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Open Homework Posted by: arwaabdullah Posted on: 18/09/2020 Deadline: 2 Day

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first discussion:

Consider the following article: L.1.P1.File 1.pdf That i have attached 

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Given the distinction between risk and uncertainty, what do you think happened to consumption demand by American households when plans/proposals for CARES Act 2020 passage were first announced, if we are to assume that:

  1. Households perceived the prospect of the passage of the CARES Act to be a risky event (they had some expectations of probability of the Act passage into law), as opposed to 
  2. Households perceived the prospect of the passage of the CARES Act to be an uncertain event (they formed no prior expectations of probability of the Act passage)?

Do you think households increased their consumption spending in anticipation of the Act passage under (1) above, or decreased their consumption spending in anticipation of the Act passage under (2)?

Note: we can think of increased consumption prior to Act passing as an event of households cashing-in on their advance insurance policy (income supports under the Act), while we can think of decreased consumption prior to Act passing as an event of households insuring themselves against income loss by 'saving' funds promised in the Act prior to its passage for future use.


Second discussion:

Two papers on CEO compensation structure and firm risks:

Minor, Dylan (2016), "Executive Compensation and Misconduct: Environmental Harm", available at https://corporate-sustainability.org/wp-content/uploads/Executive-Compensation-and-Misconduct.pdf (Links to an external site.)

and

Chircop, Justin and Tarsalewska, Monika and Trzeciakiewicz, Agnieszka, (2020), "CEO Risk Taking Equity Incentives and Workplace Misconduct" (July 20, 2020), available at 

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3511638

Note: in looking at these papers, please read papers' Introduction and Conclusions sections. You do not need to read the specifics of econometric analysis and modeling, unless these are of interest to you, personally.

Both papers indicate that empirical evidence supports the proposition that CEO incentives materially impact firm-level operational risks, hazard risks and strategic risks. on the other hand, risk-taking incentives for CEOs are also seen by investors as tools for mitigating some financial risks (e.g. driving up longer term returns and increasing firm commitments to innovation and investment. Insurance providers often see the amelioration of financial risks as warranting reduction in overall insurance premiums charged on the firm, but ignore increases in strategic risks and operational risks. The reason for this is that financial rewards from increased risk-taking by the CEOs may arise on a different timing from the adverse risk impacts on operational and strategic risks. 

How does this evidence fit with the distinction between risk and uncertainty we discussed in the VUCA context?

Do you think longer term contractual relations between firms and their insurance providers can mitigate this problem of differential timings between financial gains and operational and strategic shocks?

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Attachment 1


16/08/2020 Difference Between Risk And Uncertainty - Business Insider

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HOME STRATEGY CONTRIBUTORS

Few People Understand The Di�erence Between Risk And Genuine Uncertainty Tim Kastelle, Innovation For Growth Mar 27, 2013, 7:38 AM

What are the odds that your new idea will succeed? If it

does, what will the return to you be?

One of the problems that we have in business (and life!) is

that we often can’t know the answer to questions like this in advance. And this drives us nuts. Consequently, a lot of

people invest a great deal of e�ort into reducing

uncertainty. There are two problems with this approach.

The �rst is that we often don’t understand uncertainty very well, and the second is that pro�tably opportunities

only exist where outcomes are genuinely uncertain.

Frank Knight wrote about this in 1921 in a great book

called Risk, Uncertainty and Pro�t (which you can

read here). He distinguished between two types of

uncertainty. The �rst type is when we know the potential

outcomes in advance, and we may even know the odds of

these outcomes in advance. Knight calls this type of

uncertainty risk.

An example of risk is rolling a pair of dice. Before we roll,

we know in advance what the odds are for each possible

outcome (provided that the dice are fair). Knowing these

odds forms the basis for all of the games of chance that we

can play. Dice are relatively simple, cards a bit more

complicated, but we can know all of the odds with them in

advance.

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Genuine uncertainty is di�erent. This occurs when we

don’t even know the possible outcomes in advance, let alone their probabilities. Genuine uncertainty occurs in

complex systems, where lots of actors interact over time – the economy, for example.

The important point that Knight makes is this: real

opportunities for pro�t only exist in the face of

genuine uncertainty. Which means that if we want to

innovate successfully, we not only have to deal with

uncertainty, we must seek it out.

