What we can learn about risk management from Michael Jordan

I will probably write a detailed piece to define core risk management concepts including what do we mean by ‘risk’, how academics and organisations measure risk and what is the common vocabulary we might want to use for risk.

What I want to do as part of this post is to discuss our intuitions about risk and why they might be wrong.

For the sake of argument, let’s assume that a ‘risk’ is an uncertain event that, if realised, would have a negative impact on an entity (individual or organisation) and the ability of that entity to realise their desired outcomes.

To break this down into core components:

1. A universe of events
2. An entity (either individual or business), let’s call it Alpha (A)
3. A set of outcomes that A wants to achieve
4. A sub set of (1) events that, if realised, would have a negative impact on the set of outcomes Alpha has (3).

Note that the constituents of the set described in point (4) are usually both known and unknown to A i.e. I probably know that I might get hit by a car crossing the road but I definitely did not know until recently that I am at risk of getting infected by a novel Corona virus.

They are also probabilistic in terms of both likelihood and impact. There is a certain chance of event X happening — the chance of a coin landing heads is 50%. There is a certain chance of the impact of event X being small or large — if I decide to swing a samurai sword at a Van Gogh I can probably slice the entire thing or just part of it.

Some of the research on how humans perceive probability seems to suggest that we are not particularly good at conceptualising it. Thinking, Fast and Slow (a great read) is a seminal piece of research describing common heuristics and biases, a few relevant examples below:

• Anchoring — When people see lesser / greater numbers prior to answering a quantitative question they would give lesser / greater answers depending on the initial number they saw.
• Your answer to how many elephants exist on planet Earth is influenced by the number of Giraffes you read about previously.
• Framing — Our perceptions of the same issue changes depending on they way it is framed (90% success rate vs 10% failure rate).
• Overconfidence — We are generally bad at predicting outcomes and the more qualified we are the worse we perform at prediction.

Why should you care?

The reason I am quite interested in this topic is that, in a lot of cases, it is very difficult to convince people that a very unlikely event (say less than 10%) with an outsized negative outcome is worth mitigating. A few examples:

• There is 5–10% chance that an event occurs that will wipe out your business
• There is a 3% chance that it will wipe out your entire industry
• Etc.

The default heuristic that some people go to is:

If there is 10% chance that X will happen, therefore there is 90% chance that it will not

But is it really that simple?

Here comes Jordan

The best way I can describe why this is wrong comes from the world of sport and specifically the Last Dance documentary that Netflix released a few months ago now.

In the 80s Jordan had a leg injury which took him out of the third game of his second NBA season. Doctors advised him that if he continues playing there is a 10% chance that he will suffer a career-ending re-injury. Jordan wanted to play, the owners of the Bulls wanted him to be out for the rest of the season. Jerry Reinsdorf (Bulls chairman), explained the scenario as:

…You’re not thinking about the risk-reward ratio. If you had a terrible headache and I gave you a bottle of pills and nine of the pills would cure you and one of the pills would kill you, would you take a pill

To which Jordan replied, rather hilariously:

It depends on how bad the headache is

Facing six weeks of doing nothing, Jordan returned to the University of North Carolina and practiced drills without informing the Bulls.

The compromise that was reached was that Jordan will play for 7 minutes each half to ensure that the risk that he will break his foot is minimised.

To state the obvious, nothing happened and Jordan created one of the most legendary franchises in the NBA. However there is a parallel universe where Jordan played, broke his foot and the Air Jordans sadly never came into existence.

If that is not the best analogy on why should businesses make sure they put the baseline level of control they need to ensure that an ‘extinction’ level event does not happen, I don’t know what is.

Cool stuff

The Last Dance is awesome. Go watch it, if you haven’t already.

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