The Value of Investing in Enterprise Risk Management

Abstract

Prior studies show that enterprise risk management improves firm performance. This article investigates which aspects of enterprise risk management add value. We find that the use of economic capital models and dedicated risk managers improve operating performance. Requiring the dedicated risk manager report to the board of directors or to the chief executive officer (CEO) also increases value. The following combination of enterprise risk management initiatives yields the greatest increase in firm value: a simple economic capital model, a dedicated risk manager that is a cross‐functional committee, and requiring the risk manager report to the board or CEO.

Strategic Risk Management

“…Quon, Zeghal, and Maingot (2012) measured ERM adoption by the level of risk assessment reported in annual reports and financial statements and did not find an effect on performance. The result of a study by Grace et al (2014) shows that firms that put more emphasis on a combination of ERM-related activities (including weight on a simple economic capital model, having a dedicated risk manager or risk management team, and risk managers reporting to the board) reaped the benefits of an improved cost and revenue efficiency. The authors also found that moving from simple risk-based capital allocation models to more advanced models -based on scenarios, stress test, and stochastic simulation -did not contribute to any further performance efficiency improvements.…”

“…By developing ERM into a core competence, firms can experience an increased capital efficiency in that ERM enhances a firm's ability to allocate corporate resources on an informed risk-reward trade off basis (Grace et al, 2014;. That is, firms choose between firm-specific investments by assessing the return on the investments after compensating for the costs associated with the increase in the total risk of the firm .…”

“…A few studies have shown a positive relationship (Eckles, Hoyt, and Miller, 2014;Grace, Leverty, Phillips, and Shimpi, 2014;, others find no beneficial effects (Pagach and Warr, 2010;Quon, Zeghal, and Maingot, 2012;Sekerci, 2012), while Lin, Wen, and Yu (2011) show that it erodes firm value. Such inconsistencies raise questions about whether the anticipated beneficial effects of ERM can be realized.…”

Could Enterprise Risk Management (ERM) Create, Protect and Enhance Shareholders’ Wealth Among Malaysian Listed Issuers

“…Study [20] suggested that firms demonstrated progressively higher value as the ERM matured. Further, study [21] suggested that the use of a dedicated risk manager is capable of improving the firm's operating performance and emphasized that the existence of a direct reporting line from the risk manager to the board or CEO could lead to superior firm value.…”

“…As the ERM is mandated for all listed companies in Malaysia, for the purpose of developing a comprehensive panoply of ERM tools, large firms may utilize greater financial resources than a small firm [27,[31][32][33]. Total revenue was used as proxy for firm size.…”