Enterprise Risk Management (ERM) provides practitioners all of the tools necessary for assessing, quantifying, and managing risk on an aggregated, holistic basis. However, in practice it is often found that there is a tendency for company managements and even seasoned risk practitioners at times to navigate their risk exposures one at a time. This habitual approach produces sub-optimal results due to the oversimplification of risk events and understating the complexity of the world in which decision makers must navigate. At the heart of this sub-optimal behavior is the human predilection towards mental accounting. As with financial accounting, mental accounting employs a ledger function that mentally registers debts and balances. However, unlike a traditional ledger, the mental ledger is not precise, does not always sum debits to equal credits, and creates arbitrary categories for resources that are treated as independent, unrelated pools. These differences in function profoundly impact financial judgments and decision-making. Learn more about the long history of mental accounting, including examples from daily life to illustrate the principles involved. Discuss how mental accounting can arise during the ERM process cycle, with a special emphasis on its impacts on effectively quantifying risk and how this results in sub-optimal decision making. Discover behavioral tools specifically designed to mitigate the risk of mental accounting creeping into a company's ERM activities.
By attending the session, you will be able to:
- Understand the concept of mental accounting and how it is applied in financial management.
- Realize instances when mental accounting results in sub-optimal outcomes.
- Recognize where mental accounting arises in the ERM process cycle.
- Enhance ERM model development to avoid the pitfalls of mental accounting in risk quantification.
- Apply individual and behavioral techniques to reduce mental accounting tendencies during ERM activities.
TRACK: Cultivating future opportunities, Protecting long-erm economic progress