Risky Business

In peacetime, you think about other people’s intentions. In wartime, only their capabilities matter. VaR is a peacetime statistic.

In financial risk management, Value at Risk (VaR) is a widely used measure of the risk of loss on a specific portfolio of financial assets.

If a portfolio of stocks has a one-day 5% VaR of $1 million, there is a 5% probability that the portfolio will fall in value by more than $1 million over a one day period, assuming markets are normal and there is no trading. Informally, a loss of $1 million or more on this portfolio is expected on 1 day in 20.

With the current economic downturn, the role, relevance, success and dangers of VaR are being hotly debated and – at least for now – Honestly Lay Bare is not going to dirty its keyboard to enter such a discussion.

What Honestly Lay Bare has found of interest in researching this entry is the history of VaR and how it came to be.

In less than a decade it appeared that we had mastered the quantification of risk!

**

The late 1980s and the early 1990s were a time when many firms were trying to devise more sophisticated risk models because the world was changing around them.

Banks, whose primary risk had long been credit risk — the risk that a loan might not be paid back — were starting to meld with investment banks, which traded stocks and bonds.

Derivatives and securitizations — those pools of mortgages or credit-card loans that were bundled by investment firms and sold to investors — were becoming an increasingly important component of Wall Street.

But they were complicated to value.

For one thing, many of the more arcane instruments didn’t trade very often, so you had to try to value them by finding a comparable security that did trade. And they were sliced into different tranches each of which had a different risk component. In addition every trading desk had its own way of measuring risk that was largely incompatible with every other desk.

**

JPMorgan’s chairman at the time VaR took off was a man named Dennis Weatherstone.

Weatherstone, who died in 2008 at the age of 77, was a working-class Englishman who acquired the bearing of a patrician during his long career at the bank. He was soft-spoken, polite, self-effacing.

At the point at which he took over JPMorgan, it had moved from being purely a commercial bank into one of these new hybrids.

Within the bank, Weatherstone had long been known as an expert on risk, especially when he was running the foreign-exchange trading desk. But as chairman, he quickly realized that he understood far less about the firm’s overall risk than he needed to.

Did the risk in JPMorgan’s stock portfolio cancel out the risk being taken by its bond portfolio — or did it heighten those risks? How could you compare different kinds of derivative risks? What happened to the portfolio when volatility increased or interest rates rose? How did currency fluctuations affect the fixed-income instruments?

Weatherstone had no idea what the answers were. He needed a way to compare the risks of those various assets and to understand what his companywide risk was.

The answer the bank came up with was Value at Risk.

To phrase it that way is to make it sound as if a handful of math whizzes locked themselves in a room one day, cranked out some formulas, and — presto! — they had a risk-management system.

In fact, it took around seven years, according to Till Guldimann, a former JPMorgan banker who ran the team that devised VaR and who is now vice chairman of SunGard Data Systems.

“VaR is not just one invention,” he said. “You solved one problem and another cropped up. At first it seemed unmanageable. But as we refined it, the methodologies got better.”

Early on, the group decided that it wanted to come up with a number it could use to gauge the possibility that any kind of portfolio could lose a certain amount of money over the next 24 hours, within a 95 percent probability.

That became the core concept. When the portfolio changed, as traders bought and sold securities the next day, the VaR was then recalculated, allowing everyone to see whether the new trades had added to, or lessened, the firm’s risk.

“There was a lot of suspicion internally,” recalls Guldimann, because traders and executives — nonquants — didn’t believe that such a thing could be quantified mathematically. But they were wrong. Over time, as VaR was proved more correct than not day after day, quarter after quarter, the top executives came not only to believe in it but also to rely on it.

For instance, during his early years as a risk manager, pre-VaR, Guldimann often confronted the problem of what to do when a trader had reached his trading limit but believed he should be given more capital to play out his hand.

