Donald R. Lessard

Understanding and Managing Risks in Large Engineering Projects

Large engineering projects are high-stakes games characterized by substantial irreversible commitments, skewed reward structures in case of success, and high probabilities of failure. Drawing on 60 real life projects, this article shows that successful projects are not selected but shaped with risk resolution in mind. Rather than evaluating projects at the outset based on projections of the full sets of benefits, costs and risks over their lifetime, successful sponsors start with project ideas that have the possibility of becoming viable. Successful sponsors then embark on shaping efforts to influence risk drivers.

BREAKING THE SILOS: DISTRIBUTED KNOWLEDGE AND STRATEGIC RESPONSES TO VOLATILE EXCHANGE RATES

A model of effective decision-making in a situation of distributed knowledge is developed, drawing on three perspectives: the sociocognitive perspective, which focuses on framing issues; the economic perspective, which focuses on the role played by incentives in the integration of knowledge and decision-making authority; and the process perspective, which stresses the role of integrating mechanisms and of processes that either hinder or foster risk awareness and flexibility. The model is tested on a sample of managers from different functional areas of Fortune 500 firms, using strategic responses to exchange-rate volatility as the context. The results show that all three perspectives - framing, incentives and process - are significant in explaining the effectiveness of strategic responses to volatile exchange rates. The findings suggest that simultaneously addressing managerial mindsets, incentives and process may be crucial to generating effective strategic responses across functions.

Country risk and the structure of international financial intermediation

Country risk stands out in today’s global financial system for several reasons. It is perceived to be a major threat to the system’s stability, more so than virtually any other single category of risk. It also is perceived to follow different rules than most other types of risks, and hence to require different institutional approaches. This is reflected in the specialization of particular institutions in bearing country risk, the important risk mitigating role of multilateral institutions or arrangements, including the International Monetary Fund, the World Bank, and the Paris Club, and the lack of specialized markets for laying off this risk.

Currency changes and management control: resolving the centralization/decentralization dilemma

ABSTRACT Multinational corporations with decentralized responsibility for operations face a serious dilemma. If financial policies, including the treatment of foreign exchange risks, are set centrally, the performances of operating groups will be influenced by exchange risk policies over whose effect they have little control. If financial decisions are left to the operating units, on the other hand, they are likely to overreact to exchange risks and thus suboptimize from a corporate perspective. This article suggests that this dilemma can be resolved through the use of “internal forward rates”—rates at which the corporate treasury agrees to translate future foreign currency revenue and expense items. It illustrates the impact of differing treatments of exchange rate changes in budgeting and tracking the performance of decentralized operating units. The article concludes with a discussion of how internal forward rates should be set and updated.

Evolving Strategy: Risk Management and the Shaping of Mega-Projects

The authors of this paper argue that the succession of shaping episodes that form the front-end process to cope with risks can be reinterpreted in terms of the real-options framework that is currently revolutionizing academic treatments of project evaluation. In fact, as is often the case with cutting-edge practice, managers have been successful at creating value through the development and exercise of sequential options without explicitly framing the process in options terms. Academics have simply codified this practice in the form of a new conceptual framework. The real-options framework is based on the same logic as that of financial options as previously developed. It recognizes that the decisions that determine project cash flows are made sequentially over many episodes. This paper illustrates the rich varieties of mechanisms through which these options are shaped and exercised over the life of the project – the real management that is integral to real options.

House of Project Complexity - Understanding Complexity in Large Infrastructure Projects

This paper describes our conceptualization of complexity in large infrastructure projects. Since complexity itself is an emergent concept that is hard to pin down, we focus on the relationship between various project features and properties associated with complexity such as difficulty, outcome variability and non-linearity, and (non) governability. We propose a combined structural and process-based theoretical framework for understanding contributors to complexity—the ‘House of Project Complexity’ (HoPC). The formulation of the HoPC draws from a rich projects literature and is developed iteratively by first applying it to two trial samples and then to the main data set of 20 detailed case studies of infrastructure projects prepared for the IMEC study. A main contribution of this work is the conceptual distinction in the HoPC between ‘inherent project features’, ‘architectural features’, and their relationship with project outcomes and emergent properties—the ‘ilities.’ A second contribution is the separa...

