What type of research study design is each of the following A.docx
SBA FINAL
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A Narrative Literature Review on the Driving Forces behind Enterprise
Risk Management and the Value of it.
Aleisha Herbert
Student ID: 201128029
Supervisor: Helen Scott
Submitted in part fulfilment of the MSC Management September 2016
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Acknowledgements.
I would like to thank my SBA tutor Helen Scott who has been a great help in developing my work. I
would also like to thank my family and close friends for their belief and perseverance throughout this
review.
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1. Introduction.
Since its inception, enterprise risk management (ERM) has increasingly gained large momentum in the
literature. Several researchers have attempted to provide insights of how ERM enhances firm
performance to result in maximization of shareholders' value (Beasley et al., 2008 and Gordan et al.,
2009). However, the success of this concept is still a clouded vision. Entering a new paradigm of risk
management ERM abandons the traditional silo approach of risk management where firms sought to
avoid losses within a limited scope. Traditional risk management (TRM) has been described as being a
reactive model, referring to individual risks as if they don’t interact (Simona-Lulia, 2014) (See
Appendix 1). Looking at Kloman's (1976) 'Risk Management Revolution' many practitioners were
already advocating a coordinated approach to risk management. Crockford (1980) is one who argued
for a multidisciplinary risk management instead of one 'siloed and fragmentedamong a number of sects'.
In the 1990's, at a time where risk management went beyond hazard risks, becoming closely related to
financial, operational and strategic risks, managers were required to mitigate risks more proactively
(CAS, 2003; Cassidy, 2005; Skipper and Kwon, 2007). The importance of integrating all risks is
reflected by Mercer Management Consulting who showed that most Fortune 1000 companies suffered
a decline in stock because of failure in decisions in strategic (58%), operations (31%) and financial
(6%) risks (Razali and Tahir, 2011).
There are ambiguities and disagreements about whatconstitute ERM. Power(2009) has assertedto how
ERM is an umbrella concept which inevitably leads to the risk management of nothing. A basic primary
thought of ERM is that it is a way of measuring, understanding and controlling risks which firms face.
Since the beginning of ERM there has been a compelling need for a common language and clear
direction for the term. In 2001 the Committee of Sponsoring Organizations of the Treadway
Commission (COSO) initiated a project engaging with Pricewater Coopers to develop a framework and
improve ERM. Since then, COSO’s definition of ERM has gradually became widely accepted and is
defined as follows:
'Enterprise risk management is a process, effected by an entity's board of directors and other personnel,
applied in strategysetting and acrossthe enterprise, designed to identify potential eventsthat may affect
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the entity, and manage risk to be within risk appetite, to provide reasonable assurance regarding the
achievement of entity objectives'.
Existing literature suggests a range of factors which might influence decisions to carry out ERM. An
assumedvalue creation through the implementation of ERM is one.However,there is still only a limited
selection of companies who have adopted this holistic management approach (Kleffner, Lee &
McGannon, 2003; Liebenberg and Hoyt, 2003; Pagach and Warr, 2008). Therefore, it is important to
recognise the value gained by companies through the use of ERM as well as understanding what
stimulates companies to adopt an ERM framework.
This piece of work aims to give an up to date review of the literature surrounding ERM. Producing a
narrative review of the current ERM research will develop our understanding as to why, and why not,
organizations choose to implement ERM. Additionally, comparing published research on ERM will
allow us to identify the value ERM implements within different organizational structures.Lastly, taking
into consideration the recent ‘Brexit’, this paper will point to why ERM research is still of importance
and continuity.
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2. Outline of Topic.
The complexity of business transactions, technology advances, globalization,speed of product cycles,
and the overall pace of change have increased the volume and complexities of risks facing
organizations over the last decade’ (COSO, 2009).
Emerging in the mid-1990s, the use of enterprise risk management (ERM) as a financial tool has been
encouraged to manage risks evolving inside and outside of the firm. Traumatic events like 9/11/2001
and the 2008 Global Economic Crisis have propelled the need for ERM further, and in 2004 The
Harvard Business Review listed ERM as one of their 'Breakthrough Ideas' (Baranoff, 2004; Buchanan,
2004; Wu et al., 2010). Yet there is still doubt cast upon the efficiency of ERM and many firms have
still not adopted ERM. Writers like Power (2009) have contended ERM is a ‘programmatic aspiration’
as it promises mistakes of the past will be avoided with a more rational and synthetic conception of risk
management (Drori, 2006).