“How would I know if he should get the increase?” Guldimann says. “All I could do is ask around. Is he a good guy? Does he know what he’s doing? It was ridiculous. Once we converted all the limits to VaR limits, we could compare. You could look at the profits the guy made and compare it to his VaR. If the guy who asked for a higher limit was making more money with lower VaR” — that is, with less risk — “it was a good basis to give him the money.”

By the early 1990s, VaR had become such a fixture at JPMorgan that Weatherstone instituted what became known as the 415 report because it was handed out every day at 4:15, just after the market closed.

It allowed him to see what every desk’s estimated profit and loss was, as compared to its risk, and how it all added up for the entire firm.

Weatherstone had been a trader himself; he understood both the limits and the value of VaR. It told him things he hadn’t known before. He could use it to help him make judgments about whether the firm should take on additional risk or pull back. And that’s what he did.

What caused VaR to catapult above the risk systems being developed by JPMorgan competitors was what the firm did next: it gave VaR away.

In 1993, Guldimann made risk the theme of the firm’s annual client conference.

Many of the clients were so impressed with the JPMorgan approach that they asked if they could purchase the underlying system. JPMorgan decided it didn’t want to get into that business, but proceeded instead to form a small group, RiskMetrics, that would teach the concept to anyone who wanted to learn it, while also posting it on the Internet so that other risk experts could make suggestions to improve it.

As Guldimann wrote years later, “Many wondered what the bank was trying to accomplish by giving away ‘proprietary’ methodologies and lots of data, but not selling any products or services.” He continued, “It popularized a methodology and made it a market standard, and it enhanced the image of JPMorgan.”

In the late 1990s, as the use of derivatives was exploding, the Securities and Exchange Commission ruled that firms had to include a quantitative disclosure of market risks in their financial statements for the convenience of investors, and VaR became the main tool for doing so.

Around the same time, the Basel Committee on Banking Supervision, went even further to validate VaR by saying that firms and banks could rely on their own internal VaR calculations to set their capital requirements.

JPMorgan later spun RiskMetrics off into its own consulting company.

By then, VaR had become so popular that it was considered the risk-model gold standard.

The month RiskMetrics went out on its own, September 1998, was also when Long-Term Capital Management “blew up.”

L.T.C.M. was a fantastically successful hedge fund famous for its quantitative trading approach and its belief, supposedly borne out by its risk models, that it was taking minimal risk.

It had been an early and high profile adopter of VaR.

Post based on Risk Mismanagement by Joe Nocera New York Times January 4, 2009

The Brain Atlas

Atlas Sive Cosmographicae Meditationes De Fabrica Mundi
Translation: Atlas, or Description of the Universe. Duisburg, 1585-1595

What can the owner of the NFL’s Seattle Seahawks; the NBA’s Portland Trail Blazers and MLS’s Seattle Sounders FC teach the world of independent assurance?

Turns out – quite a bit and in a way that will surprise.

The owner of the said United States sport franchises is Paul Allen – also known as the co-founder of Microsoft; the 41st richest person in the world.

As interesting as it would be to turn Honestly Lay Bare into a biographical study of a 56 year old guy we have resisted the temptation.

What interest us is his philanthropy – and precisely the Allen Institute for Brian Science.

Allen founded the Institute in 2003 as a nonprofit corporation and medical research organization.

The first explicit goal of the Institute was to create an open-access, visual, searchable online map of genes expressed in the brain, as well as of brain circuitry and cell location.

Roughly one petabyte of data - equal to the memory necessary to hold the information held in about 50 Libraries of Congress - was produced as a result.

Utilizing the mouse model system (given its great similarity to human DNA), 20,000 genes in the adult mouse brain were mapped to a cellular level for the Allen Brain Atlas (http://www.brain-map.org/).

Did you miss the important piece of information?

Read the last three paragraphs again.

“An open-access, visual, searchable online map” … yes … the data generated from this massive effort is free and publicly available.

This freeware is available in a profession – and an area of study – that has until now tightly held its intellectual property so as to ensure a near monopoly on extracting value.

But no more.

