Asset Management. Roman Frick Pascal Gantenbein Peter Reichling (Hrsg.) Auszug aus:

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1 Roman Frc Pascal Gantenben Peter Rechlng (Hrsg.) Auszug aus: Asset Management Festschrft für Prof. Dr. rer. nat. Dr. h.c. rer. pol. Klaus Spremann zur Emerterung XXIII Seten, gebunden ISBN Haupt Verlag Bern Stuttgart Wen

2 Rs Management: Comprehensve Integraton nto the Enterprse Management Walter S.A. Schwager Abstract In the meantme there are dfferent legal requrements for the corporate governance of enterprses related to rs management. The statutory audts drectve of the European Communty [AudtsDrectve06, Artcle 41] requres that the audt commttee of the enterprse shall, nter ala montor the effectveness of the rs management systems In the nternatonal fnancal reportng standards [IFRS7.33(b)] t s requred that the enterprse shall dsclose: (a) the exposure to rs and how they arse; (b) ts objectves, polces and processes for managng the rs and the methods used to measure the rs; and (c) any changes n (a) or (b) from the prevous perod. To fulfll these requrements enterprses have to establsh effectve rs management systems. Although rs management s a broadly dscussed topc for about two decades t s stll unclear how rs management systems should be desgned, mplemented and montored for effectveness. Furthermore t s not clear n whch scentfc dscplne ths topc s actually located. In ndustral research the operatonal rss and ther measurements and n fnancal research the measurements of the fnancal rss are addressed. But a systemc object and process orentaton towards rs management and effectveness consderatons s mssng n both research felds. In ths artcle ths gap s flled by usng the cybernetc management framewor out of the engneerng scences. It allows the consstent dervaton of dfferent management process varants for separated rs management processes as well as for ntegrated rs management processes. The framewor provdes a clear gudelne to translate management nto acton and hence ought to be valuable for all who are responsble ether for desgnng and mplementng rs management systems or for montorng ther effectveness.

3 420 Walter S.A. Schwager 1 Problem Statement and Overvew An enterprse s engaged n dfferent busness actvtes along ts value chan. Accordng to the flow of the materals and servces there are acquston, converson, revenue and fnancal busness actvtes that are needed wthn a manufacturng enterprse to generate value. The ensemble of these four busness processes consttutes the enterprse value chan. In Fgure 1 the busness actvtes are modeled as actvty nodes n form of rounded rectangles. The start and the end of the actvtes are ndcated by the flled and the crossed crcles. The commodty flow through the enterprse that s assocated wth these actvtes goes from the left to the rght sde. Accordng to the dualty prncple of busness and fnancal economcs ths flow s accompaned by an equal valuable cash flow n the opposte drecton. The composton of all four busness actvtes comprses the enterprse value chan. <<Agent>> Suppler <<Agent>> Enterprse <<Agent>> Customer <<Resource>> Commodty <<Do>> Acquston <<Resource>> Commodty <<Do>> Converson <<Do>> Revenue <<Resource>> Product <<Resource>> Cash <<Resource>> Product <<Resource>> Cash <<Resource>> Cash <<Do>> Fnancng <<Resource>> Cash Fgure 1: Busness Actvtes n Enterprse Value Chans Fgure 1 shows the nterrelatons between busness economcs at the upper part and fnancal economcs at the lower part. The busness actvtes are managed at the busness level relatve to operatonal and fnancal objectves. At the enterprse level the dfferent busness unts are coordnated and strategcally algned. Fgure 2 contans the dfferent busness actvtes n the rows and the dfferent management domans are arranged n the columns. The purpose of ths artcle s to show how rs management can be ntegrated nto the busness as well as the enterprse management. Such a comprehensve ntegraton of rs management s not that easy as there are many dfferent aspects that have to be taen nto account n the dfferent busness, enterprse and management domans. Instead of a sngle ntegraton approach

4 Rs Management 421 dfferent ntegraton consderatons have to be taen. To handle ths dversty a meta management framewor s taen whch ncludes the essental elements of all tradtonal management systems (e.g. supply chan management, customer relatonshp management, qualty management, rs management, strategc management, performance management, fnancal management, lqudty management, asset and lablty management and portfolo management). In order to be applcable n dfferent management contexts the management framewor must allow flexble mplementatons so that the peculartes of the dfferent contexts can be taen nto account. Busness Level Operatonal MGT Fnancal MGT Strategc MGT Rs MGT Acquston Busness Converson Busness Revenue Busness Fnancng Busness Enterprse Level Fgure 2: Busness and Enterprse Management Rs Management Integraton The meta management framewor s based upon cybernetc deas why t s called cybernetc management framewor. There are three cybernetc prncples that are of specal mportance: feedbac prncple control and communcaton prncple double loop prncple. The frst two prncples le at the heart of the tradtonal cybernetcs defnton ntroduced by Wener [Wener48]. The double loop prncple s central to the 2 nd -order cybernetcs that was establshed by Foerster [Foer03] n the 70s of the last century (see also Scott [Scott96]). In the lterature the three prncples

5 422 Walter S.A. Schwager are dealt wth normally qute separated so that ther combned consderaton should delver nterestng and benefcal nsghts. It wll be shown that the ntegraton of the three concepts can be reached by a strct object and process orentaton where the operatonal and manageral actvtes are modeled together wth the correspondng nformaton flows. The combned modelng of objects and processes s possble n the recently developed unfed modelng language [UML07]. UML s a modelng language for object orented systems where objects and actvtes can be combned n UML actvty dagrams. The cybernetc management framewor s founded upon actvty dagram modeled management processes so that the framewor translates management nto acton. The generc cybernetc management process can be appled n dfferent management contexts. The generc management process perspectve allows a comprehensve and actvty based vew on each management system under consderaton. In ths artcle the cybernetc management framewor s appled to the rs management context. Ths applcaton s reached by specfyng the needed manageral actvtes and selectng the approprate nformaton flows ncludng the needed rs measures and operatonal as well as manageral rules. To acheve an ntegraton of the rs management nto the busness management processes the cybernetc management framewor s appled to busness performance management processes. Fnally the cybernetc management framewor s appled to strategc management processes n a way that rs management consderatons are ncluded also n the management processes at the enterprse level. The cybernetc management framewor gves a mental meta model for desgnng and mplementng cybernetc management processes n dfferent management domans. As such t should be benefcal to all who are responsble n ther functons as managers, IT desgners and mplementers or controllers for the desgn, mplementaton and well functonng of rs management systems over tme. Ths artcle s structured as follows. Frst an overvew of the research felds related to the ntegraton of the rs management nto the enterprse management s gven. Then the cybernetc management framewor s defned va three pllars that are founded upon the MGT-Actvty-dagram. The cybernetc management framewor s then appled to the rs management doman. After that the rs management s ntegrated nto the busness management va establshng a proactve performance management and nto the strategc management by usng a proactve open loop management. Fnally the paper gets concluded