Figure 1 (Wu et al., 2010)
In Figure 1 (Wu et al., 2010) presents the number of journal publications on 'Enterprise Risk' since
2000. From the above it is clear to see the correlation between 9/11/2001 and the kick start of the ERM
academic literature.
A report discussing the current state of ERM revealed 59% of companies believe the volume and
complexity of risks have changed ‘extensively’ in the last five years, with 65% admitting they were
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caught out by operational surprises (Beasley, et al., 2015). Another notable observation from the report
shows an increase from 2009 through to 2012 with a levelling off in 2013 for the number of
organizations claiming to have a ‘complete formal enterprise-wide risk management process in place’
(Beasley et al., 2015) (See Figure 2 below).
Figure 2 (Beasley et al., 2015)
This paper takes an international perspective of ERM, however the UK’s recent Brexit move is an
important implication for the future of ERM. In the wake of the June 23rd
referendum result, authors
like Veysey (2016) have suggested how all risks must now be considered principal risks for all
organizations. However, this is somewhat a bold statement. It is true that the result of the referendum
is a momentous turning point and that the complexity of modern world risks are evolving. Yet as the
impact of this decision is to be negotiated and determined over the next two years – how are we able to
make sense of this decision in a period of uncertainty and opportunity. Contributing to the gap within
ERM literature, Fraser et al., (2010) have discovered how many articles merely describe how the
process is assumed to look like and function. This observation allows us to understand why some
organizations have still not adopted an ERM framework. By aligning the same ERM framework to
various organizational structures, firms are failing to understand and implement ERM effectively.
Therefore, by reviewing present literature on what influences firms to pursue ERM programmes, as
well as looking at the value of ERM, this study attempts to contribute to ERM literature.
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3. Critical Reflection on Methods.
‘A literature review is primarily an integrative endeavour, and integration is best
accomplished if the reader is frequently told how the individual studiesfit the broad theories
and patterns’ (Baumeister and Leary, 1997).
The goal of a literature review is to bring the reader up-to-date with present literature on a topic,
alongside the further goal of justifying future research in the area (Cronin, Ryan and Coughlan, 2008).
The lack of good information on the management of enterprise risk management (ERM) has already
been noted, producing ‘great overarching statements that seem very much like motherhood statements’
(Fraser et al.,2010). As the assortment of articles on ERM are scattered,this narrative literature review
provides a much-needed bridge, helping to clarify the value which ERM supposedly creates.The ability
to focus on a range of patterns and connections amongst the chosenstudies helps to constructthis bridge
and address theoretical questions that go beyond the scope of a single study.
It is important to recognise the lack of control that literature reviews have over their evidence as they
are restricted by what others have already done. However,being led by others academics evidence can
be seen as beneficial. Baumeister and Leary (1997) suggest literature reviews are most useful for the
identification of what questions remain undecided. Selecting studies means literature reviews are
obligated to develop methodological diversity. Prizing this methodological diversity adds benefits to
narrative literature reviews asit positions it uniquely to recognize conclusions from the literature review
(Baumeister and Leary, 1997).
An important part of the narrative literature review, often resulting in a lack of integration, is providing
an overarching conceptualization – ‘a take home message’ (Sternberg, 1991). As this literature review
is simply describing various studies it is important to provide an explanation as to how all these fit
together and give an up to date commentary of ERM. A central part of reviewing literature is providing
a critique of the evidence, thus, allowing future investigators to see what aspects of ERM need further
research.
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Finally, literature reviews often neglect what the implications for future research are. From the critique
developed throughout the review, unresolved issues and questions will be recognised, as well as taking
into account ‘Brexit’ and its implications for future ERM practises.
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4. Literature Review.
‘Strategic hedging is about far more than finance and derivatives. It requires firms to understand all
the main risks to which their cash flows are exposed, not just the narrowly financial ones’ (Bishop,
1996)
Since its introduction, enterprise risk management (ERM) has been allocated different meanings.
