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Can Financial Regulation Make You Too Risk-Averse About People?

The growing fear of risk can lead to human-capital mistakes, but you can take a systematic approach to managing human-capital risk.

Evidence suggests that investors, leaders and others may become excessively fearful of risk. That creates dangers and opportunities when it comes to human capital, and “retooling” human capital risk with principles from finance and other management disciplines can help leaders stay balanced.

Financial crises may be an inevitable product of capitalism due to the mismatch between the term of assets banks hold (long-term loans) and their liabilities (short-term deposits). Financial crises disrupt the usual positive relationship between risk and return, because of a “flight to safety.” Some predict that the most recent financial crisis, followed by a long period of painful recovery and broad exposure to the trauma of unemployment, may create a generation of overly risk-averse investors.

John Boudreau ColumnistA joke on Wall Street is that the Dodd-Frank Act will require “psychiatrists” to peer into the intentions of traders, warning that “the only foolproof protection is inactivity.” Attempts to regulate risk may have the effect of stifling opportunity hunting.

If excessive fear of risk can make financial decisions overly conservative, it is an even greater danger when it comes to human capital. The most tangible effects of people decisions are costs and compliance with (or violation of) legal requirements. The potentially much greater effects on future performance, culture and innovation are more distant and less tangible.

Wayne Cascio and I have noted that risk aversion is the dominant perspective for managing human capital risk today, and it may become even more pervasive if risk aversion in finance increases. I have written about how making risk a “four-letter word” can cause leaders to attempt to remove all risk from human-capital decisions, and how PNC Bank applied actuarial principles to its incentive systems to achieve greater balance.

Actuarial risk frameworks are just one of many systems that take a balanced approach to risk and can be applied to human capital. How can you insure a more balanced perspective to human-capital risk? Try applying your best management models to human-capital decisions. The table below describes typical human-capital decisions that are framed as risk prevention, and shows how frameworks from other management arenas can “retool” the HR decisions for a more balanced approach.

1402_RetoolingHCRisk_v3

As the world becomes increasingly fearful of risk, you’ll be under pressure to manage your human capital to protect you if something going wrong. Prudent risk optimization requires balancing that by asking, “What if something goes right?”

John Boudreau is professor and research director at the University of Southern California’s Marshall School of Business and Center for Effective Organizations, and author of Retooling HR: Using Proven Business Tools to Make Better Decisions About Talent. He can be reached at editor@talentmgt.com.

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