was over.

There were many differences between those organizations that collapsed or were badly hurt ? the ?failures? ? and those that survived and prospered ? the ?successes.?? We conducted an exploratory study of leadership during this time[1] and concluded that the differentiating factors could be found in those organizations? risk prediction and management competencies; character of their leaders; commitment to hands-on leadership, especially with respect to the risk management function; their management cultures, and other factors.

In the years following our work, we looked at what organizations are doing to manage risk, taking into account that certain types of risk are Black Swans[2] whereas others are ? more or less ? predictable. Organizations face different types of risks:? strategic, operational, market, liquidity and credit risk, as well as reputational risk from the non-fulfillment of a brand promise.? The only defense against such Black Swan risks is to build organizational structures, systems, processes and cultures that can allow the particular company to weather such storms.[3]

Since we are case-writers and teachers, we have the opportunity to develop teaching materials that address risk management as well as discuss them with many audiences: executives, lower-level managers and MBA/EMBA students, both in Canada and elsewhere.? Two extensive case studies in particular have given us some deeper insights into what leaders can do to establish and maintain effective risk-management cultures: ?Risk leadership at TD Bank Group, and Maple Leaf Foods Inc.: The Listeriosis Crisis.? We discuss these cases briefly in this article, along with their implications for leadership, especially the development of comprehensive and robust risk management cultures.

?Figure 1:? Case Studies in Risk Leadership

? TD Bank Group In 2002, the new leadership of the TD Bank decided to redefine its risk management appetite. This shift in risk strategy followed many years of volatile and uneven performance, during which the bank had experienced some significant credit losses because of over exposure to single names or specific industry sectors.? Over the next decade, the bank exited risky and complex synthetic investment products, reduced its reliance on single-name and concentrated industry lending, and built out its retail banking and wealth management businesses in the U.S. and Canada.? These moves shifted its risks from those over which it had little or no control to those it could better understand and manage.? From 2002-2012, TD Bank Group moved from being the 55th largest North American bank in terms of market capitalization to become the 6th largest. It also was one of only two U.S. or Canadian-based banks with a Moody?s AAA credit rating. (Ivey case 9B12C001) ? Maple Leaf Foods Maple Leaf Foods Inc. is a $1.6 billion (market cap.) food processing company with approximately $5 billion annual sales in meat products, bakery, and agri-business operations.? The company went through a serious set-back in 2008, when processed meats sold by the company under its major brand names were implicated in the deaths of 23 people from Listeriosis Monocytogenes, a food-born bacterium that had colonized in meat slicers used in one of the company?s plants.? The direct and indirect costs of this event, its reputational aftermath and disruptions to normal patterns and terms of trade, initially shook consumer confidence in its brands, depressed the company?s leading brand shares and stock price by 50 percent, and left indelible marks on many of the company?s employees.? These effects were of course secondary to the tragedy of the consumers who had used the products and their families.? Since a low point in 2008/9, the company has recovered its brand shares, restored its margins and has a refreshed and reenergized approach to food safety management; one that it believes will minimize its future food-safety risks. A key component of this new approach was the development of a world-leading food-safety culture. (Ivey case 9B11C001) ?

In both of these cases the senior leadership, led by the CEOs and fully supported by their management teams and boards of directors, created and sustained strategic risk cultures that have had a powerful influence on risk-related behaviors at all levels in the companies.? These new risk cultures were built on existing risk practices, processes and systems that had proved wanting under severe stress.? In both cases these new cultures represented significant organizational changes, led from the top but reinforced through new structures, processes and systems, and congruent behaviors that cascaded throughout the leadership ranks.

