The Hazards of Expert Control: Chief Risk Officers and Risky Derivatives

Abstract

At the turn of the century, regulators introduced policies to control bank risk-taking. Many banks appointed chief risk officers (CROs), yet bank holdings of new, complex, and untested financial derivatives subsequently soared. Why did banks expand use of new derivatives? We suggest that CROs encouraged the rise of new derivatives in two ways. First, we build on institutional arguments about the expert construction of compliance, suggesting that risk experts arrived with an agenda of maximizing risk-adjusted returns, which led them to favor the derivatives. Second, we build on moral licensing arguments to suggest that bank appointment of CROs induced "organizational licensing," leading trading-desk managers to reduce policing of their own risky behavior. We further argue that CEOs and fund managers bolstered or restrained derivatives use depending on their financial interests. We predict that CEOs favored new derivatives when their compensation rewarded risk-taking, but that both CEOs and fund managers opposed new derivatives when they held large illiquid stakes in banks. We test these predictions using data on derivatives holdings of 157 large banks between 1995 and 2010.

Sacred Excess: Organizational Ignorance in an Age of Toxic Data

“…has led a lot of firms to refocus their entire world-view around data and to create more of it (Bean, 2018;Pernell, Jung, & Dobbin, 2017).…”

Subordinate Activation Tactics: Semi-professionals and Micro-level Institutional Change in Professional Organizations

“…In law, globalization has created pressure for new cross-border services (Smets, Morris, and Greenwood, 2012) and forms of organizing (Greenwood and Suddaby, 2006). In finance, increased market competition has created pressure for bigger risk taking (Pernell, Jung, and Dobbin, 2017) and greater work automation (Beunza and Millo, 2014). In architecture, growth in demand for new business services has created pressure for novel types of creative design (Rahman and Barley, 2017) and representation (Retelny and Hinds, 2016).…”

Forecasting unknown-unknowns by boosting the risk radar within the risk intelligent organisation

“…Nonetheless, we suggest risk management can take a leadership and coordination role, linking these functions to the rest of the organisation through a guiding theoretical concern with the purposeful cross-functional co-development of risk forecasting knowledge. As articulated in literature exploring the relationship between professions and institutional change (Daudigeos, 2013;Muzio et al, 2013) (Aabo et al, 2005;Harrison and Phillips, 2014;Pernell et al, 2017;Karanja and Rosso, 2017). Correspondingly, we envisage risk management ownership of 'booster infrastructure' for risk radar as requiring new leadership and coordination roles, as well as related job descriptions and other forms of guidance.…”

“…Speaking further to the above issue of cross-functional leadership and coordination, it can also be argued (see Aabo et al, 2005;Harrison and Phillips, 2014;Pernell et al, 2017;Karanja and Rosso, 2017), that the risk profession is already strongly aspirant towards subsuming various other -sometimes competing -organisational functions to serve its master concept of a singular, overarching, early warning risk radar for organisations. Such empirebuilding efforts by risk management entail that organisational groundwork for our proposal is already well established in many organisations.…”