The Danger of the Term “Risk Appetite” When Discussing Governance

The governance literature, including Policy Governance® writers, commonly use the term risk appetite when referring to designing board policies dealing with risk—the limitations or values-based no-nos the organization must avoid. Do we really mean we are adjusting, by policy, how risky to permit the organization to be?!

The concept of “risk appetite” comes from the investment world where it represents the willingness to trade increased risk for a higher probability of greater gain. We understand that, in the investment world, there is a putative tradeoff between risk and gain. That principle seems true in other areas of living as well. To do great things, we are told, we must step out of our comfort zone, out of the box, and take risk.

The truth is much more complicated. For example, entrepreneurs are usually thought of as risk takers. But this is not an accurate characterization. Research finds that entrepreneurs are, in fact, risk averse; they obsess about minimizing risk to accomplish their objective of creating a product and a company. They do not want greater risk so they take great pains to reduce it while proceeding. Inventors commonly see little risk (except their time and possibility of attendant cost,) but can achieve great gains. The Wright Brothers were very careful as they iterated their way to finding what design principles would permit their invention to actually fly. That care and minimization of risk paid great dividends.

More soberly however, there are risks we do not want at all, if possible. Board policies, for the most part, actually address these, and “risk appetite” does not apply. The answer is "as little as possible, even none, please." In the world of organizational risks we should try diligently to minimize risk associated with organizational efforts (operations, HR, customers, assets, environment, etc). The domain we are in often is the greatest determiner of risk—working with kids, camping, health care, carnival rides as part of a fundraiser, etc. What would a high risk appetite look like in terms of assets? Loose controls because we don’t want to bother?! What about operations? No attention to safety for the same reason? We need to think carefully about the way we use terms, their origins and implications when imported into another part of life.