The Problems of Uncertainty

We’re not the most rational decision-makers in the �rst place, and confusing uncertainty with risk makes things

worse. Here’s how:

We act like everything is just a risk. Here is how Knight

puts it:

Business decisions, for example, deal with situations which are far too unique, generally speaking, for any sort of statistical tabulation to have any value for guidance. The conception of an objectively measurable probability or chance is simply inapplicable. The confusion arises from the fact that we do estimate the value or validity or dependability of our opinions and estimates, and such an estimate has the same form as a probability judgment; it is a ratio, expressed by a proper fraction. But in fact it appears to be meaningless and fatally misleading to speak of the probability, in an objective sense, that a judgment is correct.

When we act like everything is a risk, we greatly increase

the chance of failure. However, the opposite can also be a

problem:

We act like everything is unknowable. Uncertainty

often gets blamed for inaction. Barry Ritholtz takes aim at

the problems with this:

It �nally dawned on me what the uncertainty trope is all

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Microsoft salaries revealed: The highest-paying job titles at the $1.58 trillion tech titan, paying as much as $336,290

about. It took a conversation with a nervous chief executive to reveal it, but I teased out the answer.

Most of the time, people exist in a happy little bubble of self-created delusion. We engage in selective perception, seeing only the things that agree with us. Our selective retention retains the good stu� and disregards most of the

rest. In our minds, we are all younger, better-looking, slimmer, with more hair than the camera reveals.

In short, we construct a reality that bears only passing resemblance to the objective universe.

During those brief instances when the facade fades, the curtain gets pulled back and the ugly reality becomes clear. We get a glimmer of understanding about our own lack of understanding. That’s when the grim reality of the human condition is revealed — and it terri�es us.

The next time you hear someone mention uncertainty, ask yourself this: How much less do they actually know about the future today vs. what they knew last week or year? How much less do they think they know?

We can’t use not knowing as an excuse to not act – because we never know.

It seems like we either suppress uncertainty, and act

overcon�dently, or we overemphasize uncertainty, and

don’t act at all. Both are bad outcomes.

How to Respond to Genuine Uncertainty

Managing risk is pretty straightforward. You match up

your investment to the odds of it paying o�. Managing

uncertainty is trickier.

Fortunately, there are a few things that we can do. It’s important to cope with uncertainty e�ectively, because

doing so allows us to go where the opportunities are. Here

are some strategies:

1. Aggregate. When I get in my car to drive to work

tomorrow, it’s impossible to know if I’ll have an accident or now. And yet I have car insurance. How can this be?

Insurance works because when you add up enough

individual cases of uncertainty, you might end up with

probabilities.When we’re talking innovation, this means that Linus Pauling was exactly correct when he said that

the best way to have a great idea is to have a lot of ideas.

Volume can reduce uncertainty. This is what venture

capital �rms do too when they make a wide range and high

number of investments.

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2. Seek out uncertainty to increase the chance of

hitting it big. If you enter the lottery, the odds of winning

are higher than the payout – it’s a sucker bet. Innovation is the opposite – the odds of winning are lower than the payout – it’s a positive feedback loop. Taking advantage of this is a smart play. This is the process of looking for

positive outliers.

Understand that when we face uncertainty, some

ideas will fail. But this is what drives progress. William

Janeway has an interesting take on this in his book Doing

Capitalism in the Innovation Economy:

Schumpeter’s process of creative destruction can only proceed by trial and error. We see that which is created

through the lens of survivors’ bias and ignore the “hopeful monsters” that economic evolution has spawned and left behind in metaphorical emulation of Darwin’s process of natural selection. No doubt every one of them was

launched on the basis of an exercise in forecasting future

revenues, costs and an expected value to be compared with

a rough estimate of the cost of capital. As Schumpeter well

knew, the wastage is the measure of the inescapable

uncertainty that attends the practice of doing capitalism:

We need only visualize the situation of a man who would … consider the possibility of setting up a new plant for the

production of cheap airplanes which would pay only if all

people who drove motorcars could be induced to �y. The

major elements in such an undertaking simply cannot be

known … Neither error nor risk expresses adequately what we mean.

Waste measures uncertainty!

It’s important to understand the distinction between risk and uncertainty. The two situations require di�erent

responses – and if we confuse the two, we won’t use the right approach.

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International Editions:

And that really increases the risks we face!

Now Read: Trying To Be Certain About Everything Kills

Great Ideas

Read the original article on Innovation For Growth.

Copyright 2013.

MORE FROM INNOVATION FOR GROWTH:

The Power of Purposeful Innovation

Taking a Long Term View During Turbulent Times

Technological Revolutions and the Governance Gap

Are You Working On the World’s To-Do List?

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