Explanation:
The senior management should display commitment to the RAROC system and expand in-house communication and education regarding the system. This is because RAROC is not just a common language of risk, but a quantitative technique that can be used to maximize shareholder value. It can be thought of as an internal capital market where businesses compete with each other for scarce balance sheet resources. This makes RAROC a useful tool for capital allocation, both for banks and nonbank corporations. Therefore, instead of disregarding the concerns of the local management, the senior management should take steps to educate them about the benefits and workings of the RAROC system. This would help in ensuring a smooth transition to the new system and in addressing any misconceptions or misunderstandings about it.
Choice A is incorrect. Neglecting the dissatisfaction of local management and enforcing the RAROC system at all costs may lead to further discontent and resistance, which could negatively impact the overall operations of the mines. It’s important for senior management to address concerns and provide clarity on any new systems implemented.
Choice C is incorrect. Disregarding RAROC and returning to an old risk management system may not be beneficial in the long run as it might not adequately account for risk-adjusted returns on capital. The adoption of RAROC was likely due to its ability to better manage risks associated with strategic investments, hence reverting back might expose Kimberley Excavations to higher risks.
Choice D is incorrect. Allocating resources for stricter employee monitoring does not directly address the issue at hand – dissatisfaction with RAROC’s high economic capital attribution. Instead, it could potentially create a hostile work environment by implying mistrust towards employees, which can further exacerbate existing issues.
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Q.2212 Kimberley Excavations, a diamond-mining company from South Africa, has implemented a RAROC (risk-adjusted return on capital) system for future strategic investments. Kimberley Excavations owns several diamond mines which have been showing signs of a decrease in yield, with sharp rises and drops. Management of the mines is deeply dissatisfied with the new system, complaining that RAROC is lacking fairness in attributing economic capital (EC) to their businesses – namely that the EC is too high. What is the correct course of action for senior management in this case?
A
Neglect dissatisfaction in the local management and enforce the RAROC system at all costs.
B
Display commitment to RAROC, expand in-house communication and education regarding the system.
C
Disregard RAROC and return to the old, tried and proven risk management system.
D
Allocate resources to each of the businesses for purpose of stricter employee monitoring.