Under CEO Ed Clark?s leadership, TD Bank:

• Pursued profitable long-term, institution building consistent with his views about stewardship, leaving an organization in better shape when he left it than when he had found it, and not pursuing fads and short-term opportunities at the expense of long-term growth. ?
• Developed and promulgated a risk appetite that had three fundamental pillars:? not taking risks you don?t understand and can?t control; not taking long-tail risks with low probabilities but very severe consequences; and not taking risks that could result in serious reputational damage to the bank, its brands and its franchises.
• Explicitly targeted a mix of 70 percent retail/30 percent corporate and capital markets banking.? In pursuit of this goal the bank intensified activity in Canadian retail through extended hours and convenience banking, and started to acquire banks in the Northeastern U.S. (Banknorth), then the tri-state area around New York (Commerce Bank of New Jersey), and then with selective acquisitions in the Carolinas and Florida (South Financial Group).? These were careful acquisitions, made over time and based on sequential learning where the acquisitions could benefit from superior TD Canada Trust management, systems, processes, etc., as well as a stronger balance sheet.?
• Made major investments in TD Ameritrade, a business that he knew well through TD?s experience with Internet banking (TD Greenline). TD also bought Chrysler Financial, again a business (automobile financing) that they knew well and with which they were very comfortable.
• Avoided sub-prime lending either in Canada (where it was, in any case, highly unusual because of the structure of the Canadian mortgage market, government insured mortgages, etc.) or the United States, in which it was becoming very common and which turned out to be the epicenter of the 2008 financial crisis.
• Avoided investment in or trading of third-party, asset-backed commercial paper other than a very limited amount for its internal, treasury needs.?
• Exited the profitable but very high-risk structured-products field.
• Talked constantly about the bank?s risk appetite, what they were doing to ensure that they complied with it, what successes they were having.?
• Instituted formal executive- and management-development programs, in which risk strategy, management and the role of senior managers and executives as risk leaders were addressed and discussed with more than 800 senior leaders, and which formally cascaded down to lower-level managers and non-managerial employees. The CEO personally participated in the vast majority of these programs.?????????
• Avoided strategic drift or muddying the message by not pursuing high-risk strategies in emerging markets or unfamiliar geographies.?
• Instituted formalized risk governance and risk management systems, starting in 2002 but evolving to very highly sophisticated levels by 2011.
• Understood and appreciated the value of regulation and worked proactively and effectively with regulators, thereby extending his influence within the financial community.
• Built up the bank?s Tier 1 capital reserves in anticipation of tighter Basel regulations.? This meant restricting dividend growth at a time when some of his competitors were increasing their dividend payouts.??

Maple Leaf Foods:

• Defined its risk appetite ? zero tolerance for pathogens in products ? while nevertheless recognizing the ubiquity of certain pathogens in plant environments.
• Established control systems with strong management oversight, locally and corporately, as well as good governance through the Environment, Health and Safety Committee of the board of directors.
• Created a new position, Senior Vice-President, Food Safety, and hired a high-profile, dedicated leader with a direct reporting relationship to the CEO. It incorporated a matrix of the food safety role into the plants? operations and provided the leader with adequate resources, even during hiring freezes when it had imposed very tight expense controls on all other functions.
• Spoke about, wrote about, and blogged about food safety leadership as a strategy not just in the immediate, post-recall phase but for years afterward.? The CEO and senior leaders became very visible in video messages, meetings, conferences, leadership development programs, press briefings and other venues.
• Mobilized an increased industry focus on food safety by organizing conferences and other events that were attended by customers, suppliers, competitors and regulators.
• Took appropriate disciplinary actions in those very rare situations where employees, at any level in the organization, breached food-safety protocols.
• Worked with regulators, proactively, to improve the national food-safety system.
• Beefed up centralized oversight of food safety while keeping responsibility at the local plant levels.? The plants clearly understand that they ?own? the risks but that they are now centrally controlled, tracked and reported.
• Showed integrity when it came to executive compensation.? The consequences of the 2008 Listeriosis incident were reflected in significantly reduced leadership pay, bonuses and stock price; there was no re-pricing of share units or options or adjustment of short-term bonuses because of this incident.?

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Establishing and Maintaining Risk Cultures

By these actions, the leaders at both TD Bank Group and Maple Leaf Foods were re-engineering the cultures of their organizations with respect to risk.? By culture, we refer to the shared assumptions, values, beliefs, and behavioral norms as they relate to risk management or, in a more colloquial way, ?how things are to be done around here? when it comes to managing risk.[4] The culture of an organization manifests itself in various artifacts that can be seen, felt or heard, including but not limited to behaviors or patterns of interaction, language, emotion, stories, structures and systems, rituals or ceremonies, and so forth.? In Figure 2 we represent the establishment and maintenance of a strategically driven culture as a set of five activities:

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