Here is the first ever atlas of the brain and it is free to anyone – scientist or non scientist alike – that wants to use it.

A vital part of the project – taking up some one-third of the total budget – was developing software that allowed scientists to rapidly search and analyze the massive database.

Using these programs, all freely available on the brain map Web site, scientists can make a few mouse clicks to achieve what used to take months of experimentation.

More than 250 researchers use the Web site on a daily basis.

**

The idea of an open source Atlas got Honestly Lay Bare thinking.

Why cannot the same cartographical effort be undertaken to map the neurons of business.

Allow yourself to imagine a world of assurance where there was some form of legislative imperative that all business had to declare their internal control deficiencies to a central repository (the brain – so to speak) and there was a consistency of presentation of the issues (the atlas – so to speak).

How would it benefit independent assurance?

Well for starters all the issues that are ever likely to confront a normal business (even one under great distress) would be mapped out for you.

To use an atlas analogy – all the prospecting is done.

What it would allow you to do is to focus not on the symptoms of a poor control environment but to unravel the mysteries of the causes of a poor control environment.

Secondly it would transform the role of independent assurance into one of a discoverer rather than that of a policeman (even if we have long since seeing ourselves as the latter).

**

Imagine the day that an independent assurance report details not only the issues; not only the process improvement opportunities but where the deficiencies sit within the broader spectrum of the business world.

Therein you have independent assurance providing unarguable value and we will have conquered forever our own mountain of agnotology.

Anatomy of an Orator

To mark the Inauguration of the 44th President of the United States of America, Honestly Lay Bare is taking leave of its regular publishing schedule.

We the people

Honestly Lay Bare has always said that it would retire the day that it writes the perfect sentence.

The sentence that encapsulates everything that the writer wanted to say.

The sentence that encapsulates everything the writer needed to say.

The sentence that encapsulates everything the reader wanted to hear.

The sentence that encapsulates everything the reader needed to hear.

In that sense, the journey that anyone interested in internal audit, risk management and corporate governance is really a journey of words.

We interested in the art of the profession we practice seek out the right words for the right moment for the right audience for the right impact.

Tomorrow - as Barack Obama declares before the world that he will preserve, protect and defend the Consitution of the United States - it is worth taking time out to consider the lessons that can be learnt from the modern day man of words.

**

Barack Obama was not a politician when, at the age of 34, he wrote Dreams from My Father (1995).

He was just out of law school and had been invited to write a memoir after becoming the first black president of the Harvard Law Review.

The book emerged to friendly reviews, sold unremarkably and fell out of print. It’s a personal book, apparently unguarded. In it, he describes his memories of the month he had spent, as a schoolboy, with the father who had lived for most of his life on another continent. The chief thing that struck the child about his father was the way he spoke.

“Whenever he spoke ... his large hands outstretched to direct or deflect attention, his voice deep and sure, cajoling and laughing – I would see a sudden change take place in the family ... It was as if his presence had summoned the spirit of earlier times.”

Obama made his first political speech as a very young man. At university in Los Angeles, he had become involved in student politics and he was called on to introduce a small anti-apartheid rally. It was a crowd, as he describes it, of “a few hundred restless after lunch” – with a couple of half-interested students playing frisbee to one side. Yet as he waited to speak, he recalled “the power of my father’s words to transform. If I could just find the right words, I had thought to myself. With the right words everything could change – South Africa, the lives of ghetto kids just a few miles away, my own tenuous place in the world.” He mounted the stage, he writes, “in a trancelike state”.

On Tuesday, Barack Hussein Obama will make the most important speech of his life.

His audience will not be a couple of hundred students idling on a college campus. Instead, he will address millions of people around the world and speak, for the first time, as the 44th president of the United States of America.

With the right words, everything did change. Speaking in public seems to be both a personal need and a political creed for Obama. He is not just a fine orator: he is consciously putting oratory at the centre of his political being – and in so doing seeks to embed himself in a vital American tradition.