6 Rs Management 423 and an outloo to the desgn and mplementaton of enterprse management nformaton systems s gven. 2 Related Research Felds The audts drectve of the European Communty was establshed to mprove the confdence nto the functonng of the fnancal marets. Ths drectve requres from the audt commttee of an enterprse to montor the effectveness of rs management system: the audt commttee shall, nter ala: (b) montor the effectveness of the company s nternal control, nternal audt where applcable, and rs management systems; [AudtsDrectve06, Artcle 41]. In the nternatonal fnancal reportng standards (IFRS) t s requred that enterprses dsclose ther fnancal rss and gve more detaled nformaton on ther rs management systems by explctly specfyng the management objectves, polces and processes: Qualtatve dsclosures For each type of rs arsng from fnancal nstruments, an entty shall dsclose: (a) the exposure to rs and how they arse; (b) ts objectves, polces and processes for managng the rs and the methods used to measure the rs; and (c) any changes n (a) or (b) from the prevous perod. [IFRS7.33(b)]. In Fnance there s a long tradton n measurng fnancal rss. The mathematcal defnton and measurement of rs s the startng pont of modern fnance that goes bac to the semnal paper of Marowtz [Mar52] on portfolo selecton. In the portfolo theory the rate of returns of assets are modeled as normally dstrbuted random varables where the mean specfes the expected rate of return and the standard devaton specfes the uncertanty surroundng the mean. The portfolo theory s normatve by usng utlty functons and dervng optmal allocatons for the assets held n the portfolo. Based on the wor of Marowtz consderable progress was made n the refnement of rs defnton and rs measurement consderatons. In contrast to ths progress t s nterestng that the conceptual approach to rs management dd not change that much. In the neoclasscal tradton the man objectve n the portfolo selecton framewor conssts out of optmzng the tradeoff between one perod expected proft and rs. Accordngly the manstream fnance lterature on rs management (see e.g. [Hull09]) addresses predomnantly the problem of defnng rs measures and optmzng one perod re-

7 424 Walter S.A. Schwager turns. In the future, and as a consequence of the fnancal crss of , t seems desrable to overcome one-perodc modelng. However, any type of consderaton of a hyperopc optmal strategy requres a specfcaton of the mult-perod rs measure r, the general return functon and the non-statonary process (Y t ) t>0. It remans a bg but promsng challenge for further research to proceed n ths drecton. [BDW11, p. 3007]. The topc of rs management s addressed n dfferent rs management framewors that are connected wth legal requrements n dfferent regulaton domans. For the fnancal servces ndustry the Basel Commttee on Banng Supervson (BCBS) standardzed the measurement of fnancal and operatonal rss. The measured rs must be covered by equty captal to ensure the stablty of the banng ndustry. The rs measurements have to be embedded n sound rs management systems. The overall adequacy s ensured by the supervsory revew process that s performed by the local regulatory authortes: 720. The supervsory revew process of the Framewor s ntended not only to ensure that bans have adequate captal to support all the rss n ther busness, but also to encourage bans to develop and use better rs management technques n montorng and managng ther rss. [Basel2 06, 720]. The BCBS framewor s very specfc on the measurement of rss but related to the rs management procedures detaled nformaton s mssng. The specfcaton of procedural aspects s left to the natonal authortes on banng supervson what seems doubtful n the lght of the fnancal crses n the banng ndustry. The rs management framewor specfed by the nternatonal standardzaton organzaton (ISO) s much more elaborated by havng a clear process orentaton and by gvng prncples for the desgn, mplementaton and mprovement of the rs management framewor. Organzatons of all types and szes face nternal and external factors and nfluences that mae t uncertan whether and when they wll acheve ther objectves. The effect ths uncertanty has on an organzaton s objectves s rs. All actvtes of an organzaton nvolve rs. Organzatons manage rs by dentfyng t, analysng t and then evaluatng whether the rs should be modfed by rs treatment n order to satsfy ther rs crtera. Throughout ths process, they communcate and consult wth staeholders and montor and revew the rs and the controls that are modfyng the rs n order to ensure that no further rs treatment s requred. Ths Internatonal Standard descrbes ths systematc and logcal process n detal.

8 Rs Management 425 Fgure 3: ISO-Rs Management Framewor Interrelated Components [RMS09, p. 9] Whle all organzatons manage rs to some degree, ths Internatonal Standard establshes a number of prncples that need to be satsfed to mae rs management effectve. Ths Internatonal Standard recommends that organzatons develop, mplement and contnuously mprove a framewor whose purpose s to ntegrate the process for managng rs nto the organzaton s overall governance, strategy and plannng, management, reportng processes, polces, values and culture. [RMS09, p. v]. Embedded wthn the ISO-rs management framewor s the ISO-rs management process. The ISO-rs management s defned n Fgure 4 and t has to be mplemented accordng to (4.4) n the ISO-rs management framewor shown n Fgure 3.

