How the history and science of uncertainty and risk can lead to better risk management.

• Author: Kavanagh, Shayne
• Position: Against the Gods: The Remarkable Story of Risk - The Failure of Risk Management: Why It's Broken and How to Fix It - The Drunkard's Walk: How Randomness Rules Our Lives - Book review

Against the Gods: The Remarkable Story of Risk

Peter L. Bernstein

John Wiley & Sons

2008, 383 pages, $70

The Failure of Risk Management: Why It's Broken and How to Fix It

Douglas W. Hubbard.

Wiley

2009, 304 pages, $49.95

The Drunkard's Walk: How Randomness Rules Our Lives

Leonard Mlodinow

Pantheon

2008, 252 pages, $15.95

In Against the Gods: The Remarkable Story of Risk, Peter Bernstein explains that the concepts of uncertainty and risk are a modern phenomenon. Only in recent centuries has the Western world concluded that the future is not just a matter of fate or the plans of a higher power, but that human beings have the ability to shape their own future. In fact, Bernstein posits, our "ability to define what may happen in the future and to choose among alternatives lies at the heart of contemporary societies."

This ability also lies at the heart of the modern finance officer's job. Finance officers are asked to predict future revenues and expenditures and to help the organization craft financial plans and budgets that will allow the organization to reach its goals. These decisions entail risks like the possibilities of revenue shortfalls and cost overruns. Finance officers are often called upon to help the organization manage other uncertainties and risks as well, such as:

* Navigating a changing regulatory/legal environment, like how federal health care reform might affect the cost of the health-care benefits offered to employees.

* Holding the right amount of fund balance --enough to allow the organization to respond decisively to shocks like an economic downturn or natural disaster, but not so much that the organization forgoes the opportunity to provide public services or lower taxes.

* Entering into financial relationships with third parties like private firms to build infrastructure and encourage economic development.

The increasing speed at which business occurs and the increasing number of options that organizations have, thanks to forces like the Internet and globalization, means that governments face even more uncertainty and risk going forward.

NOT UP TO THE TASK

On top of that ever-increasing risk, finance officers face a third challenge: The human brain may be fundamentally ill-suited to the task. In The Drunkard's Walk: How Randomness Rules Our Lives, Leonard Mlodinow points out that many psychological studies suggest a close connection between the portions of our brains that assess uncertain situations and those parts that handle emotion. Emotion is not usually closely associated with rational decision making, which does not bode well for our ability to easily make clear-eyed...