What Must Be True: Strategic Thinking for Managing Risk

Roger Martin, former Dean of the Rotman School, has written a fascinating and insightful article about risk management, emphasizing that a robust strategic process is the only effective way to approach it. Martin argues that, in most cases, risk management conducted by corporate boards often amounts to little more than box-ticking to comply with the Sarbanes-Oxley Act (S-OX) Section 404. This requirement, enacted after scandals like Enron and WorldCom, has become a lucrative exercise for consulting firms but provides little real value to management or investors. Instead of addressing critical risks, these efforts often generate exhaustive lists of potential risks (as seen in typical 10-K filings), which serve as "safe harbor" statements for management rather than actionable insights. A more effective way to approach risk management is by applying the Rumsfeld Risk Matrix (as illustrated in the accompanying graphic). This matrix divides risks into four quadrants: 1.Known Knowns – Risks we are aware of and understand well enough to measure and manage. 2.Known Unknowns – Risks we recognize but do not fully understand. 3.Unknown Knowns – Risks we are unconsciously aware of but fail to identify as risks. 4.Unknown Unknowns – Risks we are entirely unaware of. The ultimate goal of risk management is to increase awareness, turning unknowns into knowns, and improving precision by addressing uncertainties. This involves identifying key risks that are not fully understood, assessing their material impact and likelihood, and investing in understanding them better. It also requires implementing systems to monitor risks that might not be obvious and to uncover entirely new risks. So how is this achieved? The answer lies in a strong strategic process. A well-designed strategy explicitly considers what must be true (WWHTBT) for success and potential derailment, addressing factors such as industry dynamics, customer behavior, organizational capabilities, competitor actions, vendor dependencies, and technological advancements. By conducting thorough internal (IFE) and external (EFE) factor evaluations, along with a comprehensive SWOT analysis, organizations can identify key risk factors, enhance awareness, and improve their ability to detect unknown risks early. This article offers valuable insights and is highly recommended for anyone interested in strategic risk management. (text revised by a LLM) https://rogermartin.medium.com/risk-management-strategy-59869afd3558

- Pedro

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How Games Shaped Probability, Strategy, and Economics

An excellent Economist’s Podcast that features Kelly Clancy—a neuroscientist, physicist, and author of Playing With Reality—discussing the profound impact of games on our lives and societal dynamics. Clancy emphasizes that games are a powerful form of learning, shaping how we think and interact with the world. Games like Chess, Go, Dice, and Cards introduced humanity to the concept of uncertainty, paving the way for probability theory (via Pascal and Fermat’s correspondence) and, subsequently, modern statistics. The episode also highlights the critical role of war games, such as Chess and Go, which evolved into more complex systems like Kriegsspiel. The latter was instrumental in training military officers and predicting battlefield outcomes, particularly during World War II. Clancy then connects this history to Game Theory, one of the most significant developments in economics, pioneered by John von Neumann. Game Theory has informed concepts like nuclear deterrence and continues to influence modern strategic thinking. However, it’s essential to complement it with insights from behavioral economics to understand human decision-making fully. The takeaway? Games are not just entertainment; they’re essential tools for education and skill-building. They can influence our behavior, shape our knowledge, and enhance problem-solving abilities. For instance, Miegakure (https://miegakure.com/) challenges players to solve problems in four dimensions—a fascinating way to expand your cognitive boundaries. All of this in just 38 minutes (at normal speed)—a fantastic return on your time! (revised by a LLM) The surprising ways in which games have changed the world—an interview with Kelly Clancy https://www.economist.com/podcasts/2024/11/27/the-surprising-ways-in-which-games-have-changed-the-world-an-interview-with-kelly-clancy

- Pedro

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10 Trends to Watch in 2025: Insights from Tom Standage

