Exposure Cascade: Hierarchical Risk Budgets

Exposure Cascade: Hierarchical Risk Budgets

TL;DR

Child Exposure Budget = Parent Budget × Allocation Factor. Each level in a hierarchy keeps some exposure for direct decisions and delegates the rest downward. Tighter oversight = more retained at top = less risk at edges.

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The Setup

Consider a corporation with a standard hierarchy:

• Board of Directors: Sets total organizational risk tolerance
• CEO: Runs the company day-to-day
• Executive Suite: ~5 VPs/C-level executives
• Managers: ~20 middle managers
• Employees: ~200 frontline workers

The Board decides: “We’re willing to accept $5 million in total delegation exposure for this organization.”

This $5M is the exposure budget—the maximum expected harm from all delegation relationships combined. But how does it flow down through the hierarchy?

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The Cascade Principle

At each level, the principal (delegator) makes a choice:

1. Retain some exposure for direct decisions (things only they can do)
2. Delegate the rest to subordinates

Exposure_delegated = Exposure_received - Exposure_retained

Why retain exposure? Because some decisions are too important to delegate:

• Board retains authority over CEO compensation, major acquisitions
• CEO retains strategic pivots, executive hiring
• Managers retain performance reviews, team conflicts

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Visualization: Hierarchical Tree

Here’s the standard oversight scenario flowing down:

flowchart TB
    subgraph L1["Board Level"]
        B["Board<br/>$5M total exposure budget<br/>Retains: $500k"]
    end

    subgraph L2["Executive Level"]
        CEO["CEO<br/>Receives: $4.5M<br/>Retains: $1.5M"]
    end

    subgraph L3["Senior Management"]
        E1["VP Engineering<br/>$600k"]
        E2["VP Sales<br/>$600k"]
        E3["VP Product<br/>$600k"]
        E4["CFO<br/>$600k"]
        E5["VP Ops<br/>$600k"]
    end

    subgraph L4["Middle Management"]
        M["20 Managers<br/>$1M total<br/>$50k each"]
    end

    subgraph L5["Frontline"]
        EMP["200 Employees<br/>$600k total<br/>$3k each"]
    end

    B -->|"$4.5M"| CEO
    CEO -->|"$3M split"| E1 & E2 & E3 & E4 & E5
    E1 & E2 & E3 & E4 & E5 -->|"$1M total"| M
    M -->|"$600k total"| EMP

Reading the Diagram

• Board has $5M total budget, keeps$500k for board-level decisions
• CEO receives $4.5M, keeps$1.5M for CEO-level decisions, passes $3M to executives
• Executives (5 people) share $3M ($600k each), collectively pass $1M to managers
• Managers (20 people) share $1M ($50k each), collectively pass $600k to employees
• Employees (200 people) share $600k ($3k each)—this is their individual exposure budget

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Visualization: Exposure Flow

Another way to see this—how exposure is consumed vs delegated at each level:

Level	People	Receives	Retains (direct)	Delegates	Per-Person
Board	7	$5.0M	$500k (10%)	$4.5M	$71k
CEO	1	$4.5M	$1.5M (33%)	$3.0M	$4.5M
Executives	5	$3.0M	$2.0M (67%)	$1.0M	$600k
Managers	20	$1.0M	$400k (40%)	$600k	$50k
Employees	200	$600k	$600k (100%)	$0	$3k

Key observation: Higher levels retain more proportionally. The CEO keeps 33% for direct decisions; managers keep 40%. This is because higher-level decisions tend to be more consequential.

$5M budget flows as:

Board    ████████████████████████████████████████████████████ $5.0M
         ██▓▓ retained ($500k)

CEO      ██████████████████████████████████████████████ $4.5M
         ███████████████▓▓▓▓▓▓ retained ($1.5M)

Execs    ██████████████████████████████ $3.0M
         ████████████████████▓▓▓▓▓▓▓▓▓▓ retained ($2.0M)

Managers ██████████ $1.0M
         ████▓▓▓▓ retained ($400k)

Employees ██████ $600k
          ██████ all retained (end of chain)

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Comparing Oversight Scenarios

Different organizations make different choices about how much exposure to retain at each level. Let’s compare three styles:

Scenario A: Tight Oversight (Conservative)

