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Published online by Cambridge University Press: 02 January 2018
Corporate governance best practice now includes the requirement for a board to ensure that the system of internal control is effective in managing risks in the manner which it has approved. The Turnbull Guidance on this matter is ‘based on the adoption by a company's board of a risk-based approach to establishing a sound system of internal control and reviewing its effectiveness’. This involves the identification and prioritising of risks and embedding the risk management approach in the culture and processes of the business. This article explores the use of risk assessment in the law, particularly as it applies to the activities of companies. It is suggested that a concentration on, and perhaps a spurious quantification of, risk could mask the difficulty of making board-level decisions under conditions of true or Knightian uncertainty. Knight maintained that true uncertainty was something distinctly not of the character of risk. It occurs when ‘. . . there is no possibility of forming in any way groups of instances of sufficient homogeneity to make possible a quantitative determination of true probability. Business decisions, for example, deal with situations which are far too unique, generally speaking, for any sort of statistical tabulation to have any value for guidance. The concept of objectively measurable probability or chance is simply inapplicable’.
1. The Turnbull Working Party Internal Control: Guidance for Directors on the Combined Code (known as the Turnbull Guidance) (London: ICAEW, 1999)Google Scholar, para 9.
2. Knight, F Risk, Uncertainty and Profit (Boston and New York: Houghton Mifflin Company, 1921) pp 19–20 Google Scholar (emphasis added).
3. Ibid, p 231.
4. Belcher, A The Boundaries of the firm: the theories of Coase, Knight and Weitzman’ (1997) 17(1) LS 22 Google Scholar.
5 This may also fit with the idea of the firm as a place where knowledge is created, if uncertainty demands a creative decision-making response See Belcher, A and Naruisch, T The evolution of business knowledge in the context of unitary and two-tier board structures’ (2005) July, Journal of Business Law 443 Google Scholar.
6 See Belcher, A The invention, innovation and diffusion of self-regulation in corporate governance’ (1996) 47(3) Northern Ireland Legal Quarterly 322 Google Scholar for a discussion of the take-up and spread of technologies.
7. Thomas, L Financial risk management models’ in Ansell, J and Wharton, F Risk: Analysis, Assessment and Management (Chichester: John Wiley & Sons, 1992)Google Scholar.
8. C Chapman ‘A risk engineering approach to risk management’ in ibid.
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14. X v HM Customs & Excise [2005] EWHC 953 (Admin): the decision-maker's obligation was to evaluate all the material factors and to take them into account, but the author of the risk assessment was not aware them.Google Scholar
15. Collective Conditional Fee Agreements Regulations 2000, SI 2000/2988, reg 4(4). See Cavanagh v Athenaeum Press Ltd [2003] CLY 333 for a decision on the components of a success fee.Google Scholar
16. Water Supply (Water Quality) Regulations 2000, SI 2000/3184, reg 27 and Water Supply (Water Quality) Regulations 2001, SI 2001/3911, reg 27 apply broadly to England and Wales, respectively, and contain the requirement for a cryptrosporidium risk assessment as defined in reg 25.
17. [2005] 1 WLR 223
18. The company was convicted rather than any of its workers using s 217(3) of the Water Resources Act 1991.
19. These regulations replace the Management of Health and Safety at Work Regulations 1992, SI 1992/2051 that contained the earliest explicit requirement for a risk assessment to be carried out.
20. Health and Safety at Work etc Act 1974, s 33(c).
21. HSE Five Steps to Risk Assessment INDG163REV2 (HSE, 2nd edn, 2006).
22. Control of Substances Hazardous to Health Regulations 2002, SI 2002/2677.
23. Avian Influenza (Preventive Measures) (No 2) Regulations 2005, SI 2005/3394.
24. Management of Health and Safety at Work Regulations 1999, SI 1999/3242, reg 16
25. 1996 SLT 1230.
26. [1999] 2 All ER 249.
27. SI 1992/2051.
28. [1999] IRLR 434 at 437 (emphasis added).
29. 2004 WL 1808947.
30. [2002] IRLR 516.
31. 2006 WL 176922, [2006] All ER (D) 157 (Feb).
32. 2004 WL 3091690 (EAT). This case is currently being appealed to the Court of Appeal.
33. 3 November 2005 (unreported).
34. [2005] EWHC 1342 (QB).
35. Ibid, at [33].
36. [2006] EWCA Civ 39, [2006] 1 WLR 953 at 958.