Evaluating International Projects: An Adjusted Present Value Approach

In evaluating projects that cut across national boundaries, firms must deal with a variety of issues seldom encountered within a single country that affect the distribution of net operating cash flows available to the parent, as well as the valuation of these cash flows.1 Factors influencing the statistical distribution of net operating cash flows, in addition to differences in fundamental economic and political conditions in various countries, include differing rates of inflation and volatile exchange rates that may or may not cancel each other, differences in tax rules and tax rates, and restrictions or taxes on cross-border financial transactions. Factors that may influence the valuation of operating cash flows with a given statistical distribution include incomplete and often segmented capital markets that result from controls on financial transactions both within and among countries; the dependence of net of tax cash flows available to the parent on the firm’s overall tax and cash-flow position in various countries; the availability of project-specific concessional finance—loans, guarantees, or insurance against commercial or political risks; and, on occasion, requirements to issue securities—especially equity—within markets partially or totally isolated by barriers to internal or cross-border financial transactions. Further, the available cash flows and their value to the firm often depend on the specific financing of the project, not only because of concessional financing opportunities, but also because the costs or limits on cross-border transfers often depend on the nature of the financial transaction involved, e.g., interest or principal, fees, dividends, or payment for goods.

Real Asset Valuation: A Back-to-Basics Approach

Different valuation methods can lead to different corporate investment decisions, and the conventional “static, single discount rate” DCF approach in particular is biased against many of the kinds of decisions that corporate managers tend to view as “strategic.” Reducing the bias from valuations involves two main tasks: treating risk in a way that is consistent with observed market pricing, and accounting for the ability of companies to make decisions “dynamically” over time. The authors propose two separate tools, market‐based valuation and complete decision tree analysis, for accomplishing these two improvements in valuation. The authors also suggest working with the full distribution of future cash flows, one possible realization at a time, rather than working with the aggregate measure of expected cash flow. From a technical perspective, it is necessary to work with the full distribution to value real options properly. Valuing the cash flows one realization at a time also leads to a much better understanding of the interaction between economy‐level, systematic risks and local asset‐level, technical risks. Just as important, the proposed approaches support an effective division of labor between local asset managers, who are better positioned to model technical considerations and other asset specifics, and the central finance staff, who can ensure the consistent treatment of economy‐wide risk and to create the rules of engagement for evaluating opportunities. After presenting an overview of both the valuation and the organizational issues, the authors present a case involving a corporate investment in carbon capture and storage that illustrates both the application of the proposed methods and the various sources of bias in the typical DCF analysis.

The shaping of large engineering projects

This comprehensive and accessible Handbook presents state-of-the-art research on the decision-making processes in the deliverance of mega-projects – large infrastructure projects for the transportation of people and/or goods.

Evolving Strategy: Risk Management and the Shaping of Large Engineering Projects

Large engineering projects (LEPs) are high-stakes games characterized by substantial irreversible commitments, skewed reward structures when they are successful, and high probabilities of failure. Their dynamics also change over time. The journey from initial conception to ramp-up and revenue generation takes 10 years on average. While the €U¦ront endÂ€Ý of a project €O project definition, concept selection, and planning €O typically involves less than one third of the total elapsed time and expense, it has a disproportionate impact on outcomes, as most shaping actions occur during this phase. During the rampup period, the reality of market estimates and the true worth of the project are revealed. Sponsors may find that actual conditions are very different from expectations, but only a few adaptations are possible. Once built, most projects have little flexibility in use beyond the original intended purpose. Managing risks is thus a real issue. The purpose of this chapter is to sketch out the various components of risk and outline ranges of strategies for coping with risks and turbulence based on an assessment of 60 projects as part of the IMEC study. Further more, we propose the elements of a governance system to master their evolutionary dynamics. The main finding is that successful projects are not selected but shaped. Rather than choosing a specific project concept from a number of alternatives at the outset based on projections of the full sets of benefits, costs and risks over the project€U³ lifetime, successful sponsors start with project ideas that have the potential to become viable. These sponsors then embark on shaping efforts to influence risk drivers ranging from project-related issues to broader governance. The seeds of success or failure of individual projects are thus planted early and nurtured over the course of the shaping period as choices are made. Successful sponsors, however, do not escalate commitments, and they abandon quickly when they recognize that projects have little possibility of becoming viable.