The history of the American republic is one that can be traced through its rhetoric: “Four score and seven years ago our fathers brought forth on this continent ... ”; “We shall overcome”; “Ask not what you can do for your country ... ”; “Ich bin ein Berliner”; “I have a dream”; “It’s morning in America”.

The greatest presidents have tended to be remembered as the greatest speakers. In modern public life, of course, politicians are able to draw on the services of whole teams of speechwriters. But it’s unthinkable that a politician of Obama’s background – his skills in the persuasive arts honed as a community organiser and political activist in Chicago; polished in the debating halls and lecture theatres of Harvard – would simply read from someone else’s script.

The written style of Obama’s books – mellifluous, nuanced – is consonant with the baseline language of his higher-flown speeches. It is reasonable to assume that Obama takes a very close interest in the language and content of his speeches and that he has worked with his speechwriters to ensure they capture, so to speak, the better angels of his literary style.

As lawyer, lecturer and politician, Obama’s “certain talent for rhetoric” (as he describes it himself in his second, bestselling memoir of 2006 The Audacity of Hope ) has been what propelled his rise. And his speeches are filled, thrillingly, with highly formal rhetoric of the sort that would be recognisable to ancient philosophers and scholars of the medieval trivium – in which rhetoric, along with grammar and logic, formed one third of an education. He absolutely pours it on. What Obama’s doing is as old as Aristotle – whose Rhetoric set out the ground rules for the art of persuasion four centuries before the birth of Christ.

“Ethos” was the name Aristotle gave to that part of rhetoric that establishes the speaker’s bona fides. “Logos” – or the actual argument – was only one among three of the persuasive appeals; “pathos” – manipulating the audience’s emotions – was just as important. Think of it this way. Ethos: “Buy my old car because I’m Jeremy Clarkson.” Logos: “Buy my old car because yours is broken and mine is the only one on sale.” Pathos: “Buy my old car or I’ll twist the head off this kitten.”

The formal terms used to describe rhetorical figures haven’t changed because the figures haven’t changed. They still work the same way on the human ear and the human heart as they did in Aristotle’s day.

Take the “tricolon”, for example – three terms in ascending order such as “I came, I saw, I conquered”; or, to borrow an instance from American rather than Roman history, Lincoln’s second inaugural with its line “with malice toward none, with charity for all, with firmness in the right ... ” This is perhaps the most famous rhetorical figure, other than the so-called “rhetorical question”, and Obama, like most politicians, is addicted to it.

Indeed, he often builds his tricolons out of the balanced doubles known in formal rhetoric as syntheton (“men and women”, “colour and creed”, “young and old”, and so forth) that fill his sentences. Last July, in a speech before 100,000 people at the Victory Column in Berlin – walking pointedly in the footsteps of JFK – he said: “As we speak, cars in Boston and factories in Beijing are melting the ice-caps in the Arctic, shrinking coastlines in the Atlantic, and bringing drought to farms from Kansas to Kenya.”

A double (“Boston” and “Beijing”), leading to a tricolon whose third term is itself doubled up, the whole mixture thick with alliteration. This is very far from informal or direct or off-the-cuff speech. It is marvellously and intentionally musical.

TS Eliot said something to the effect that the meaning of a poem was merely something the poet used to distract the reader while the poem did its true work upon him. You might say something similar about political rhetoric. And as rhetoricians from Aristotle down have recognised, the mode and shape of address are vital to its persuasive force. Much of the work of political rhetoric depends on what it sounds like – or, if you want to be technical, how it scans.

Think of the steady, obdurate thump of stresses in Churchill’s wartime invocation of “blood, toil, tears and sweat”; or the perfect musical rightness of the opening line of the main part of the US Declaration of Independence. “We hold these truths to be self-evident” is a perfectly cadenced iambic pentameter.