9 426 Walter S.A. Schwager Fgure 4: ISO-Rs Management Process [RMS09, p. 14] The rs management framewor developed by the Commttee of Sponsorng Organzatons (COSO) of the Treadway Commsson casts the rs management explctly nto the enterprse context. Enterprse rs management s a process, effected by an entty s board of drectors, management and other personnel, appled n strategy settng and across the enterprse, desgned to dentfy potental events that may affect the entty, and manage rs to be wthn ts rs appette, to provde reasonable assurance regardng the achevement of entty objectves. [COSO2 04a, p. 4]. The COSO-enterprse rs management framewor provdes an enterprse wde language for rs management that s process orented, relates to strategc, operatons, reportng and complance objectves and s relevant for all organzatonal unts of the enterprse (subsdares, busness unts, dvsons and entty-level). To vsualze the three aspects of the COSO-enterprse rs management framewor the cube form shown n Fgure 5 s used.

10 Rs Management 427 Fgure 5: COSO-Enterprse Rs Management Framewor COSO Cube [COSO2 04, p. 7] The COSO-enterprse rs management framewor s characterzed by ntutvely clear defnton of rss and chances that are based on events. An event s an ncdent or occurrence from nternal or external sources that affects achevement of objectves. Events can have negatve mpact, postve mpact, or both. Events wth negatve mpact represent rss. Accordngly, rs s defned as follows: Rs s the possblty that an event wll occur and adversely affect the achevement of objectves. Events wth adverse mpact prevent value creaton or erode exstng value. Examples nclude plant machnery breadowns, fre, and credt losses. Events wth an adverse mpact can derve from seemngly postve condtons, such as where customer demand for product exceeds producton capacty, causng falure to meet buyer demand, eroded customer loyalty, and declne n future orders. [COSO2 04, p. 16]. The event based defnton of rss and changes s qute ntutve and therefore helpful for establshng a common rs management language throughout the enterprse. From the theoretcal sde the event based defnton s the ey as s shown later on that opens the rs management framewor to stochastc modelng.

11 428 Walter S.A. Schwager 3 Cybernetc Management Framewor: Translatng MGT nto Acton The three rs management framewors just presented.e. BCBS-rs management framewor, ISO-rs management framewor and COSO-enterprse rs management framewor are conceptually qute dfferent. Management systemc consderatons are clearly underlyng the ISO- and the COSO-framewor whereas they are mssng n the BCBS-framewor. The ISO-framewor explctly rests on the cybernetc feedbac prncple n form of PDCA-cycles. Management system standards provde a model to follow n settng up and operatng a management system. Ths model ncorporates the features on whch experts n the feld have reached a consensus as beng the nternatonal state of the art. The Plan Do Chec Act (PDCA) cycle s the operatng prncple of ISO s management system standards. Plan establsh objectves and mae plans (analyze your organzaton s stuaton, establsh your overall objectves and set your nterm targets, and develop plans to acheve them). Do mplement your plans (do what you planned to). Chec measure your results (measure/montor how far your actual achevements meet your planned objectves). Act correct and mprove your plans and how you put them nto practce (correct and learn from your mstaes to mprove your plans n order to acheve better results next tme). [ISO-MSS11]. Fgure 6: ISO-PDCA-Cycle [ISO-MSS11] Fgure 6 shows the PDCA-cycle that s used as the operatng prncple n all ISO s management system standards. The cybernetc feedbac mechansm s ndcated n the fgure by the arrow whose tp ponts towards ts end.

12 Rs Management 429 Shewhart [Shew80] appled the PDCA-cycle to statstcal qualty management already n the 30s of the last century. He therefore used cybernetc concepts before they were termed cybernetc. Ten years after Wener [Wener49] created the term Cybernetcs ts concepts were appled by Beer [Beer59] to the management context. Mal [Mal08] s the most promnent current representatve n the feld of Management Cybernetcs that s based on the deas of Beer. In ths artcle the cybernetc plannng and control framewor ntroduced by Anthony [Anth65] s taen to put the PDCA-cycle nto a manageral plannng and control framewor. Usng the plannng and control framewor the busness management system s composed out of a plannng system and a control system that are establshed to manage the operatng actvtes n the operatng system. In Fgure 7 ths defnton of the busness management system s vsualzed by a Venn-dagram. The overlappng crcles ndcate that there are dfferent assocatons between the three sub-systems of the busness management system. Busness Management System Plannng System Control System Operatng System Fgure 7: Cybernetc Busness Management System Sub-Systems The ntegraton of the plannng and control framewor, the PDCA-cycle and ts related nformaton flows s realzed by usng MGT-Actvty-dagrams. In the MGT-Actvty-dagram the object and process orentaton s mplemented by smultaneously modelng the manageral PDCA-actvtes as processes and the related nformaton flows as objects. In the sprt of Cybernetcs as the scence of control and communcaton n the anmal and the machne the MGT-

13 430 Walter S.A. Schwager Actvty-dagram s the object and process orented modelng technque for plannng, control and communcaton n management. Fgure 8 contans a smple varant of a MGT-Actvty-dagram that relates to rather mechancal systems where only sngle loop learnng occurs. In ths dagram the busness actvty s modeled as a blac box to abstract from the detals of the busness process tself. The process detals are not modeled by usng MGT-Actvty-dagrams but usng REA-Actvty-dagrams nstead (see Fgure 1) where the economc Event related Resource flows between Agents are specfed. Furthermore the busness process s modeled as an ongong process whch can be seen n Fgure 8 by the arrow that goes from the end of the busness process va the damond agan nto the process. Ths gong concern vew s characterstc for the busness management level. It contrasts to the executon vew whch prevals at the busness process management level where sngle executons of busness processes are desgned, montored and mproved over tme. <<Plan>> (1) Plannng Plannng System Management System <<Act>> (4) Selecton of Correctve Instructons <<Control Input>> (4a), (4b) Correctve Instructons <<Do >> (1b) Operatng <<Control >> (1d) Actng <<Devaton>> (3a) Varance NOK <<Control >> (1c) Checng OK <<Chec>> (3) Comparson <<Objectve>> (1a) Standard Control System: Open/Closed Sngle Loop Control Busness System <<Do>> Busness Process <<State Varable>> (2b) Realzaton perodc <<Measure>> (2) Measurng <<Performance>> (2a) Realzaton <<Measure >> (1e) Measurng Operatng System Fgure 8: 1 st -order Cybernetc MGT Framewor Sngle Loop Learnng

