What Is Management Risk?
Management risk is the risk—financial, ethical, or otherwise—associated with ineffective, destructive, or underperforming management. Management risk can be a factor for investors holding stock in a company. Management risk can also refer to the risks associated with the management of an investment fund.
Understanding Management Risk
Management risk refers to the chance that an investor’s holdings will be negatively affected by the management activities of its directors.
Key Takeaways
- Management risk is the risk—financial, ethical, or otherwise—associated with ineffective, destructive, or underperforming management.
- Management risk can be a factor for investors holding stock in a company.
- The risks associated with managing an investment fund is also called management risk.
Directors of publicly traded stocks have an obligation to their shareholders and must act in the best interest of the shareholders when making financial decisions.
Portfolio managers have a fiduciary responsibility when managing capital for investors. Any breach of these obligations can create risks for shareholders and could result in shareholder lawsuits.
Company Management Risk
Numerous rules, regulations, and market practices are implemented to protect shareholders of publicly traded companies against management risks. The Sarbanes-Oxley Act of 2002 increased the importance of transparency and investor relations for public companies.
Publicly traded companies have extensive investor relations departments that are responsible for managing investor events and communicating compliance with investor obligations.
Fund Management Fiduciary Responsibilities
Fiduciary responsibilities are a common practice associated with the management of investment funds. Funds must comply with the Investment Company Act of 1940. This Act includes some built-in provisions that help to protect investors against management risk. One such provision is the requirement for a board of directors. The board oversees all activities of the fund and ensures that it is investing according to its objective.
While fund managers must comply with legal obligations that mandate fiduciary responsibilities, they do generally have some latitude for investment decisions. Within a broad market investment strategy, portfolio managers may shift investments into and out of various investments. Generally, this type of investing may cause style drift,which can become a risk for investors.
When style drift occurs, investors may find their investments at risk to new investing styles for which they are not fully aware. Style drift most often is caused by return chasing, which increases the overall return for investors. However, style drift can also lead to lost capital, which typically results in fund outflows.
Fraudulent Activities
Managers who act outside of their obligations may be subject to legal actions. Noteworthy corporate scandals thatsubsequently led to Sarbanes-Oxley include Enron, Worldcom, Tyco, and Xerox, whose managers acted in a manner that eventually bankrupted the companies and destroyed shareholder wealth.
Management risk also applies to investment managers, whose decisions and actions may divert from the legal authority they have in the management of investor funds.
Fraudulent activity is less of a threat in registered funds with an established board of directors and oversight processes. However, hedge funds, privately managed funds, and offshore funds may have higher management risks for investors due to less regulation.
FAQs
Fraudulent Activities
What is the risk of fraudulent activity? ›
Fraud risk refers to the potential that an individual, organisation, or system might engage in deceptive or dishonest activities to achieve financial gain or other benefits. It involves the possibility of misrepresenting information, manipulating transactions, or exploiting vulnerabilities to deceive others.
What is the meaning of managing risk? ›
Risk management is the continuing process to identify, analyze, evaluate, and treat loss exposures and monitor risk control and financial resources to mitigate the adverse effects of loss.
What is a risk management activity? ›
The Risk Management process encompasses five significant activities: planning, identification, analysis, mitigation and monitoring.
What is the risk management process? ›
The 4 essential steps of the Risk Management Process are:
Identify the risk. Assess the risk. Treat the risk. Monitor and Report on the risk.
What are the red flags of fraudulent activity? ›
Unrestricted access to assets or sensitive data (e.g., cash, personnel records, etc.) Not recording transactions resulting in lack of accountability. Not reconciling assets with the appropriate records. Unauthorized transactions.
What is the management risk of a company? ›
Management risk is the risk—financial, ethical, or otherwise—associated with ineffective, destructive, or underperforming management. Management risk can be a factor for investors holding stock in a company. The risks associated with managing an investment fund is also called management risk.
What are the most common means of managing risk? ›
The basic methods for risk management—avoidance, retention, sharing, transferring, and loss prevention and reduction—can apply to all facets of an individual's life and can pay off in the long run.
What is an example of risk management? ›
Some examples of risk management strategies include leveraging existing frameworks and best practices, minimum viable product (MVP) development, contingency planning, root cause analysis and lessons learned, built-in buffers, risk-reward analysis, and third-party risk assessments.
What is the most critical piece of the risk management process? ›
Identifying risks is the most important part of the risk management process and has the biggest impact on the process. It is the first step in the process. If a risk is not identified it cannot be assessed or evaluated.
Examples of controls may include testing, periodic internal audits or inspections, and even your training program. Your risk assessment will determine what risks are present in your company and what controls need to be placed to protect your assets.
What is the impact of fraudulent activity? ›
Human Impact
Fraud can have a devastating impact on these victims, exacerbating their disadvantage, vulnerability, and inequality. Victims of fraud may also suffer long-term mental and physical trauma. Individuals and businesses lose opportunities as a result of fraud.
What are the factors of fraudulent activity? ›
The three main factors that contribute to fraudulent activity are known as the fraud triangle. Opportunity • Financial Pressure • Rationalization (Justify committing the fraud) ▪ Employees may feel underpaid while their bosses are making a lot of money and use that as a reason to steal money from their employer.
What happens when there is fraudulent activity on your card? ›
Once you report fraudulent charges and provide any necessary documentation, the bank has 30 days to respond to your issue and begin an investigation. From there, the bank has to complete the investigation within 90 days.
Which of the following are examples of fraudulent activity? ›
The term 'fraud' usually includes activities such as theft, corruption, embezzlement, money laundering, bribery, insider trading, and extortion. All fraud activities are illegal, and people involved in these activities are categorized as criminals.