10 Trends to Watch in 2025, Inspired by Tom Standage’s Insights 1-America First Redux Geopolitical shifts will unfold as the U.S. doubles down on its "America First" policy. 2-A Call for Change Macro-political transformations are imminent, driven by demands for reform in nearly every major election of 2024. 3-Heightened Instability in Europe and the Middle East A transactional approach from the new U.S. administration could exacerbate tensions in these regions. 4-The Tariff Tsunami Expect more tariffs, with ripple effects on global trade and economic growth. 5-The Clean-Tech Boom China's advancements in clean technology could revolutionize the energy sector worldwide. 6-Inflation and Fiscal Tightening Most economies are gearing up for stricter fiscal policies, raising questions about growth and voter approval. 7-The Politics of Aging Could age limits for political leaders become a global trend? 8-AI Revolution Agentic AI systems are poised to become the most transformative innovation since the internet. 9-Tourism Backlash The pushback against overtourism will reshape the travel industry. 10-Expect the Unexpected From global pandemics to solar storms, the world must brace for unpredictable disruptions. Stay tuned for a deeper dive into each of these trends in the near future. (text revised by a LLM) Tom Standage’s ten trends to watch in 2025 https://www.economist.com/the-world-ahead/2024/11/18/tom-standages-ten-trends-to-watch-in-2025 From The Economist

- Pedro

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Benoît Mandelbrot: Why Fractals and Power Laws Redefine Science and Economics

This 7-hour interview with Benoît Mandelbrot offers a captivating deep dive into his life, encompassing his childhood, upbringing, education, professional career, and groundbreaking research. It provides a thorough perspective on his unique approach to science, emphasizing the interconnectedness of various fields—mathematics, physics, economics, biology, finance, and more. Key insights I took away: Family Influence: Mandelbrot’s family played a critical role in nurturing his interest in mathematics and creating an environment for his intellectual development. Geometric Approach to Mathematics: He championed a visual, geometrical perspective over purely analytical methods. Mentorship and Collaboration: Mandelbrot’s interactions with intellectual giants such as Kolmogorov, Nabokov, Heisenberg, von Neumann, Gaston Maurice Julia, Paul Lévy, and Max Delbrück enriched his understanding across disciplines. Power-Law Distribution: While randomness in physics follows Gaussian distributions, Mandelbrot highlighted the dominance of power-law distributions in social sciences (e.g., Pareto income distribution, city sizes). Role of Private Sector: IBM provided Mandelbrot with the resources and freedom to pursue his groundbreaking work. Measuring Roughness and Fractals: Mandelbrot’s pioneering study of fractals revealed their significance in understanding patterns across multiple domains, including finance. Insights into Finance and Economics: He argued that finance and economics are fundamentally different from physics. Traditional Gaussian approaches to risk management fail to capture the realities of financial systems, which are better modeled using fractal geometry and power-law distributions. Some individuals truly stand apart, and Mandelbrot is one of those rare, extraordinary minds. Personal Takeaway For my own work in finance and economics, this interview reinforced the urgency of studying Mandelbrot’s approaches to risk and systems in depth. If you’re interested and willing to invest the time, I highly recommend watching this interview—it’s an inspiring exploration of a brilliant thinker’s journey. (text revised by LLM) "...Benoit B.[n 1] Mandelbrot[n 2] (20 November 1924 – 14 October 2010) was a Polish-born French-American mathematician and polymath with broad interests in the practical sciences, especially regarding what he labeled as "the art of roughness" of physical phenomena and "the uncontrolled element in life".[6][7][8] He referred to himself as a "fractalist"[9] and is recognized for his contribution to the field of fractal geometry, which included coining the word "fractal", as well as developing a theory of "roughness and self-similarity" in nature.[10] In 1936, at the age of 11, Mandelbrot and his family emigrated from Warsaw, Poland, to France. After World War II ended, Mandelbrot studied mathematics, graduating from universities in Paris and in the United States and receiving a master's degree in aeronautics from the California Institute of Technology. He spent most of his career in both the United States and France, having dual French and American citizenship. In 1958, he began a 35-year career at IBM, where he became an IBM Fellow, and periodically took leaves of absence to teach at Harvard University. At Harvard, following the publication of his study of U.S. commodity markets in relation to cotton futures, he taught economics and applied sciences. Because of his access to IBM's computers, Mandelbrot was one of the first to use computer graphics to create and display fractal geometric images, leading to his discovery of the Mandelbrot set in 1980. He showed how visual complexity can be created from simple rules. He said that things typically considered to be "rough", a "mess", or "chaotic", such as clouds or shorelines, actually had a "degree of order".[11] His math- and geometry-centered research included contributions to such fields as statistical physics, meteorology, hydrology, geomorphology, anatomy, taxonomy, neurology, linguistics, information technology, computer graphics, economics, geology, medicine, physical cosmology, engineering, chaos theory, econophysics, metallurgy, and the social sciences.[12] Toward the end of his career, he was Sterling Professor of Mathematical Sciences at Yale University, where he was the oldest professor in Yale's history to receive tenure.[13] Mandelbrot also held positions at the Pacific Northwest National Laboratory, Université Lille Nord de France, Institute for Advanced Study and Centre National de la Recherche Scientifique. During his career, he received over 15 honorary doctorates and served on many science journals, along with winning numerous awards. His autobiography, The Fractalist: Memoir of a Scientific Maverick, was published posthumously in 2012. ..." https://en.wikipedia.org/wiki/Benoit_Mandelbrot https://youtube.com/playlist?list=PLVV0r6CmEsFwl4HlrIKxKmdpBAGYJ9AbR&si=9_ccF1Tln7wRLTjy