14 Rs Management 431 In the MGT-Actvty-dagram stereotypes whch are mared by <<gullemets>> are used to show the semantc meanng of the operatonal and manageral actvtes n the management process. In Fgure 8 the manageral actvtes are stereotyped as Plan-actvty (1), Chec- actvty (3) and Act-actvty (4). The operatonal busness process s characterzed as Do-actvty. Next to the actvtes whch are modeled as rounded rectangles also the nformaton flows are modeled and stereotyped. To dstngush the nformaton flows from the actvtes the nformaton flows are modeled as objects n form of rectangles. The stereotypes used ndcate ther meanng,.e. Standard of performance (1a), Do-rules (1b), Chec-rules (1c), Act-rules (1d), Measure-rules (1e), Performance-realzaton (2a), State Varable-realzaton (2b), Devaton (3a) and Control Input (4b). The numbers and letters ndcate the connectons whch exst between the dfferent actvtes and nformaton flows. E.g. n the Measure-actvty (2) the realzaton of the busness process performance (2a) and the realzaton of the state varable (2b) are measured. The performance nformaton s compared n the Chec-actvty (3) wth the standard of performance (1a) whch s set as objectve. Ths comparson consttutes a closed loop control system. The realzaton of the state varable s not connected to a Chec-actvty. Instead t goes drectly nto the Act-actvty (4) where t s evaluated accordng to the Act-rules (1b) to gve the Control Input (4b) whch changes the behavor of the busness process. The usage of the control varable consttutes an open loop control system. The open loop system s the control theoretc analogue to the classcal decson theory where the control nputs are called decson varables. The dfference between decson theory and control theory corresponds e.g. to the dfferent modelng framewors that are used n the portfolo selecton theory of Marowtz [Mar52] and the opton prcng theory of Blac and Scholes [BlSc73]. The 1 st -order cybernetc management framewor presented n Fgure 8 allows as already mentoned accordng to ts sngle loop characterstc the dervaton of only smple varants of cybernetc management processes. The adequacy of 1 st -order cybernetc management processes depends on the peculartes of the system that s to be managed. Bouldng [Bould56] defned 9 levels of systems complexty as follows: 1. Statc Systems (Framewors): Taxonomy of classfcatons and assocatons 2. Dynamc Systems (Clocwors): Somethng s movng over tme 3. Control Systems (Thermostats): Informaton s an essental part of the system

15 432 Walter S.A. Schwager 4. Lvng Systems (Cells): Open system wth self-producton and self-mantenance 5. Decentralzed Systems (Plants): Socety wth dfferentated and dependent parts 6. Thnng Systems (Anmals): Bran as nformaton organzer (mental structure) 7. Reflectve Systems (Human Bengs): Self-conscousness and self-reflexvty 8. Socal Systems (Socal Organzatons): Set of communcatng roles 9. Unobservable Systems (Transcendental Systems): Personal, socal and ethcal norms In ths complexty herarchy the 1 st -order cybernetc management framewor seems to be adequate for level 3 complex systems. In these systems nformaton plays an essental role and the nformaton s used to algn the system to specfed objectves or control rules. To mae the cybernetc management framewor sutable for more complex systems the transton to 2 nd -order cybernetcs has to be taen. The transton to the 2 nd -order framewor ncludes a qualtatve change whch corresponds to the transton onto level 7 to 9 complex systems. In these systems the selfreflecton prncple s ncluded. Ths means that the system s aware of ts system structure and t has the potental and the power to change the system structure at wll. In the 2 nd -order cybernetc management framewor presented n Fgure 9 ths qualtatve transton gets ncorporated by the addtonal loop whch provdes the double loop learnng mechansm. The second loop refers bac to the plannng system. Ths means that the system can learn also about ts sngle loop learnng effectveness. Compared to the sngle loop learnng system there s an addtonal adaptve Act-actvty (5) and an addtonal nformaton flow n form of adaptve nstructons (5a, 5b) bac to the Plan-actvty. Ths double loop feedbac s used to adjust the overall system structure.

16 Rs Management 433 <<Plan>> (1) Plannng <<Plan >> (1f) Plannng Plannng System Management System <<Control Input>> (5a), (5b) Adaptve Instructons <<Act>> (5) Selecton of Adaptve Instructons <<Act>> (4) Selecton of Correctve Instructons <<Control Input>> (4a), (4b) Correctve Instructons <<Do >> (1b) Operatng <<Control >> (1d) Actng <<Devaton>> (3a) Varance NOK <<Control >> (1c) Checng OK <<Chec>> (3) Comparson <<Objectve>> (1a) Standard Control System: Open/Closed Double Loop Control Busness System <<Do>> Busness Process <<State Varable>> (2b) Realzaton perodc <<Measure>> (2) Measurng <<Performance>> (2a) Realzaton <<Measure >> (1e) Measurng Operatng System Fgure 9: 2 nd -order Cybernetc MGT Framewor Double Loop Learnng The 2 nd -order cybernetc management framewor n Fgure 9 s a flexble constructon that allows dfferent specfcatons. The cube presented n Fgure 10 contans eght dfferent control process varants that can be derved by dstngushng n three dmensons,.e. open vs. closed loop, sngle vs. double loop and proactve vs. reactve loops. The smplest varant s the rght upper front feld whch s characterzed as a combnaton of a closed, sngle and reactve loop so that t s called reactve closed sngle loop control process. Ths process s reactve as t uses realzaton related nformaton n ts sngle closed loop learnng mechansm. The process gets proactve f the measured nformaton s transformed nto future related nformaton. Ths happens f e.g. forecasts about future results are derved out of observable nformaton whch s compared n the Chec-actvty wth the standard of performance.

