Enterprise Risk Management: Review, Critique and Research Directions

By Philip Bromiley, Michael McShane, Anil Nairand Elzotbek Rustambekov

CitationBromiley, P., et al, Enterprise Risk Management: Review, Critique and Research

Directions, Long Range Planning (2014), http://dx.doi.org/10.1016/j.lrp.2014.07.005

Article Review

Universiti Teknologi MalaysiaInternational Business School

StudentKevin Koo Seng Kiat

20th December 2014

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Notice

Enterprise risk management (ERM) is mostly discussed in accounting and finance journals,

but not management journals.

ERM is an important opportunity of researchfor management scholars.

Overview

What is ERM?

Enterprise risk management (ERM) is “the integrated management of all risks an organization faces, which

inherently requires alignment of risk management with corporate governance and strategy.”

What is ERM?

1. Overly focused on mathematical models – useless outside finance and accounting.

2. Discussion of ERM has not factored in recent developments in field of risk management, strategy management, organizational change and other topics.

Problems with Existing Research

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Problems with Existing Research

3. Many articles describe “what ERM is” but not “how to implement ERM”. Fail to describe “how to get there”.

4. Inability to bring silos together.

5. Impact of corporate culture on ERM implementation and practices not well discussed.

Problems with Existing Research

Definition problems

No agreed definition

Some major divisions

1. Independent of Firm's objectives vs. In terms of Firm's Performance

2. Source of value creation vs. problem to be mitigated

Historically...

… different functions of a firm handled different parts of risk,

with their own approach / emphasis.

For exampleFinance → currency / interest

Insurance → Natural disasters / liabilityOperations → Quality / safety

Over time, however...… the emphasis shifted toward integration of

different types of risks.

● Merging of insurance and financial risk approaches.

Emerging Consensus on ERM

1. Managing risk of portfolio is more efficient than managing risk of individual units.

2. ERM includes not only traditional risks, but also strategic risks e.g. product obsolescence, competitor actions.

3. Risk is not just a problem. It can be a a source of value. If the firm can manage the risk, it has competitive advantage.

Empirical findings of ERM Research

1. More leveraged firms tend to use CRO (Chief Risk Officer), indicating higher risk management efforts.

Empirical findings of ERM Research

2. ERM implementation related to presence of CRO.

3. Hiring a CRO may get positive or negative market reactions, e.g. CRO appointment causes firm value to rise.

4. ERM and firm's value relationship dependent on ERM implementation matching firm-specific factors.

Empirical findings: Problems

1. Problem of Endogeneity = ERM implementation is not random.

E.g. High performing firms will implement ERM. This will cause positive relation finding.

Methodological errors render it difficult to draw conclusions about ERM effectiveness.

Empirical findings: Problems

2. Studies fail to address inter-firm differences in implementing ERM.

3. Core practitioner concepts are not investigated in studies, e.g. “risk cultures”, “risk appetite”, “risk management team structure”.

Management Research & ERM

Management Research & ERM

1. Management research could lead ERM research along a different path than research based on accounting and finance methods, which are based on “optimal conditions”.

2. ERM measurement through accounting methods or stock-based performance is inadequate if the company has objectives beyond accounting / stock returns. Management researchers could address the issue of corporate goals and ERM.

Management Research & ERM

A Different Path

Management Research & ERM

3. Concepts of risk vary greatly across parts of the organization and across organizations. Management scholars could use qualitative and survey approaches to understand how managers conceive risk.

4. Management scholars could research managerial perceptions of risk to explain managerial behaviour.

Management Research & ERM5. Management scholars could research selection and promotion of managers; how such processes affect managers' confidence; and how managers assess risk.

6. Management scholars could also research risk judgments and preferences of managers as individuals and as groups.

7. Management scholars could integrate aspects of managerial time horizon into assessing managerial risk-taking.

Management Research & ERMThe Hawthorne experiments are an example of

successful management research

Management Research & ERM

8. Management scholars could study “risk culture” and “risk appetite”; how firms aggregate smaller risks in assessing risks.

9. Implementation of ERM is a form of organizational change, which accounting and financial research rarely explores. However management research has often studied change in organizations.

Management Research & ERM

10. ERM literature assumes that strategic ERM decisions occur in the strategic planning process. However, strategy scholars find that strategic decisions tend to occur outside of the process. Management scholars can research this difference empirically.

11. Management scholars should focus on effectiveness of ERM measures.

Conclusions

1. There is a lack of empirical evidence to prove effectiveness of ERM as claimed by ERM advocates.

2. ERM is a new domain for management scholarship.

Thank you