Is Trust a Substitute for Risk Management?

Some financiers say the current financial crisis is a risk management issue. Unwarranted risks were taken; better risk management tools are needed.

They misunderstand the difference between risk management and trust.

Risk management is when we contract that you’ll staff my project with the best people, you’ll use best practices, charge me a fair rate, that I can terminate with 30 days’ notice, and so forth. And if you don’t do those things, you’ll be in violation of a legally enforceable agreement.

Trust is where we look each other in the eye, shake hands, and say, “we’re going to do right by each other, including changing whatever else it takes to do so.”

Risk management is for hurricanes—things, events. Trusting the weather won’t change it one whit, and can be suicidal.

But treating people like hurricanes actually increases the risk. The more you give employees lie detector tests, the more they’ll lie—“someone must be getting away with it, why else would they keep testing us?” More fine print just leads to gaming the system.

Conversely, when you trust people, you increase their trustworthiness. A client once cut short my praise of a proposed subcontractor. “Charlie, enough–if you say he’s good, he’s good—I trust you,” the client said. I instantly felt the weight of the burden of trust.

When people are involved, risk management partially raises risk. Trust lowers it. Why do the financiers have it wrong? Because they think our crisis is about securities capable of being evaluated in absolute terms. It’s not–it’s about people relationships, capable of being evaluated only in subjective terms. It’s not a crisis of derivates valuation–it’s a crisis of trust.

Trust won’t eliminate risk. Some people steal from honor boxes, and take advantage of others. I commonly hear, “Charlie, you’re naive. You need to legally enforce legal rights to copyright, employee behavior, or pricing. There are no sanctions with trust.”

In fact, there are sanctions, both carrot and stick, and they can be more powerful than contracts.

Suppose I trust a French contractor with my intellectual property. I could get a legal contract stating sanctions. If violated, I could enforce it in France. But at what cost in euros, time spent, and time elapsed?

Here’s the trust carrot. “Pierre, think of the great business you and I can do together—new markets, products, opportunities; as long as, of course, you continue to respect my property rights, we can do this again and again. This can be the beginning of a beautiful friendship.”

And the trust stick? “In the inconceivable event that you, Pierre, were to violate this agreement—not that you ever would, of course—then I would be forced to make that fact public. In a blog. In letters, emails, articles, public websites, aimed at your other business partners and potential partners, your customers, your employees. That would be most harmful to your reputation for trustworthiness, Pierre, and we both know that, so we needn’t speak more of such terrible things, now do we? We understand each other, oui?”

The common way to manage risk is with lawyers and contracts. The better way is often to create trust–over a fine French meal and a bottle of wine.

One of those ways is cheaper, faster, stronger, more pleasant. Why would I want to use lawyers when I can use trust? Why manage “people risk” like you manage hurricanes, when you can use trust instead?

(The usual pushback is how to scale trust: more on that soon).