17 434 Walter S.A. Schwager Proactve Closed Loop Reactve Sngle Loop Double Loop Open Loop Fgure 10: Control System Desgn Control Process Varants The 2 nd -order cybernetc management framewor possesses already substantal flexblty so that the cybernetc management processes derved thereof can be appled n many dfferent management domans. Despte the flexblty there s stll one more pecularty to be consdered to establsh a generc cybernetc management framewor. Ths pecularty relates to the problem that the agents nvolved n the system have next to ther self reflectvty and ther system reflectvty also self nterests. Ths means that agents do not always conform n ther behavor to what s expected from them. Arrow [Arrow64] brngs ths clearly to the pont: In ths address, I wsh to set forth some consderatons on one aspect of the worng of an organzaton how t can best eep ts members n step wth each other to maxmze the organzaton s objectve functon. Ths may be referred to as the problem of organzatonal control. It dvdes tself naturally nto two parts: the choce of operatng rules nstructng the members of the organzaton how to act, and the choce of enforcement rules to persuade or compel them to act n accordance wth the operatng rules. Varous other terms for these two problems have appeared n the lterature; a wdespread usage s to refer to the operatng rules as control-n-the-large and the enforcement rules as control-n-the-small. It should be noted that enforcement, here as elsewhere, ncludes both the detecton and the punshment of devatons from the operatng rules. [Arrow64, p. 398]. Fgure 11 shows the generc cybernetc management framewor where also the supervsory enforcement rules are ncluded whch are mplemented to supervse the agents n order to eep ther actual behavor n lne wth the

18 Rs Management 435 proposed rules. The Supervson-actvty s modeled n the MGT-Actvty-dagram as an excepton handler. The excepton handler catches dsturbances from the observed processes. Ths s ndcated by the lghtnng bolt symbol and the small rectangle to whch t shows. In the Supervson-actvty tself the nformaton s processed and the correspondng excepton handler acton s selected and feed bac to the regon where the out-gong arrow refers to. Thus the excepton handler possesses an embedded cybernetc structure whch s not explctly shown n ts symbol. <<Supervsory Control>> (8) System Montorng <<Supervsory Control>> (7) Control Montorng <<Plan>> (1) X-MGT Plannng <<Plan->> (1f) Plannng Plannng System Management System <<Control Input>> (5a), (5b) Adaptve Instructons <<Act>> (5) Selecton of Adaptve Instructons <<Act>> (4) Selecton of Correctve Instructons <<Control Input>> (4a), (4b) Correctve Instructons <<Do->> (1b) Operatng <<Control->> (1d) Correcton- and Adaptaton- <<Devaton>> (3a) Varance NOK OK <<Chec>> (3) Comparson <<Control->> (1c) Checng- <<Objectve>> (1a) Standard of Performance Control System: Supervsed Closed/Open Double Loop Control Busness System <<Supervsory Control>> (6) Process Montorng <<Do>> Busness Process <<State Varable>> (2b) Realsaton perodc <<Measure>> (2) Measurng <<Performance>> (2a) Realsaton <<Measure->> (1e) Measurng Operatng System Fgure 11: Generc Cybernetc MGT Framewor Double Loop Learnng and Supervson

19 436 Walter S.A. Schwager In the generc cybernetc management framewor there are 8 manageral actvtes: 1. Plan-actvty 2. Measure-actvty 3. Chec-actvty 4. Correctve Act-actvty 5. Adaptng Act-actvty 6. Process related Supervson-actvty 7. Control related Supervson-actvty 8. System related Supervson-actvty Compared to the 2 nd -order cybernetc management framewor three addtonal Supervsory-actvtes are ncluded whch tae care of the control-nthe-small aspect. The supervsory actvtes are establshed to ensure the actual executon of the operatonal Do-rules and the manageral Control-rules. At the overall level they are mplemented to ensure the rule complant behavor of the complete management system archtecture. In the presentatons of the cybernetc management framewor so far the focus was exclusvely on the cybernetc aspects of the framewor. In Fgure 12 the cybernetc pllar s shown n the mddle of three pllars upon whch the cybernetc management framewor s based. Furthermore there s a foundaton n form of the UML based MGT-Actvty-dagrams. By usng these dagrams t s ensured that cybernetc management systems are translated nto manageral actons. Cybernetc Management Framewor Economc Pllar Cybernetc Pllar Stochastc Pllar Unfed Modelng Language Foundaton Fgure 12: Foundatons of Enterprse Management Systems

20 Rs Management 437 Next to the cybernetc pllars there are two more pllars n the cybernetc management framewor. The economc pllar carres the economc context of the framewor. Its ntegraton nto the MGT-Actvty-dagram s over the specfed Measure-rules where the performance measure and the state varable are defned. The economc context s prevalng when economc performance measures or state varables are used n an applcaton. The thrd pllar of the cybernetc management framewor s the stochastc pllar. The stochastc pllar carres the uncertanty that s ntrnscally connected to all socal systems whch are level 8 complex systems n the systems complexty herarchy of Bouldng. 4 Cybernetc MGT Framewor: Appled to Rs MGT Processes The applcaton of the generc cybernetc management framewor to the rs management context requres the context specfc specfcaton of the manageral actvtes and the related nformatonal objects. Fgure 13 contans the cybernetc rs management process modeled as MGT-Actvty-dagram. The process s constructed as double loop control system wth three supervsory actvtes related to the busness process, to the control system and to the overall system. The stereotypes reman the same as n the generc framewor to enable a consstent semantc nterpretaton of the dagram. In the Plan-actvty the Objectve s set n form of the rs lmt and the Measure-, Chec- and Actrules are specfed to establsh a double loop management system. The supervson specfcatons are defned n the three Supervson-actvtes.