Heightened interest in ERM implementation among firms across the world has been fuelled by both
internal and external influences (Kraus and Lehner, 2012). Internal influences include maximisation of
shareholder wealth and the anticipation of losses (Lam, 2001 and Kraus and Lehner, 2012). External
influences which drive organizations to adopt ERM include increasing complexity of risk, globalization,
competitive advantage and institutional investor pressure (Dickinson, 2001 and Rosen and Zenios,
2006). As a result of these factors, ERM has become an emerging standard and can be described as a
highly essential tool for all types of organizations (Stroh, 2005 and Manab et al., 2010). In order to gain
a critical and in depth understanding to the value of ERM provides organizations with, it is essential to
understand what influences firms to pursue ERM programmes. Ten studies have been selected which
help to do so (See Appendix 2).
4.1 Firm Size
The Contingency Theory, traceable to the 1950s, looks to explain how differences in contextual and
structural dimensions are related (Hanisch and Wald, 2012; Rejc, 2004). Additionally, it also looks at
how the level of risk management in an organization is affected by several contingent variables such
as: firm size, firm complexity, industry type, support of the Chief Risk Officer (CRO) and ownership
structure. COSO (2004) have pointed to the importance of entity size and enterprise risk management
(ERM) implementation. Beasley et al., (2005) support this assumption suggesting how larger entities
require the need for more effective enterprise wide risk management techniques and are more able to
implement ERM due to their greater resources. However, small entities cannot be ignored. In fact,
COSO (2004) tell us how they too are still able to have an effective ERM programme as long as their
components are present and functioning properly.
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Hoyt and Liebenberg’s (2003) investigation is consistent with this rational thinking. Their study
primarily focuses on the appointment of a CRO using a size and industry matched control sample. They
discover how the magnitude of average firms reflecthow those appointing CROs are the most prevalent
within their particular industry. In this case, this is the financial and energy industry, which is also
consistent with previous survey evidence (Thiessen et al., 2001). Hoyt and Liebenberg (2011) continue
to emphasize this point in their later study carried out in 2009, which focused on publicly traded
insurers. In fact, there studies from Paape and Speklé (2011), Pagach and Warr (2008) and Eckles et
al., (2014) all consistently point to the assumption that entity size is positively associatedwith the extent
of ERM implementation. Amongst these findings though, was the observation that larger organizations
are faced with increased uncertainty and risk (Standard and Poor,2005; Pagach and Warr, 2008). From
this we can assume how it is both firm size and a firms’ complexity which drives ERM application.
This is not saying small entities are incapable of implementing ERM.Under the basis of COSO’s(2004)
framework, Lukianchuk (2015) has spoken about the possibility for SME’s to implement useful risk
management techniques.
4.2 Firm Complexity
According to Gordon, et al., (2009) firm complexity is related to the number of business segments
within a firm, and has been suggested to be another driving force behind the implementation of ERM
(COSO, 2004; Rosen and Zenious, 2006). Two types of complexity which have been discussed in the
literature are; industrial diversification and international diversification. Both have been positively
related to engagement of an ERM framework.
Studies have suggested industrial diversification is linked with both costs and benefits (Hoyt and
Liebenberg, 2011). Costs include reduced organizational performance which eventually leads to
inefficient cross subsidization of poorly performing businesses (Berger and Ofek, 1995). Whereas
Teece (1980) has described diversification as performance-enhancing, with benefits associated with
scope economies, larger internal capital markets and risk reduction. It is worth taking note of the date
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of Teece’s (1980) assumption as the level and knowledge of ERM would be more limited. Reason why
these thoughts might not be viable in more recent studies.
Hoyt and Liebenberg’s (2008) study into the U.S insurance industry reveals systematic differences
between ERM users and non-users. More specifically they discovered ‘ERM users are larger, more
internationally and industrially diversified’ (Hoyt and Liebenberg, 2008). However, these results are
only significant when firm size is omitted from the regression. Meanwhile, both Gordon et al., (2009)
and Pagach and Warr (2008) studies have confirmed firms which are more complex are more likely to
implement the ERM concept.Although, both of these studies have limitations, they canbe used together
in a complimentary manner. The study by Gordon et al., (2009) study covers data from only 2005,
whereas Pagach and Warr’s (2008) study has a collected data set for over five years. Thus, these studies
combined make these theoretical predictions stronger.