Obama’s winning slogan, “Yes we can,” draws much of its strength from its three stressed syllables. It is a metrical object called a molossus – thump, thump, thump; as in Tennyson’s “Break, break, break” or Seamus Heaney’s “squat pen rests”. You could, arguably, scan it as an anapaest (diddy dum) but our boy certainly doesn’t. The official transcript of his speech at the New Hampshire primary punctuates it thus: “Yes. We. Can.”

Repetition, particularly in the form of anaphora – where a phrase is repeated at the beginning of successive lines – is another of the prime tools of political oratory and one that Obama revels in. His speech at the Iowa caucus on January 3 2008 opened: “You know, they said this time would never come. They said our sights were set too high. They said this country was too divided, too disillusioned to ever come together around a common purpose.”

He went on to declare: “I’ll be a president who finally makes healthcare affordable ... I’ll be a president who ends the tax breaks ... I’ll be a president who harnesses the ingenuity ... I’ll be a president who ends this war in Iraq ... ” Then: “This was the moment when ... this was the moment when ... this was the moment when ... ” And, as his speech built to its climax, “Hope is what I saw ... Hope is what I heard ... Hope is what led a band of colonists to rise up against an empire.”

To an American literate in his own country’s history, Obama’s rolling repetitions will bring consciously or unconsciously to mind the Declaration of Independence. The run of charges against King George in that document rolls out in an unstoppable anaphoric fugue. “He has refused ... He has forbidden ... He has refused ... He has called together ... He has dissolved ... He has refused ... ”

But the acute listener will also hear in Obama’s oratory a deeper and older rhythm: the strophic structure and the parallelisms of psalms in the King James version. And that flows into his language through another tributary: the rhetoric of the civil rights movement born and nurtured in the Baptist churches of the American south.

Obama sets out to position himself, and his rhetoric positions him, as the inheritor of the oratorical and political traditions of Abraham Lincoln, Martin Luther King, and Jesus Christ. That last sounds facetious, perhaps, but it isn’t entirely intended to be.

On two of the occasions – at the declaration of his candidacy in Springfield, Illinois, and on the night of the New Hampshire primary – he refers to Dr King, he puts him in an expressly Biblical passage: “A King who took us to the mountaintop and pointed the way to the Promised Land”; “We heard a King’s call to let justice roll down like water, and righteousness like a mighty stream.”

There is a strong sense of Obama locating himself in history – not so much of the past couple of decades but millennial. One of his early campaign catchphrases was, “There is something happening in America.” He’d talk about “unyielding faith”, “impossible odds”, “the voices of millions”. He’d urge crowds to recognise that “this was the moment” – that past tense giving the curious sense of already looking back on the moment, of being in and out of time; as well as burnishing the sense that the decision has already been taken. If you share Obama’s faith, as many Americans do, that’s by no means a paradox.

The great double movement of his election night speech in Chicago on November 4 is expansion: from the local to the national to the global; from the moment to the grand arc of history.

Anchoring the final section of the speech in the life of 106-year-old Ann Nixon Cooper, he moves through the 20th century to the present, and from the segregated south to the moon.

Obama’s other dominant oratorical influence, Lincoln, encapsulates a separate strand in his self-presentation. Declaring his candidacy on February 10 2007 in Springfield – pointedly, he chose to launch his campaign in the town where the great 19th-century champion of the union practised law – Obama began by talking about what the life of “a tall, gangly, self-made Springfield lawyer tells us”. “He tells us that there is power in words. He tells us that there is power in conviction ... He tells us that there is power in hope.” He talked about how Lincoln achieved change through “his will and his words”.

In his election night speech, Obama returned to Lincoln, channelling his appeal “to a nation far more divided than ours”: “though passion may have strained it, it must not break our bonds of affection.” In The Audacity of Hope, he writes that to abandon our values would be “to relinquish our best selves”, echoing Lincoln’s celebrated invocation in his first inaugural of “the better angels of our nature”.

For, as well as being the conciliator after civil war, the emancipator of black slaves and the architect of a new nation, Lincoln was a fellow lawyer.