21 438 Walter S.A. Schwager <<Supervsory Control>> (8) System Montorng <<Supervsory Control>> (7) Control Montorng <<Plan>> (1) Rs MGT Plannng <<Plan->> (1f) Plannng Plannng System Management System <<Control Input>> (5a) Instructon for Rs MGT Adaptaton <<Act>> (5) Selecton of Instructons for Rs MGT Adaptaton <<Act>> (4) Selecton of Instructons for Rs Reducton <<Control Input>> (4a) Instructon for Rs Reducton <<Do->> (1b) Operatng <<Control->> (1d) Rs Reducton- and Adaptaton- <<Devaton>> (3a) Excess Rss RLDj,(st,) NOK OK <<Chec>> (3) Actual/Lmt- Comparson <<Control->> (1c) Lmt/Actual- Checng <<Objectve>> (1a) Rs Lmt RsLmtj, Control System: Supervsed Closed Double Loop Control Busness System <<Supervsory Control>> (6) Process Montorng <<Do>> Busness Process perodc <<Measure>> (2) Measurng Rs <<Performance>> (2a) Actual Rs Rsj,(st,) <<Measure >> (1e) Measurng Operatng System Fgure 13: Cybernetc Rs MGT Process Supervsed Closed Double Loop MGT The cybernetc rs management process n Fgure 13 s stll generc as t relates to all nd of rs at the operatonal, fnancal and strategc level. The separaton of the cybernetc management methodology from the rs type demonstrates the appled abstract reasonng whch the MGT-Actvty-dagram allows. The nformatonal output of the Measure-actvty s the actual rs Rs j, (s t, ). The actual rs s compared n the Chec-actvty wth the RsLmt j,. If the resultng devaton s wthn acceptable ranges the management process s stopped what s ndcated by the crossed crcle. If there s an excessve rs the devaton s forwarded to the two Act-actvtes where t s evaluated accordng to two Act-rules,.e. n form of the rs reducton rule for the sngle loop mechansm and the adaptaton rule for the double loop mechansm. The correctve control

22 Rs Management 439 nput contans the nformaton needed to brng the rs of the busness process down. Related to operatonal rss ths could be the executon of mantenance servces to the equpment used n the busness process. Related to fnancal rss ths could be the nstructon so sell the most rsy fnancal nstruments. A closer loo at the rs defnton shows that the rs has two sub-ndces attached and that t s a functon of a varable. The varable used n the rs measure defnton s the state varable s t,. It ndcates that the measured actual rs s dependng on the prevalng state that occurs at the tme t when the rs s measured. Ths dependence structure already hghlghts the dynamc nature of the MGT-Actvty-dagram. The cybernetc management modeled theren s an teratng process that starts perodcally when the tmer symbolzed by the wat cursor ntalzes the Measure-actvty. Furthermore n a future orented loo the dynamcs are stochastc. That means that from the current tme pont on there are dfferent possble developments the state varable can tae. In Fgure 14 dfferent developments are shown for llustratve purposes n a smple set up where the state varable follows a bnomal process. In such a process at each pont there are two possble movements that are ndcated by the two arrows startng from each pont. Over tme dfferent states can be reached by the state varables whch are specfed by the two sub-ndces of the state varable. T t0 t1 t2 t3 t4 1 s 4,1 s 3,1 2 s 4,2 s 2,1 3 s 4,3 4 s 4,4 5 s 4,5 s 3,3 6 s 4,6 s 2,2 7 s 4,7 8 s 4,8 s 0 s 1,1 9 s 4,9 s 3,5 10 s 4,10 s 2,3 11 s 4,11 12 s 4,12 s 1,2 13 s 4,13 s 3,7 14 s 4,14 s 2,4 15 s 4,15 16 s 4,16 s 3,2 s 3,4 s 3,6 s 3,8 Fgure 14: Modelng the Uncertanty Event Tree Approach

23 440 Walter S.A. Schwager In stochastcs the bnomal tree shown n Fgure 14 corresponds to the event space upon whch the stochastc process s defned. Stochastc processes are measurable functons that map the event space nto the real numbers. The measurablty of the functons means that the dfferent elements n the event space have probabltes assocated. These probabltes allow the calculaton of state condtonal expectatons and state condtonal rs measures. In ths sense the measured actual rs Rs j, (s t, ) s condtonal n the -th state at tme t. The stochastc vew underles the COSO-enterprse rs management framewor what maes t qualtatvely dstnct from the BCBS- and the ISOrs management framewors. In the COSO-framewor the stochastc vew s presented n prose form wthout usng formulas. Uncertanty of potental events s evaluated from two perspectves lelhood and mpact. Lelhood represents the possblty that a gven event wll occur, whle mpact represents ts effect. Lelhood and mpact are commonly used terms, although some enttes use terms such as probablty, and severty, serousness, or consequence. Sometmes the words tae on more specfc connotatons, wth lelhood ndcatng the possblty that a gven event wll occur n qualtatve terms such as hgh, medum, and low, or other judgmental scales, and wth probablty ndcatng a quanttatve measure such as a percentage, frequency of occurrence, or other numercal metrc. [COSO2 04, p. 50]. In equaton (1) the rs defnton out of the COSO-framewor s formulated n mathematcal terms where the mpact s defned by the loss gven event (LGE) and the lelhood by the probablty of event (PE). The two sub-ndces used n the defnton of the rs relate to the j-th busness whch can be assocated wth dfferent rss that are ndexed by the -letter. Rs j, ( s t, LGEj, ( st, ) ) PE j, ( st, ) (1) In the BCBS-rs management framewor [Basel2 06] there are many dfferent rs measures defned. Most of them can be captured by the generc rs model presented n equaton (2). The s t, -condtonal rs arses out of the negatve mpact the -th rs factor RF can have n ths state. In the smplest case t