Bies (2007) has also claimed ‘improving risk management should depend on the size and level of
complexity of the institution’. Recently, a study from Ping and Muthuveloo (2015) carried out in
Malaysia proved that firm complexity does have a significant influence on the extent ERM is
implemented within an organization. Results of their analysis provides a 𝛽 − 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 0.245 𝑎𝑛𝑑 𝑝 <
0.01 for their second hypothesis which proposes the more complex a firm, the more likely it is to
implement ERM. Including Ping and Muthuveloo’s (2015) study shows how these assumptions apply
to other parts of the globe.
Theoretical predictions described for industrial diversification apply equally to international
diversification. However,when reviewing the literature there are suggestions on how the complexity of
doing business across international lines can dilute the consistency of formal ERM programmes.
Contradicting Hoyt and Liebenberg’s (2008) work aswell asGordon etal., (2009) and Pagachand Warr
(2008).
Extending this thought, Frigo and Anderson (2011) remind us how ERM is still a relatively new
discipline. Therefore, it can be expected that firms will experience difficulty in implementing ERM
across geographical boundaries. This point is proven with prior findings from Hoyt and Liebenberg
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(2011) and more recently, Farrell and Gallagher’s study (2015) which uses a maturity model for ERM.
Modelling ERM via a maturity model provides additional useful and unique information. Their study
discovers firms which are internationally diversified usually have lower ERM maturity scores ‘ceteris
paribus’.
A firm’s complexity on both an industrial level and international level are shown to impact on the
implementation of ERM. The lack of support for internationally diversified firms reiterates how ERM
is still continuing to evolve.
4.3 Internal Influences
Emphasizing their commitment to ERM, many organizations choose to locate ultimate responsibility
for risk management explicitly at the senior executive level by appointing a Chief Risk Officer (CRO),
who Beasley et al., (2005) have called a ‘catalyst for organisational change’. Although the CRO is an
important proxy for the deployment of a holistic risk management system, the use of this as a sole
indicator can be misleading resulting in the oversight of critical ERM activities (Kraus and Lehner,
2012).
Despite this, researchers have noted how the presence of a risk officer does relate to the adoption and
implementation of ERM. Kleffner et al., (2003) provide evidence from Canada, discovering of the 37
firms who had implemented ERM,13 had individuals within the organization allocated the title of chief
risk officer. Question 18 from their study; ‘Which of the following are the driving forces behind the
adoption, or consideration, of an ERM approach?’ revealed 61% thought it was due to the influence of
the risk manager. Paape and Speklé (2011) and Gottwald and Mensah (2015) also agree with this
positive relationship. Using SPSSto analyse their data,Gottwald and Mensah(2015) reveala significant
and positive relationship between the presence of a CRO and ERM from stage 2 onwards B=1.691, p
<.05). Furthermore, for those firms who answered yes for having a CRO, also have a better ERM
implemented than those who answered no. All of these three studies prove that firms do believe having
a CRO leads to ERM implementation.
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4.4 Firm Industries
Naturally, some industries are more regulated than others. Firms operating in intensive-regulated
industries are more likely to adopt ERM, being at the forefront of ERM implementation (Golshan and
Rasid, 2012). Industry competition is a fundamental concern for all organizations. On one hand there is
a competition-intensive industry where there are many firms providing the same services and products.
On the other hand, we have a monopolistic situation. As long as demand for such products and services
continue the individual firms will achieve profits and sales.
Industries like energy and financial firms face substantial risk of not earning sustainable levels of
profits. Kleffner, et al., (2003) tell us how energy firms are relatively heavy users. More specifically,
since the release of Basel II, banks especially have experienced strong incentives to adopt ERM. This
serves as a valuable commitment device in this industry (Wahlström, 2009). In their study of the level
of ERM adoption, Beasley, et al., (2005) found banking, education and insurance industries are further
into their ERM implementation – all having positive coefficients respectively (1.764, 1.064, 1.476).
Paape and Speklé (2011) also provide consistent results observing firms in the financial sector
(p=0.012) tend to have more sophisticated ERM systems. These three studies correlate with the
theoretical assumption of firms within a competitive industry being more inclined to implement ERM.