And the basic substrate of this other gangly Illinois lawyer’s speeches is the language of a clever advocate thinking on his feet, a Harvard debating champ and lecturer. His language is littered – not just for euphony but to give the impression of striving for the right word, the exact idea – with parallels, mock hesitations, qualifications.

As we have seen, he seldom uses one word when a balanced pair will do.

Like all the best orators, he at times affects to mistrust rhetoric, remembering perhaps the points in his dorm-room debates as a student – described self-reproachingly in Dreams from My Father – “where I stopped thinking and slipped into cant”.

The lawyer in Obama dovetails with the preacher. The legal instruments of the US constitution are invested, for Obama, with a sort of sanctity.

And the language of the Founding Fathers is so deeply plumbed into the American unconscious, he wrote in The Audacity of Hope, that when he was teaching law at Harvard, “Sometimes I imagined my work to be not so different from the work of the theology professors who taught across campus – for, as I suspect was true for those teaching scripture, I found that my students often felt they know the constitution without having really read it.”

Obama borrows one of Lincoln’s most effective rhetorical tricks too – the sudden drop in register to plain style. The folksiness of Obama’s injunction, delivered on the night of the New Hampshire primary, “to disagree without being disagreeable” is straight from the Lincoln who talked about “cheerfully” giving protection to the states in his first inaugural. Obama described in The Audacity of Hope watching in person the way that, at the podium, George Bush’s “easy affability was replaced by an almost messianic certainty”. Obama, you could say, strives for a sort of messianic affability.

During the election campaign, various Republican outriders publicly sneered at Obama for precisely his facility as a speaker. The former Republican senator Rick Santorum called him “a person of words”, and political activist Phyllis Schlafly – amusingly identified by The New Yorker’s James Wood as “a leathery extremist” – dubbed him “an elitist who worked with words”. This attempt to parlay George Bush’s inarticulacy into an electoral virtue played perfectly into his opponent’s hands.

Formal oratory, as the fiercely well-educated president-elect knows, was the foundation stone of American democracy.

And unless I miss my guess, we’re going to see quite something at his inauguration.

***

For all our sakes, may he be a great President.

(Discussion of Obama's speaking style - A Man of his Words - Financial Times by Sam Leith - Saturday 17th January 2009)

Otto Rohwedder's Invention

Honestly Lay Bare today salutes the inventor of the sliced bread maker and his contribution - until today unrecognised by anyone ... not even himself - in the development of the risk advisory profession.

Otto Rohwedder of Iowa invented the first loaf-at-a-time bread-slicing machine.

A prototype he built in 1917 was destroyed in a fire, and it was not until 1928 that Rohwedder had a fully working machine ready. The first commercial use of the machine was by the Chillicothe Baking Company of Missouri, which produced their first slices on July 7, 1928.

St. Louis baker Gustav Papendick bought Rohwedder's second bread slicer and set out to improve it by devising a way to keep the slices together at least long enough to allow the loaves to be wrapped. After failures trying rubber bands and metal pins, he settled on placing the slices into a cardboard tray.

The tray aligned the slices, allowing mechanized wrapping machines to function.

As an aside, during 1943, U. S. officials imposed a short-lived ban on sliced bread as a wartime conservation measure.

**

What does this have to do with risk?

Is this another feeble attempt by Honestly Lay Bare to link two topics that have no real linkage?

Could it be that sliced bread has NO connection with risk (other than the danger of cutting one's fingers off)?

Thankfully - at least for the purposes of this blog entry - there is a linkage.

**

Rohwedder took one of the oldest prepared foods - dating back to 10,000 BC - and represented it in such a way as to increase its usefulness and save the end user time that would have otherwise been spent slicing each and every piece of bread.

Correlate that now to the world of risk advisory.

Risk is not a new phenomenon (older than even bread) just as bread wasnt a new food when Rohwedder came onto the scene.

Nor is advising on those risks a fee generating service invented in recent times just as the profession of baking had long existed to satisfy hungry consumers.