37. Occupiers' Liability Act 1984, s 1(3)(c)
38. [2003] UKHL 47, [2004] 1 AC 46.
39. [2006] EWCA Civ 39, [2006] 1 WLR 953.
40. [2003] UKHL 47, [2004] 1 AC 46 at 87.
41. Ibid, at 65.
42. [2006] EWCA Civ 39, [2006] 1 WLR 953 at 959.
43. [2005] EWHC 2829 [2005] All ER (D) 11 (Aug).
44. 2000 WL 664535.
45. [2006] All ER (D) 104 (Mar).
46. Ibid, at [54].
47. Ibid, at [64].
48. Ibid, at [57]; Ms and Mrs are both used in the original.
49. Ibid, at [68].
50. [2001] IRLR 336.
51. [2005] EWHC 420, [2005] 2 Lloyd's Rep 13.
52. [2001] CLY 4475.
53. ‘As the danger increases, so must the precautions increase’: Read v J Lyons & Co Ltd [1947] AC 156 at 173.Google Scholar
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56. Power, M The Audit Society: Rituals of Verification (Oxford: Oxford University Press, 1997) p 55 Google Scholar.
57. At that time referred to as the Cadbury Code of Best Practice.
58. For instance in the UK Statement of Auditing Standard (SAS) 300.
59. Turnbull Guidance, above n 1, and revised version (Financial Reporting Council, June 2005).
60. Ibid, para 28.
61. A review of the continued appropriateness of the Turnbull Guidance was published by the Financial Reporting Council in June 2005 which confirmed that ‘The guidance should continue to cover all internal controls, and not be limited to internal controls over financial reporting’. Overall the review concluded that significant changes are not required.
62. Ibid, para 13.
63. Ibid, appendix.
64 This is explored in more detail in the context of the risks of a potential corporate killing in Belcher, A Corporate killing as a corporate governance issue’ (2002) 10(1) Corporate Governance: An International Review 47 CrossRefGoogle Scholar.
65. Ibid, para 16 (emphasis added).
66. A Carey and N Turnbull ‘The boardroom imperative on internal control’ [1999] Mastering Risk 6.Google Scholar
67. Turnbull Guidance, above n 1, para 9.
68. Ibid, para 17
69. Ibid, appendix.
70. Jones, ME and Sutherland, G Implementing Turnbull: A Boardroom Briefing (London: ICAEW, 1999) p 21 Google Scholar.
71. The updated version of the Cadbury Code is referred to as the Combined Code.
72. The FRC review of Turnbull encourages boards to include in the internal control disclosure such information as is considered necessary to assist shareholders' understanding of the main features of the company's risk management processes and system of internal control.
73. Kahnemen, D and Tversky, A Subjective probability: a judgement of representativeness’ (1972) 3 Cognitive Psychology 430 CrossRefGoogle Scholar.
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76. The Sheen Report, MV Herald of Free Enterprise Report No 8974 (Department of Transport, 1987) para 14.Google Scholar
77. [2004] UKHL 31, [2004] 4 All ER 221. Also in Penrose v Official Receiver [1996] 2 All E R 96 the court itself was confused about what risks it was to assess: the risk of allowing the company to trade under a prohibited name or the risk relating to the competence of directors.Google Scholar
78. Regulations 4 and 7.
79. [2004] UKHL 31, [2004] 4 All ER 221 at 230–231.
80. Ibid, at 236.
81 For examples of safety climate and culture, see R Flin et al ‘Measuring safety climate: identifying the common features’ (2000) 34 Safety Science 177 and Cox, SJ and Cheyne, Ajt Assessing safety culture in offshore environments’ (2000) 34 Safety Science 111 CrossRefGoogle Scholar. For organisational culture and climate, see .
82. Pidgeon, N and O'Leary, M Man-made disasters: why technology and organizations (sometimes) fail’ (2000) 34 Safety Science 15 CrossRefGoogle Scholar at 22 referring to .
83. Ibid.
84. A popular approach is to use the Australian/New Zealand Standard AS/NZS 4360:2004 – Risk Management. This uses a five-point scale for the likelihood of the incident/problem occurring and to measure the impact on the organisation should it occur. Each potential incident/problem can then be plotted in a two-by-two matrix and risk managed according to which of the four boxes it falls into. The use of this method can make risk management appear to be a fairly qualitative, rough and ready process, but it must be remembered that behind each plotted point in the matrix is a quantitative assessment coupled with the assumption that a quantitative approach is valid. An imprecise approach to risk management does not equate to an acknowledgement of true uncertainty.