4.5 Auditor Influence/ Ownership
The auditing literature proposes the larger auditing firms (i.e the Big 4) provide higher audit quality.
The persuasivenessof these firms push clients to improve their ERMsystems to show their commitment
to risk management (Beasley,et al., 2005). Interestingly, Paape and Speklé (2011) discovered no effect
on ERM development which is at odds with Beasley et al., (2005) who confirm ERM is positively
affectedby the firms’ auditor type. Paape andSpeklé (2011) discovered no effecton ERM development
and assume this is down to the quality of the Dutch CPA being truly world class.
Pressure from external stakeholders is regarded as an important driving force behind the adoption of
ERM programmes (Lam, 2001). In comparison to individual shareholders, institutions exert greater
pressure for the adoption of an ERM programme. Reasoning behind this is because owner-managers
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have less incentive to press for ERM and rely less on formal control systems (Paape and Speklé, 2011;
Lovata and Costigan, 2002). Hoyt and Liebenberg (2008) confirm their expectations of firms with a
higher percentage of institutional ownership engaging more proactively in ERM. The positive
coefficient on institutional ownership proves Lam’s (2001) thinking that pressure from institutional
owners is a driving force behind ERM adoption producing estimates of 0.020; 0.0005. Their use of the
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maximum-likelihood method to estimate ERM engagement avoids potential selectivity bias (See
Appendix 3).
Again, Paape and Speklé (2011) find no effect on institutional ownership. As their sample is derived
from the Netherlands, they tell us how institutional block holders are traditionally reluctant to interfere
with management. Findings from these studies lead us onto our next factor of regulatory influence and
ERM implementation.
4.6 Regulatory Influence
Across different countries, regulation has pressed firms to improve risk management and reporting
(Collier, Berry and Burke, 2006). One example being the Combined Code on Corporate Governance in
the UK. As pressure is largest for publicly listed firms it is therefore expected that these firms are more
likely to adopt ERM (Kleffner et al., 2003). Results gathered by Paape and Speklé (2011) support this
expectation, confirming how publicly traded firms do have more mature ERM systems (p=0.014), in
comparison to owner managed firms who appearless inclined to invest in ERM (p=0.058). At this point
we can refer to previous observations relating to firm size and choice to implement ERM as studies
have proven (Hoyt and Liebenberg, 2003; Pagach and Warr, 2008; Paape and Speklé, 2008).
It is worth noting how ERM frameworks were invented in the United Kingdom, Australia and New
Zealand before the emergence of COSO’s (2004) ERM framework. Hoyt and Liebenberg (2003) have
suggested that firms in the United Kingdom and Canada are more likely to adopt ERM programmes
than those in the US.
4.7 Concluding Comments
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Figure 3
Despite the vast amount of literature on ERM, some organizations still fail to understand its benefits. It
has beenrecognised that the costsand benefits of ERM are firm specific. For this reason,the same ERM
framework which is specific to one firm cannot be prescribed to another (Beasley, et al., 2008). It is
therefore important for policymakers to recognize factors which should be considered before
introducing an ERM programme. Out of the 10 studies reviewed, all recognised the following factors:
firm size, firm complexity, internal influences, firm industries, auditor influence/ ownership and
ERMImplementation
Firm Size
Firm Complexitiy
Internal Influences
Firm Industries
Auditor Influence/
Ownership
Regulatory Influence
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regulatory influence. For organizations to grasp the full benefit of ERM, they must first consider the
above factors when deciding about ERM.
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The Value of Enterprise Risk Management
Although Enterprise Risk Management (ERM) has emerged as a construct which ostensibly overcomes
limitations of silo based traditional risk management – the literature on the effectiveness of ERM is still
in a pre-paradigmatic state. The uncertainty of the concept is further added to by Beasley et al., (2008)
who suggest a definitive statement about the costs and benefits of the term is not possible.
In essence, academics argue that ERM drives value in terms of financial aspects, increasing capital
efficiency and return on equity as well as decreasing earnings and stock price volatility and reducing
external capital costs (Miccolis and Shah, 2000; Lam, 2001). However,Woon et al., (2011) have stated
how these all rely on some critical success factors (CSF), during the implementation phase.
Additionally, writers including Stroh (2005) have told us value is created within non-financial aspects.