- Pedro

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O-Ring Theory of Development and its importance on a company organization, HR, output & wages

Came across this economic theory by chance (on the Marginal Revolution Blog - Tyler Cowen and Alex Tabarrok) and it was surprisingly insightful, simple and helped to structure my line of thought on the areas of: Management, Organization setup and the importance of Areas of Excellence within an organization. 

Additionally, it also explains the pay gap between excellent (A-players) and very good & below associates (B/C/D - Players).

I strongly advise you to see the video of 19 minutes that provides a great overview of this theory (so you can also understand the math).

So the O-Ring Theory of Development (Michael Kremer, 1993) is underpinned by the following assumptions:

1. Production (broad sense) depends on completing a number of tasks;
2. Failure or quality curtailment of any task reduces the entire product (weakest link problem);
3. Quantity cannot substitute quality (2 mediocre Finance Directors will not do a better job than a great Finance Director)

If you take a broad approach to this production function you have a company or even an entire economy.

Main practical deliverables of such theory:

• Quality matching - you should put your high quality workers together (preferentially allocated to the company areas of excellence, based on its value chain) and the other workers (B/C) also together, instead of mixing them up, as the results will be significantly better;
• Higher quality it will imply better results (i.e. better outputs)
• Higher outputs/results will result in better wages (macroeconomics 101) for any organization & that the function Output/Wages is not linear

• The wage distribution is severely skewed to the right and the talent distribution follows a normal distribution (that is why small incremental talent on the top decile can have a significant impact on the associates wages);

• Workers performing in high-skill firms will have higher wages than low-skill firms (look at the wage gap of tech/pharma companies compared with other industries);
• Talent attracts Talent - High quality worker will want to work with other of the same standards (virtuous cycle)
• There is an tremendous incentive to invest in skills/quality of the workers (company and and associates)
• This theory has several "equilibria", meaning that if your are surrounded by high quality workers it pays-off to invest in becoming one, but if you are within a non-high quality organization it does not pay-off to invest, as your higher potential output will be severely curtailed by the others;
• Capital will be allocated to high quality organizations or within the organization to the areas with the highest quality potential - so if you are investing within your organization make sure you have your A-team on that area.

You can think your organization is performing several activities throughout your value chain, thus applying this theory you can identify bottlenecks, linkages and complementarities and don't forget where are your areas of excellence based on the Value Proposition so you can have your A-players on it!

Direct Listing vs. IPO

Bill Gurley – Direct Listing vs. IPO - [Invest Like the Best, EP.144]



Great podcast on going public: direct listing vs IPO. Also read the latest blog post money stuff I have shared last week on the same subject (why there is this implicit pop). Let you make your own analysis & opinion

Again on IPO Lessons for Public Market Investors.

Pricing vs. Valuation

Review: Due Diligence: The Critical Stage in Mergers and Acquisitions

Due Diligence: The Critical Stage in Mergers and Acquisitions by Peter Howson
My rating: 3 of 5 stars

Read this book to get a quick refresher and also to allow me to structure my knowledge on Due Diligence. I achieved both objectives. Not bad!

The book is a good guidance on the subject and makes you think through different lenses/areas of expertise the basics of this important and more often than not difficult phase of every M&A project.

It provides you practical watch-outs and leads you through the main areas of a Due Diligence and presents the main objectives, activities that should be undertaken & discloses the main risks and concerns.

For the areas where you are not an expert, it brings awareness of what you should expect and allows you to have an educated conversation with the subject matter expert on the required deliverables.

The check lists presented are a good tool, nonetheless the main one on appendix A should have been organized by area and not has it was disclosed (it seems randomly made).

