A recent KPMG survey of executives in large companies across the world has confirmed the findings of other recent surveys by PriceWaterhouse and Lehman Brothers: executive teams are significantly under-prepared for handling the risks associated with climate change. In fact, less than a quarter of these executives said that their companies had any plans at all for handling the effects of climate change on their businesses. The KPMG authors comment that this is an example of a general shortfall in corporate risk management: dealing with so-called ‘tail risks’.
This phrase refers to the assumptions made in most quantitative models that deal with risk. These models almost always use probability theory based on the Gaussian curve–the normal distribution. This bell-shaped curve, as everybody knows, falls sharply away from its peak frequencies as it moves away from the mean. That implies that highly unusual events will occur with vanishingly small frequencies. In fact, there is a growing view that this doesn’t model our world particularly well. Unusual events seem to occur more often, and to have very large, system-wide effects, than probability theory suggests. Another description of this phenomenon is known as ‘fat tails’–a reference to the shape of the distribution curve when extreme events are modelled as being more probably than the normal distribution curve.
A highly readable, if somewhat arrogant, account of this view can be found in Nassim Nicholas Taleb (2007) The Black Swan, Allen Lane Penguin, New York.
Summary of the KPMP Report link here.