For example, better risk awareness, facilitating better operational and strategic decision making.
Consistent with these thoughts, major rating agencies have now increased their focus on risk
management and ERM. In October 2005, Standard and Poor (2005) announced with the emergence of
ERM, risk management would become a major category of its own analysis. Then in 2006, A.M. Best
released a special report describing its increased focus on ERM within the rating process.
Seven studies have been identified which empirically deal with how ERM impacts firm performance.
Four of which have shown correlations in the factorsthey think hold a relationship with implementation
of ERM and firm value (Hoyt and Liebenberg, 2008; Pagach and Warr, 2008; McShane et al., 2011 and
Tahir and Razali, 2011).
Author Date/ Time period Methodology Objective: Impact of
ERM on
Hoyt and Liebenberg 2008/ 2000-2005 ML Method Shareholder value
Gordon, Loeb and
Tseng
2009/ 2005 Linear Regression Performance
Pagach and Warr 2008/ 1992-2004 Linear Regression Performance
Grace, Leverty,
Phillips and Shimpi
2010/ 2004-2006 Linear Regression Performance
Hoyt and Liebenberg 2011/ 1998-2005 ML Method Shareholder value
McShane, Nair and
Rustambekov
2011/ 2004-2008 Linear Regression Shareholder value
Tahir and Razali 2011/ 2007 Linear Regression Shareholder value
Figure 4
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4.8 Size
Tongli et al., (2005) have argued size is positively related to firm performance. This is because larger
firms are more capable of capturing economies of scale aswell asincreasing their currentsize (McShane
et al., 2011; Tahir and Razali, 2011). This is favourable from a shareholders’ perspective as it reflects
their dividend pay-out, resulting in more investment. McShane et al., (2011) have conducted a study
which collects data from 82 insurers disagrees with this thought. Unexpectedly, they find firm size to
be insignificant in their regressions (-0.008). Tahir and Razali’s (2011) study within the Malaysian
market also continues this disagreement producing negative but significant coefficients with firm value
at the 1% level. Adding to this discussion, Rahid and Rahman (2009) suggest how some institutions
only adopt ERM because of requirements set by regulators, meaning size is not always related to the
extent of ERM development.
Reinert’s (1994) Theory of Diminishing Return proposes how small companies are also able to create
value without ERM, producing more profits and attracting stakeholders to invest into the company. All
of this suggests how the size variable and its relationship with firm value is still unclear, needing further
research.
4.9 Leverage
The impact of firm value and leverage after ERM adoption is unclear. On one hand, higher leverage
causes firms financial distress as well as limiting a firms’ flexibility. On the other hand, Aggarwal et
al., (2008) have postulated that leverage can increase firm value as debt forces managers to pay out
funds otherwise invested in a negative project. Agreeing with the thoughts of Aggarwal et al., (2008)
thinking are the conclusions from Fama and French (2002) and Sharma (2006). More recently, Tahir
and Razali (2011) have also shown a positive and significant coefficient at 1% within the Malaysian
market.
Modigliani and Miller’s (1958) theory suggests a return on equity should be increased by a rise in a
firm’s level of debt. However, this is not the case with Rayan’s (2008) and McShane et al., (2011)
studies. Both provide findings showing an inverse relationship between leverage firm value. More
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specifically, McShane et al., (2011) prove leverage to be significantly related to value at -0.505. Both
of these studies contradict significant prior research Tahir and Razali and Aggarwal et al., (2008)
thinking. Whilst the studies used provide mixed results, we are able to see how leverage can increase
firm value as it sways managers away from damaging decisions. As well, the rejection of Modigliani
and Miller’s (1958) theory confirms ERM’s evolutionary state.
4.10 Profitability
In finance, profitability is the ability of the firm to generate earnings. Looking at a firms’ assets,
profitability allows managers to assess how adequately their operations are performed. The three most
accepted financial ratios which profitability is derived from are; profit margin, return on equity (ROE)
and return on assets (ROA). All showing how companies are able to generate revenue from the
investment of assets. As with leverage the effect of ERM implementation on profitability is ambiguous.