Finally, i think what is called Commercial Due Diligence should have been named Strategic Due Diligence and the area of Risk is clearly lacking inputs and it's significantly below the other chapters of the books.

ps - due to the author nationality, the subjects presented are clearly skewed from an UK perspective, but that does not undermines the quality and insights conveyed.





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Review: CFA Program Curriculum 2017 Level II, Volumes 1 - 6

CFA Program Curriculum 2017 Level II, Volumes 1 - 6 by CFA Institute
My rating: 4 of 5 stars

Excellent curriculum books on the subjects/topics under study

Ethical & Professional Standards,
Quantitative Methods
Economics
Financial Reporting and Analysis
Corporate Finance
Equity
Fixed Income Derivatives
Alternative Investments
Portfolio Management

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Do have to dust this one off...4 years afterwards have to think of something else. CFA III exam next year and then something else from academia,,,


Capital structure active management : a contingent claim approach

Review: Nudge: Improving Decisions About Health, Wealth, and Happiness

Nudge: Improving Decisions About Health, Wealth, and Happiness by Richard H. Thaler
My rating: 3 of 5 stars

Easy and nice read on behavior economics (specially for non-economists), with good takeaways, insights and useful advice ...from 2/3 of the book onwards slightly repetitive as the thesis, associated concepts were already duly presented and explained.

Do recommend its reading if interested on the subject!

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Review: Superforecasting: The Art and Science of Prediction

Superforecasting: The Art and Science of Prediction by Philip E. Tetlock
My rating: 3 of 5 stars

A turn pager book, very insightful on the behaviors that entail a forecasting activity.

Recommend its reading for all the ones interested on the topic and it's not a hard skills book, thus it can be read by anyone interested.

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Missão e Objectivos

Há já algum tempo, durante a minha actividade profissional, constato que a maioria dos meus colegas, clientes, fornecedores e outros agentes (stakeholders), detêm, em média, um nível de conhecimentos muito reduzido sobre o valor que as actividades secundárias (tais como: Gestão Financeira, Gestão do Capital Humano, Gestão Estratégica, Controlo de Gestão e Performance, Gestão dos Sistemas de Informação, etc...) podem e devem aportar a qualquer organização.

Na realidade, estas actividades são percepcionadas como um custo necessário e obrigatório e raramente são tratadas como uma fonte de valor acrescentado. Situação, que na minha opinião, delimita de uma forma substancial a capacidade operacional, económica e financeira de qualquer organização e consequentemente a economia como um todo (e que me levou a criar uma empresa que visa fornecer este tipo de serviços).

Adicionalmente e mais recentemente, em especial desde Setembro de 2008, todos nós somos expostos diariamente a um conjunto de conceitos e termos económicos e financeiros que a maioria não domina e não sabe do que se trata, mas que, percebemos e sentimos, têm um impacto directo na nossa qualidade e nível de vida. Existe, de facto, uma natural iliteracia económica e financeira por parte daqueles que não têm formação específica nestas áreas.

De forma a mitigar este défice de informação e conhecimento (promovendo uma espécie de intermediação de informação), quer seja a nível empresarial, quer seja a nível individual, decidi criar este blog que pretende ser um fórum onde possamos partilhar o conhecimento que cada um tem em determinadas áreas e dessa forma minimizar o diferencial de conhecimento e informação que actualmente existe.

A missão do blog “Prémio de Risco” é fomentar o conhecimento e divulgar de uma forma simples e directa conceitos básicos nas áreas de Economia, de Estratégia, de Finanças, de Gestão Financeira, de Mercados Financeiros e de Controlo de Gestão e Performance que acrescentem valor aos seus leitores.

Deste modo, pretendo publicar neste “fórum”, de uma forma regular, artigos/”posts “que permitam um debate construtivo sobre cada um dos temas e assuntos mencionados anteriormente.

Os objectivos que me proponho com este blog são: 

•  Apresentar e explicar os conceitos associados aos Mercados Financeiros;
•  Apresentar e explicar os conceitos e os impactos das políticas Macroeconómicas;
•  Fomentar o conhecimento e o interesse pelas actividades secundárias;
• Promover o intercâmbio de ideias e experiências dos participantes neste fórum;
• Divulgar de uma forma regular artigos sobre cada uma das áreas de conhecimento em análise.