A risk-averse organization where senior leaders retain most exposure:

flowchart TB
    B["Board<br/>$5M"] -->|"$4M"| CEO["CEO"]
    CEO -->|"$2M"| E["Executives (5)"]
    E -->|"$500k"| M["Managers (20)"]
    M -->|"$200k"| EMP["Employees (200)"]

    style EMP fill:#fdd

Per-employee exposure: $1,000

Characteristics:

• Heavy verification at every level
• Employees have minimal authority
• Slow but safe

Scenario B: Standard Oversight (Balanced)

The example we’ve been using:

flowchart TB
    B["Board<br/>$5M"] -->|"$4.5M"| CEO["CEO"]
    CEO -->|"$3M"| E["Executives (5)"]
    E -->|"$1M"| M["Managers (20)"]
    M -->|"$600k"| EMP["Employees (200)"]

    style EMP fill:#dfd

Per-employee exposure: $3,000

Characteristics:

• Balanced delegation and oversight
• Employees can make meaningful decisions
• Standard corporate structure

Scenario C: Loose Oversight (High Delegation)

A flat, fast-moving organization:

flowchart TB
    B["Board<br/>$5M"] -->|"$4.8M"| CEO["CEO"]
    CEO -->|"$4M"| E["Executives (5)"]
    E -->|"$2M"| M["Managers (20)"]
    M -->|"$1.5M"| EMP["Employees (200)"]

    style EMP fill:#ddf

Per-employee exposure: $7,500

Characteristics:

• Minimal verification overhead
• Employees empowered to act
• Fast but risky

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Comparison Table

Scenario	Board	CEO	Execs	Managers	Employees	Per-Employee
Tight	$5M	$4M	$2M	$500k	$200k	$1,000
Standard	$5M	$4.5M	$3M	$1M	$600k	$3,000
Loose	$5M	$4.8M	$4M	$2M	$1.5M	$7,500

What the Numbers Mean

Per-employee exposure is a key metric. It represents the expected harm budget for an individual frontline worker’s decisions.

• $1,000/person (tight): Employees need approval for almost everything. Good for nuclear plants, bad for startups.
• $3,000/person (standard): Employees can handle routine decisions autonomously. Most organizations.
• $7,500/person (loose): Employees are trusted to make significant judgment calls. Tech companies, professional services.

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The Retention Decision

How much should each level retain? It depends on:

1. Consequence Magnitude

Higher levels make bigger decisions, so they need bigger exposure budgets for direct action.

Level	Typical Decisions	Consequence Range
Board	M&A, CEO selection	$10M -$1B
CEO	Strategy, reorgs	$1M -$100M
Executives	Department direction	$100k -$10M
Managers	Team operations	$10k -$500k
Employees	Daily tasks	$100 -$50k

2. Verification Overhead

Each delegation relationship has overhead—time spent checking work. More retention = less overhead but less scale.

Effective capacity = Raw capacity - Verification overhead

3. Trust Level

Lower trust = retain more. If you don’t trust your executives, keep more exposure at CEO level.

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Key Insights

Key Insights

1. Exposure cascades multiplicatively: Each level passes a fraction down, so the bottom gets the product of all fractions
2. Per-person exposure shrinks at scale: 200 employees sharing $600k =$3k each, while 1 CEO gets $4.5M
3. Retention reflects control: High retention = tight control, low retention = high delegation
4. The total is conserved: All exposure either gets retained or delegated—it doesn’t disappear
5. Structure determines risk: Same people, different cascade = different risk profile

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Worked Example: Adjusting the Cascade

Your company has been running with Standard oversight, but after a compliance incident, the board wants to tighten up.

Current state (Standard):

• Per-employee exposure: $3,000
• Total employee exposure: $600k
• Incidents last year: 3 (expected ~2 at this risk level)

Proposed change: Move to Tight oversight

• Per-employee exposure: $1,000 (67% reduction)
• Total employee exposure: $200k

How to implement:

1. Managers retain more (increase approval thresholds)
2. Executives take on decisions previously delegated to managers
3. CEO handles exceptions that executives used to approve

Trade-off:

• Risk reduction: 67%
• Velocity reduction: ~40% (more approvals = slower execution)
• Is this trade-off worth it? Depends on the cost of the compliance incident vs. the cost of slower execution.

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See Also

• Delegation Accounting — Balance sheet view for individual delegations
• Trust in Organizations — Detailed case studies with specific roles
• Risk Inheritance — The math of how trust flows through networks
• Risk Budgeting Overview — Cross-domain methods for allocating risk budgets