Just as the bread consumers of the 1920s were aware of the many uses of bread, businesses are acutely (or at least should be) aware of their risks.

So in that sense advising on what risks they have is of limited benefit.

The true benefit of risk advisory is exactly what Rohwedder did for bread.

He repackaged it.

Just as Rohwedder was not a baker; risk advisors are not the owners of the risks on which they advise.

Risk advisory exists - in good times and bad - because there will always be a need for Management to have an independent assessment of the risks (dough ... excuse the cutting edge humour!) they are making.

There is always a need for someone to repackage risk in a way that improves the usefulness of that information for the end consumer.

So in that moment just before you next criticise a risk advisor for telling you what you already know ask yourself - did you similarly complain the last time you had a piece of sliced bread?

Wheels Up

Errare humanum est - to err is human
Plutarch, c.100 AD

Like the best of us, Honestly Lay Bare has been known to fall into the trap of assuming that only recent events / studies are worthy of discussing and that the passage of time corrodes the usefulness of dated data analysis.

Never could this be further from the truth in this case of a study released 15 years ago.

The study still holds valuable lessons not only in terms of its subject matter – the causes of aircraft accidents – but in the way that assurance providers can, and should, seek to add value by providing interested spectators with a deeper level of understanding of root cause failures.

The study is by the National Transportation Board (NTSB) – an independent United States Government agency responsible for civil transportation accident investigation. In this role the NTSB investigates and reports on aviation accidents and incidents, certain types of highway crashes, ship and marine accidents, pipeline incident and railroad accidents.

The January 1994 study was titled A Review of Flightcrew-Involved Major Accidents of US Air Carriers, 1978 Through 1990 (reference: Safety Study NTSB/SS-94/01, 1994).

Honestly Lay Bare takes no responsibility – if after reading this entry – you never want to fly again or you unnecessarily delay the ontime departure of a flight whilst you check the bona fides of the flight crew.

**

The study analysed 37 accidents.

The captain was the flying pilot and the first office was the non-flying pilot in more than 80% of the accidents

73% of the accidents occurred on the first day the captain and the first officer had flown together.

Within that set, 44% of the accidents occurred on the first flight together for the captain and the first officer.

55% of the accident flights had departed late or were operating behind schedule prior to the accident.

Half the captains had been awake for more than 12 hours prior to their accidents, and half the first officers had been awake more than 11 hours.

Crewmembers who had been awake longer than these median values made more errors overall and specifically more procedural and tactical decision errors, than did the crewmembers who had been awake for less time.

43% of the accidents occurred between 2pm and 9.59pm local time; 30% occurred between 10pm and 5.59am the next morning and 27% occurred during the period 6am to 1.59pm.

The majority of the accidents occurred either during takeoff (27%) or landing (51%).

**

That is the context.

Now the really interesting part from the perspective of anyone ever interested what can go wrong when the fundamental elements of a strong internal control environment – procedure compliance; communication; monitoring – are missing.

Of the 302 specific errors identified in the 37 accidents, the most common were related to procedures, tactical decisions and failure to monitor or challenge another crewmember’s error.

Monitoring / challenging failures occurred in 31 of the 37 accidents.

The type of error most frequently unchallenged was a captain’s tactical decision that was an error of omission.

**

We therefore have a situation where planes crashed because there were poor information and communication protocols within the cockpit.

Worse still – for whatever reason – there appeared to be some sort of hierarchy in the cockpit which left poor decisions by the most senior person (the captain) unchallenged.

We can dismiss such findings as relevant to aircraft crashes alone.

We do so at our own folly.

How many times has a poor decision within an organisation gone unchallenged solely on the grounds that the most senior person in the room (or the company) has expressed it.

Honestly Lay Bare has always thought that there is a key element missing from a strong internal control framework.

Alongside tone at the top; risk assessment; policy and procedures; information and communication; monitoring we should add another pillar – that of courage.

