Opportunity Costs of Risk Analysis

Merck’s Art Misyan, currently Director, Financial Evaluation and Analysis at the company and a longtime practitioner of risk analysis and decision evaluation, has offered some cogent comment in response to my blog about the calculating the opportunity costs of risk analysis in making decisions under uncertainty:
"In the Vail Daily News comment, they refer to the cost of being the second entrant.  The impact of losing your innovative advantage can be somewhat quantified in a sales forecast, for example: if our launch is delayed, or if we are no longer the first entrant, then there is an EPS impact of $X.
For day-to-day risk management activities, quantifying opportunity costs is more challenging.  Sometimes the best decision is the one you didn’t make, and other times it costs you either in ongoing transaction costs, deal premiums, etc.  For example, transaction costs can rise if the markets become more illiquid over the course of a trading day (say you’re trying to trade Far East currency, but now it’s late in the day Eastern Standard Time).  Or, if you are executing a large-sized deal but don’t place the order until late in the day – and the trade has to happen.  So, hypothetically, you could calculate the impact of transaction costs, based upon average deal size and bid/offer spread at a time of day.
As a finance representative on the deal team, you are trying to help management arrive at quick decisions with the best available information, while understanding the potential risks. You don’t want to be the "speed bump" in the process (again, very difficult to quantify).  As part of the economic analyses, we summarize as many risks as possible, as well as a list of potential events that could impact our assessment.  After management has reached a decision, we will revisit the numbers if or when these events occur over the course of the due diligence process."

Words from the wise to the wise.

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