The World Trade Center terrorist attacks of September 11 raise a set of challenges that organizations face in dealing with low-probability events that have catastrophic consequences. More specifically, there are certain bad events that can occur only once. Death is the clearest example: an individual's death is irreversible and unrepeatable. With respect to firm behaviour, bankruptcy is the obvious analogue. This chapter explores the impact that the possibility of an extreme event, such as bankruptcy, has on the propensity of different parts of an organization to take risks.

A key point to emphasize at the outset is that the economic incentive for any division in an organization to invest in risk-reduction measures depends on how it expects the other divisions to behave in this respect. Consider Division 1. If it thinks that the other divisions will not invest in protection, this reduces Division 1's incentive to do so. However, should Division 1 believe that the others are taking appropriate steps to mitigate their risks, it may be best for Division 1 to do so as well. In other words there may be situations where no one invests in protection, even though all divisions would be better off if they had incurred this cost.