Chapter 10: The Implications of Business Risk

Overview

We have argued throughout this book that the effectiveness of any human capital practice has less to do with the particulars of its design than with how well it is aligned with the business context into which it is introduced. Thus far we have had much to say about the internal business environment but have not said much about that broader business context: the external market in which an enterprise operates. That is the subject of this chapter, particularly as it is manifested in the very real issue of business risk.

Every organization is like a ship at sea. A ship has a destination, and the captain directs the ship’s course to it. The officers and crew are responsible for the many tasks that maintain the vessel’s safety and move it toward its destination. The sea, of course, does not care about the intentions of captains and crews. It has a life of its own, one that whips up adverse winds, squalls and gales, and other impediments to smooth sailing. Every ship on the sea—indeed, every shipowner, captain, and crew member—must deal with those hazards and the risks they entail.

For business organizations, the macroeconomy and the market environment are like the mindless sea, buffeting financial performance and subjecting shareholders, managers, and employees to risks. Sensitivity to external business conditions varies across companies, depending on factors such as size, extent of diversification, financial structure, and management practices. Where a company falls along the spectrum of sensitivity has profound implications for the way it manages people and directly affects the likely costs and effectiveness of specific human capital practices such as recruitment, selection, training, staffing, and rewards.

Risk is a feature of every business and its environment. Risk lurks in the ups and downs of the economy, in the industry, and within the microeconomy of the enterprise. The important questions here are: How big are the risks? and Who will bear them? The second question is especially important because risk usually carries a cost. In free markets whose participants have alternative opportunities, few take on added risk without demanding greater compensation. What remains to be determined is who can manage that risk most efficiently and hence at the lowest cost.

This chapter deals with the role of risk and its implications for human capital management.^[1] It presents a method for measuring the level of risk and its sources and for using that information to improve decisions about how risk should be shared among stakeholders, shareholders, and employees in particular.

^[1]This chapter draws on material from two previous articles by one of the authors of this book, Haig R. Nalbantian. “Performance Indexing in Stock Options and Other Incentive Compensation Programs,” Compensation and Benefits Review, September–October 1993; and Haig R. Nalbantian and Wei Zheng, “Worth the Risk?: When and How to Use Stock in Executive Incentives,” World at Work, Q3 2001, vol. 10, no. 3.