How to manage key-person risk

January 11, 2019

By Anslee Wolfe at Financial Management on January 3, 2019

Employees with skills that are uniquely valuable to a company’s success are worth their weight in gold, but what happens when they leave, taking that institutional knowledge with them?

Relying on key individuals carries risks that, if not properly managed, may cripple profits, productivity, and confidence among remaining employees. Also at stake is the company’s image, which is particularly critical for those that rely on earning and keeping trust.

“Key-man risk can sink you,” said Chris Donegan, CEO of strategy consulting company Invention Capital Associates and chief risk officer at wealth management firm Hywin Wealth, both London-based. “You can benchmark and mitigate operational risk, credit risk, market risk, and legal risk. But key-man risk is something else entirely.” It’s considered one of the hardest risks to mitigate.

A 2018 report by Morgan Stanley Research found that big banks and asset managers are among the most vulnerable to key-person risk within the S&P 500 companies on the US stock market because of “a particularly high concentration of key individuals”. Analysts looked at the risks of having a hugely important executive — such as a CEO — suddenly depart, an occurrence which, they say, is on the rise: In 2017, 59 CEOs, or 12% of the total, left their S&P 500 company, which is the highest level of CEO turnover within this group since 2006.

The report cautions investors to be aware that such change can “meaningfully impact shareholder value”. When researchers analysed the CEO departures in 2017, they found those companies underperformed the rest of the market by an average of 11% during the following 12 months — with 32% of them underperforming the rest of the market by more than 20%.

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