How many accidents could have been averted – and how many companies could have been saved – had those who knew that something was amiss had the courage to say so.

Broken Windows

If the windows are not repaired, the tendency is for vandals to break a few more windows.

Consider a building with a few broken windows.

If the windows are not repaired, the tendency is for vandals to break a few more windows.

Eventually, they may even break into the building, and if it's unoccupied, perhaps become squatters or light fires inside.

Or consider a sidewalk. Some litter accumulates. Soon, more litter accumulates. Eventually, people even start leaving bags of trash from take-out restaurants there or breaking into cars.

With this passage in the March 1982 edition of The Atlantic Monthly by James Wilson and George Kelling a new theory was born – the theory of Broken Windows

The idea remains a controversial one, not least because it is often difficult to account for other factors that could influence crime reduction, such as changes in poverty levels, housing conditions and sentencing policy.

An experimental test of the “broken windows theory” has – until now – never been undertaken.

A group of researchers in the Netherlands – Kees Keizer and his colleagues at the University of Groningen – has proven the theorem. They constructed a series of experiments designed to discover if signs of vandalism, litter or low-level lawbreaking could change the way people behave. They found that they could – by a lot: doubling the number who are prepared to litter and steal.

**

The tendency for people to behave in a particular way can be strengthened or weakened depending on what they observe others to be doing. This does not necessarily mean that people will copy bad behaviour exactly, reaching for a spray can when they see graffiti. Rather, says Dr Keizer, it can foster the “violation” of other norms of behaviour.

It was this effect that his experiments, which have just been published in Science, set out to test.

His group’s first study was conducted in an alley that is frequently used to park bicycles. As in all of their experiments, the researchers created two conditions: one of order and the other of disorder. In the former, the walls of the alley were freshly painted; in the latter, they were tagged with graffiti (but not elaborately, to avoid the perception that it might be art). In both states a large sign prohibiting graffiti was put up, so that it would not be missed by anyone who came to collect a bicycle.

All the bikes then had a flyer promoting a non-existent sports shop attached to their handlebars. This needed to be removed before a bicycle could be ridden.

When owners returned, their behaviour was secretly observed.

There were no rubbish bins in the alley, so a cyclist had three choices. He could take the flyer with him, hang it on another bicycle (which the researchers counted as littering) or throw it to the floor. When the alley contained graffiti, 69% of the riders littered compared with 33% when the walls were clean.

To remove one possible bias—that litter encourages more litter—the researchers inconspicuously picked up each castaway flyer. Nor, they say, could the effect be explained by litterers assuming that because the spraying of graffiti had not been prevented, it was also unlikely that they would be caught. Littering, Dr Keizer observes, is generally tolerated by the police in Groningen.

The most dramatic result, though, was the one that showed a doubling in the number of people who were prepared to steal in a condition of disorder.

In this case an envelope with a €5 note inside (and the note clearly visible through the address window) was left sticking out of a post box. In a condition of order, 13% of those passing took the envelope (instead of leaving it or pushing it into the box). But if the post box was covered in graffiti, 27% did.

Even if the post box had no graffiti on it, but the area around it was littered with paper, orange peel, cigarette butts and empty cans, 25% still took the envelope.

The researchers’ conclusion is that one example of disorder, like graffiti or littering, can indeed encourage another, like stealing. Dr Kelling was right.

**

Such empirical evidence has strong relevance to the improvement of a sound and robust internal control environment.

Ever noticed how a company that insists – as two major Australian mining companies do – that when you are walking down a flight of stairs that you hold onto the rail has a strong focus on occupational safety.

Essentially what the companies are trying to do is to create that environment of order so that variances from the expected norm are more obvious.

(Try walking down a flight of steps and not hold onto a rail with an employee from one of these Australian mining companies and see how long it takes for them to at least comment, if not correct you, on your behaviour).

From an internal controls perspective, there is a myriad of applications that can be considered.

When you next see a senior manager in your company ignoring an internal control deficiency remind them of the broken window theory!