24 Rs Management 441 s assumed that the rs factor s normally dstrbuted what can be seen n the last row of the equaton. Out of the rs factor s dstrbuton the coeffcent of varaton (CV) s calculated by dvdng the standard devaton σ through the mean μ. The CV gves the relatve devaton around the mean. By multplyng t wth the quantle (z-value) assocated wth the loss probablty α (p-value) the cut-off rate (COR ) s derved. Ths rate specfes the percentage devaton of the rs factor from ts mean whch s assocated wth the loss probablty α. The cut-off rate s transformed nto the loss gven event by multplyng t wth the exposure that s at rs tmes the multpler that leverages the rs factor mpact. LGE PE wth j, j, ( s COR ( s where RF ( s t, ( s t, t, t, ) Exposure ) ( st, ) N ) ( st, ) ( st, ) N ) ~ N( ( s t, j, 1 ( s 1 2 ), ( s t, ) Multpler ( ) CV ( s ( ) ( s t, )) and Z t, t, ) z ( s ) z t, j, ( s ( s t, ( s t, ) ) ) ~ N(0,1) ) COR ( s t, t, ) CV Model Vola Model ( f s zero) (2) The rs model n equaton (2) s generc as t can be appled to dfferent rs measures. E.g. the tradtonal Value-at-Rs (VaR) measure assumes a mean for the rs factor of zero so that the volatlty model has to be used for the calculaton of cut-off rate. As the volatlty relates to the prce of the rsy fnancal nstrument the multpler s equal to one. The exposure s the current value of the nstrument whch s equal to the future value due to the zero mean of the rs factor. In Fgure 15 the rs model out of equaton (2) s used to calculate the Earnngs-at-Rs (EaR) measure. In contrast to the VaR the EaR relates not to value related losses but to earnngs related losses. Accordngly the loss gven event s calculated by the negatve mpact that the cut-off rate related to sales deteroraton has on the operatonal earnngs (OE). The multpler used n ths rs measure s the operatonal leverage. The operatonal leverage s defned as the quotent between the overall contrbuton margn and the operatng earnngs. Accordngly the operatonal leverage ncreases when the fxed costs are ncreasng. The operatonal leverage s equal to one when there are no fxed costs.

25 442 Walter S.A. Schwager <<Measure->> (1e) for Measurng Rss Use the Rs Model ~ E[ OE] Loss Gven Event ~ 1 E[ OE] Operatona lleverage CV N ( ) Exposure Multpler Cut Off Rate and calbrate t statstca lly Fgure 15: Measure- for Measurng Operatonal Earnngs-at-Rs The frame around Fgure 15 symbolzes that the Measure-rules are an nformatonal object. In Fgure 13 t can be seen that the Measure-rules are one of the nformatonal outputs of the Plan-actvty and that they are used as nformatonal nput n the Measure-actvty. In the Measure-actvty the actual rs s measured accordng to the Measure-rules. The actual rs s used n the Chec-actvty to calculate the rs lmt devaton (RLD) as percentage of the rs lmt. The rules for calculatng the percentage rs lmt devaton (RLD % ) comes out of the Chec-rules object. RLD % j, ( s t, ) RLD j, ( s t, ) RsLmt RsLmt j, j, (3) The calculated percentage rs lmt devaton s evaluated n the correctve as well as adaptve Act-actvty accordng to the Act-rules. In Fgure 16 the Control-functon [u(rld % (s ))] for the correctve actons s setched. Dependng on the sze of the percentage devatons dfferent correctve actvtes j, t, are proposed. The selecton of the adequate actvtes depends on the relatve devaton that s realzed n the s t, -state.

26 Rs Management 443 <<Control->> (1d) Rs Reducton- u( RLD % j, Q EmergencyPlan Rs Reducton ( st, )) Observaton Nothng f f RLD RLD % j, Q % j, Q ( s ) 20% t, ( s ) 0% t, % f RLDj, Q( st, ) 5% else Fgure 16: Act- for Selectng Rs MGT Instructons If realzed devatons cause doubt about the valdty,.e. the effectveness of the sngle loop rs management system, then the double loop learnng mechansm gets nvoed and the adaptve Act-actvtes that are defned n the adaptng Act-rules are executed. Examples of adaptng actvtes are the re-calbratons or the re-constructons of the rs models used as rs measures. It s mportant to recognze that n socal systems not only the agents but also the rs models have lfe cycles. Ths requres a permanent cybernetc model lfe cycle management whch s an mportant aspect n the double loop learnng mechansm. In Fgure 13 there are three Supervson-actvtes that serve dfferent purposes. The control related montorng actvty mplements an enforcement rule n the sense of Arrow. It exsts to ensure that the mplemented double loop rs management process s performed as ntended by the dfferent agents engaged n the cybernetc rs management system. Ths actvty s exactly what n the COSO-Cube (Fgure 5) s called control actvty. The Supervson-actvty montorng the overall rs management system s usually performed perodcally and t s concerned wth the valdty of the entre rs management system. For ths purpose the usefulness of the cybernetc management framewor can be seen as t gves clear and systematc drectons for detectng the defcences of the mplemented rs management system. In the search for defcences all actvtes and related nformaton flows specfed n Fgure 13 are possble canddates.

27 444 Walter S.A. Schwager 5 Rs Management Integraton nto Busness MGT Processes Enterprse rs management s dfferent from the perspectve of some observers who vew t as somethng added on to an entty s actvtes. That s not to say effectve enterprse rs management does not requre ncremental effort, as t may. In consderng credt and currency rss, for example, ncremental effort may be requred to develop needed models and mae necessary analyses and calculatons. However, these enterprse rs management mechansms are ntertwned wth an entty s operatng actvtes and exst for fundamental busness reasons. Enterprse rs management s most effectve when these mechansms are bult nto the entty s nfrastructure and are part of the essence of the enterprse. By buldng n enterprse rs management, an entty can drectly affect ts ablty to mplement ts strategy and acheve ts msson. [COSO2 04, p. 17]. The central dea of the COSO-enterprse rs management framewor s to ntertwne busness management and rs management. At the frst glance t s not easy to magne how ths could be done. Rs management s a rather young research dscplne. It heavly rests on mathematcs and s therefore qute dfferent from the qualtatve busness management research. The ntegraton starts by consderng the objectves pursued n the busness management process and combnng the objectves wth the rs defnton gven n the COSO-enterprse rs management framewor. Accordngly, rs s defned as follows: Rs s the possblty that an event wll occur and adversely affect the achevement of objectves. [COSO2 04, p. 16]. In ths sense rs management s engaged n managng the probablty as well as the mpact of the occurrence of events wth negatve effects on the objectves. Rs management therefore ncreases the probablty that the objectves set n the Plan-actvty get actually realzed. Thus rs management has the same purpose as performance management whch s establshed to ensure the realzaton of the objectves set n the Plan-actvty. The combnaton of busness and rs management s therefore synonymous to busness performance management. The essental concepts of busness performance management are the nformaton revelaton prncple and the plan progress chec concept. In order to ensure the realzaton of the objectves set over the plannng horzon there must be possbltes to detect devatons of the objectves n an early stage and to tae correctng actons already before the fnal result s realzed. To ths end the plannng horzon s broen down nto sub-perods. After each sub-perod