85. [2001] 1 All ER 562.
86. [2004] EWHC 1116 (QB), [2004] All ER (D) 181 (May).
87 The ‘personalistic’ theory of probability (also known as Baysian) uses the devise of an ideal person. Personalists view probability as a degree of belief of an ideal person who is consistent in their beliefs. This approach allows ideal persons to differ in their personal probabilities and be equally ‘correct’ so long as they are not inconsistent. Information is also important to Bayesians. The ideal person of personalistic theory is supposed to use observed frequencies to revise their probabilities. As more data are observed, the current probabilities generally come to relate more and more to the data observed and less to the original probabilities. See Lee, W Decision Theory and Human Behaviour (New York and London: John Wiley & sons, 1971) pp 54–55 Google Scholar.
88. Kahneman, D and Tversky, A Subjective probability: a judgement of representativeness’ (1972) 3 Cognitive Psychology 430 CrossRefGoogle Scholar.
89 Kahneman and Tversky were followed by Bazerman, MH The relevance of Kahneman and Tversky's concept of framing to organisation behaviour’ (1984) 10 Journal of Management 333 CrossRefGoogle Scholar and . is a survey of research on decision making by auditors; see also . In the field of finance ‘behavioural’ research on investors' assessments of risk has led to a new branch of the subject known as ‘behavioral finance’; see .
90. Babcock, L and Loewenstein, G, ‘Explaining bargaining impasse: the role of self-serving bias’ (1997) winter, Journal of Economic Perspectives CrossRefGoogle Scholar.
91. Bazerman, Loewenstein and Moore, above n 89, at 99. This claim is based on experiments done in the context of legal negotiations; see Babcock and Loewenstein, above n 90.
92. Bazerman, Loewenstein and Moore, above n 89, use these headings.
93. Knight, above n 2, pp 19–20 (emphasis added).
94. Ibid, p 232 (original emphasis).
95. Belcher, above n 4.
96. Ibid.
97. Knight, above n 2, p 231.
98 Ibid, pp 284–285. Some of his argument is framed in terms of self-trust; see also Belcher, A Trust in the Boardroom’ (2007) 16(1) Griffith Law Review 151 CrossRefGoogle Scholar.
99. Knight, above n 2, p 311.
100. Ibid, p 325.
101. Foss, K and Foss, N The knowledge-based approach and organizational economics’ in Foss, N and Mahnke, V (eds) Competence, Governance, and Entrepreneurship (Oxford: Oxford University Press, 2000), pp 62–65 Google Scholar at p 65.
102. Belcher, A and Naruisch, T The evolution of business knowledge in the context of unitary and two-tier board structures’ (2005) July, Journal of Business Law 443 Google Scholar at 443.
103 For an accessible description see Ekeland, I Mathematics and the Unexpected (Chicago and London; University of Chicago Press, 1988)Google Scholar. The labelling of risk and uncertainty has been made particularly confusing by the development of a body of economics literature which refers to decision making under uncertainty but in fact deals almost exclusively with decision making under risk; see p 9: ‘. . . under uncertainty we do not attach probabilities or likelihoods to the states of the world…If we did introduce probabilities…the analysis would be one involving risk rather than uncertainty. On this definition most of this book is not about uncertainty but about risk. Clearly I do not adhere to this distinction at all closely. To me, and many others, uncertainty is a quite general term meaning “absence of certainty” ’. This has been followed more recently by economists explicitly working in terms of Knightian uncertainty; see below.
104 W Brock and A Xepapadeas ‘Regulating nonlinear environmental systems under Knightian uncertainty’ in Arnott, R et al (eds) Economics for an Imperfect World: Essays in Honour of Joseph E Stiglitz (Cambridge MA: MIT, 2003)Google Scholar chapter 8, pp 127–144 at pp 127–128.
105. Ibid, p 142.
106. Littlechild, SC Three types of market process’ in Langlois, RN (ed) Economics as a Process (Cambridge: Cambridge University Press, 1986) pp 27–39 Google Scholar.
107. Ibid, p 29.
108. The idea that this power in the hands of directors can be an explanation of the existence of the firm, or company, can be found in Belcher, above n 2.