28 Rs Management 445 the sub-perodc results are measured and estmatons for the remanng subperods are made. In the Chec-actvty t s judged f the objectves set for the plannng horzon can be reached condtonal on the prevalng sub-perodc results and the estmatons based upon them. If there are substantal devatons correctve actons are taen n the Act-actvty accordng to the Act-rules to brng the antcpated performance n lne wth the plannng horzon related objectves. <<Supervsory Control>> (8) System Montorng <<Supervsory Control>> (7) Control Montorng <<Plan>> (1) Sales MGT Plannng <<Plan->> (1f) Plannng Plannng System Management System <<Control Input>> (5a) Instructons for Sales MGT Adaptaton <<Act>> (5) Selecton of Instructons for Sales MGT Adaptaton <<Act>> (4) Selecton of Sales Promoton Instructons <<Control Input>> (4a) Sales Promoton Instructons <<Do->> (1b) Operatng <<Control->> (1d) Promoton- and Adaptaton- <<Devaton>> (3a) Sales Shortfall PFDj(st,) NOK OK <<Chec>> (3) Plan/Forcast- Comparson <<Control->> (1c) Plan/Forecast- Checng- <<Objectve>> (1a) Sales Plan Salesj Plan Control System: Supervsed Closed/Open Double Loop MGT Busness System <<Supervsory Control>> (6) Process Montorng <<Do>> Sales Process perodc <<Measure>> (2) Measurng Sales and Forecastng <<Performance>> (2a) Forcast E[Salesj st,] <<Measure >> (1e) Measurng Operatng System Fgure 17: Cybernetc Sales MGT Process Supervsed Closed Double Loop MGT In Fgure 17 the cybernetc sales management process s modeled n form of the MGT-Actvty-dagram for the supervsed closed double loop management process varant. The Objectve set n the Plan-actvty s the volume of

29 446 Walter S.A. Schwager the planned sales over the plannng horzon Sales j Plan. In each sub-perod the realzed returns are measured and condtonal upon ths nformaton the condtonal forecasts for the sales over the plannng horzon are calculated. ~ ~ E[ Sales j st, ] j Q j Q t Sales, E[ Sales, s, ] Q t Q t Forecast Accumulated Actual Need to Complete (4) The condtonal forecast E[Sales j s t, ] s defned accordng to the stochastc pllar of the cybernetc management framewor as a condtonal expectaton. In equaton (4) the condtonalty of the forecast s ndcated by the vertcal lne and the followng state s t, whch represents the realzed sales nformaton. The condtonal forecast conssts out of the accumulated actual sales over the realzed sub-perods up to the s t, -state (accumulated actual) and the expected future sales for the remanng sub-perods condtonal on the realzed s t, -state (need to complete). The meanng of the two dfferent tme ndces,.e. t and Q relates as s shown n Fgure 18 to the dfferent tme ponts and the dfferent tme perods between the tme ponts. Q1 Q2 Q3 Q4 t0 t1 t2 t3 t4 Fgure 18: Relatonshp between Tme Indces Tme Ponts vs. Tme Perods In the Chec-actvty the plan/forecast devaton (PFD) s calculated out of the dfference between the planned sales volume over the plannng horzon and the condtonal sales forecast whch relates to the same tme horzon. Plan ~ PFD( st, ) Sales j E[ Sales j st, ] The condtonal forecast s a feedforward nformaton as t ncludes also future sub-perods that stll have to be realzed untl the end of the plannng horzon. Consequently the correctve actons selected n the Act-actvty are proactve. (5)

30 Rs Management 447 Proactve actvtes allow to tae correctng actons to future related devatons and thereby enhancng the probablty that the objectves over the plannng horzon are realzed at the end. The proactve actons are dstnct from the reactve actvtes whch result out of comparng plan values wth realzed actual values. The cybernetc sales management process n Fgure 17 s modeled as a supervsed proactve closed double loop management process. In ths case the feedforward nformaton s also used n the double loop learnng mechansm whch feeds the nformaton related to the excessve plan/forecast devaton bac to the Plan-actvty. Ths allows the adjustment of the Objectves, the Do-rules, the Control-rules, the Measure-rules and the Plan-rules before the plannng horzon s over. Ths possblty f used correctly can further enhance the probablty of realzng the objectves set over the plannng horzon. The fnal rs management faclty conssts out of the Supervson-actvty that prevents or reduces the probablty or the mpact of potental negatve effects caused by the human agents who do not comply to the rules due to pursung ther selfnterests. The cybernetc management framewor desgned for the operatonal sales management process can also be used for fnancal busness performance management purposes. In ths case fnancal performance measures are used n the supervsed proactve closed double loop management process. In equaton (6) e.g. a generc defnton of a rs adjusted performance measure s taen. Ths resdual ncome (RI j ) whch relates to the j-th busness s calculated by subtractng the fnancng costs and the rs costs from the operatng profts. RI OperatngProfts FnancngCosts RsCosts (6) To establsh a proactve closed loop mechansm the revelaton prncple and the plan progress chec concept have to be ntegrated agan. These requrements are fulflled by ntroducng sub-perods, by defnng a feedforward nformatonal forecast and by mang sub-perodcal plan/forecast checs whch allow proactve Act-actvtes. The feedforward nformatonal forecast s defned n equaton (7) as the s t, -state condtonal expectaton for the resdual ncome over the plannng horzon consstng out of the accumulated resdual ncomes up to the s t, -state (accumulated actual) and the s t, -condtonal expected value of the future sub-perodc resdual ncomes (need to complete).