An improved co-ordinated management and loss avoidance can result in the boosting of profits as
avoidable losses are reduced. Furthermore, if firms show good returns there will be an increased
attraction in investments. Pagach and Warr’s (2008) study of 106 U.S. companies uses ROE as a proxy
for profitability observing a statistically significant increase in ROE by 16.55%. Consistent with these
results are those from McShane et al., (2011) study who also discover a positive and significant
relationship between profitability and firm value (0.019).
Yet, Tahir and Razali’s (2011) results disagree with this. Using ROA as a proxy of profitability they
discover an inverse relationship between profitability and firm value. Thus, being negative and
significant at 1%. Tahir and Razali (2011) give reason to this informing us how paying interest is
compulsory for the firm and hence affect the net profit of the company. Although we have two
conflicting views present,it is important to note how profitability is not static from yearto year,meaning
conclusions on how valuable ERM is in terms of profitability cannot be finalised.
4.11 Growth Opportunities
Writers have argued that risk management can be value creating as it aides the firm in avoiding the
direct and indirect costs, thus providing opportunities for profitable growth (Allayannis and Weston,
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2001; Stulz, 2003). Having smoother and steadier earnings firms are able to increase leverage and
pursue more growth options. Pagach and Warr (2008) have also suggested a positive relationship -
‘firms with growth options have much of the value tied to the future, and as yet, unreached cash flows’.
Yet it is surprising to discover the opposite of what has been suggested above. In their study Pagach
and Warr(2008) proxy growth options using the market-to-book (MB)ratio which indicates to investors
how valuable a firm is as well as research and development expense and find that their results reject
previous assumptions (See Appendix 4). The study conducted by Bertinetti et al., (2013) coincides with
these weak findings. Using the Tobin's Q as their dependant variable they also include a
SALESGROWTH variable. This is measured as the historical (one-year) sales growth and is used as a
proxy for future growth opportunities. According to Lang and Stulz (1994) the Tobin’s Q is a dominant
and advantageous performance measure as it is free from managerial manipulation. Their results show
that SALEGROWTH does not affect Tobin’s Q (See Appendix 5) (Bertinetti et al., 2013).
Although proponents argue that ERM allows firms to seize opportunities, there is lack of evidence
which supports these thoughts. Both of these studies show how even after ERM adoption firms still fail
to grasp greater investments in opaque assets which have opportunities for growth.
From the seven studies above, specific characteristics have been recognised to aid our understanding of
ERM implementation and value creation. However,it is also important to gather the key overall findings
from each study.
4.12 Key Findings
A significant and positive relationship between shareholder value (SHV) and ERM is represented in
three studies (Hoyt and Liebenberg, 2008; Gordon et al., 2009 and Hoyt and Liebenberg, 2011). Hoyt
and Liebenberg’s (2008) study of 125 U.S. insurers provides univariate results which, on average,
shows insurers with ERM programmes valued approximately 6% higher than other insurers.
Furthermore, in their later study Hoyt and Liebenberg (2011) find a positive and highly significant
impact of ERM resulting in higher shareholder value of approximately 17% to 20%. Both of these
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studies are partly consistent with McShane et al., (2011) study who agree, but only in the case of
traditional risk management (TRM).
Additionally, four regressions are performed to investigate the relationship between ERM rating and
firm value. Together,all regressions indicate a positive relationship betweenERM rating and firm value
up until ERM3. McShane et al., (2011) find no significant difference in firm value and have suggested
ERM4 and ERM5 indicate a move beyond TRM to ERM. Overall suggesting an increasing rating up to
ERM3 is value creating but beyond this point there is no apparent increase in firm value. Posing the
question – why does a strong ERM rating not lead to high firm value?
Continuing, Gordon et al., (2009) develop an ERM Index (ERMI) based on the four objectives COSO
have suggested for ERM (See Appendix 6). Using this index Gordon et al., (2009) measure the
effectiveness of an organization’s ERM based on its ability to achieve its objectives. Accordingly, if
firms were to choose the ‘best practise’ match between their ERM and its contingency variables, they
would improve their opportunity for high performance.
The two-year study carried out by Grace et al., (2010) focuses solely on the insurance industry. Doing
this provides a homogenous value of firms, giving a better measurement of a firms’ growth
opportunities. Focusing on cost efficiency and revenue efficiency as a proxy for performance they find
a significant positive effect on ERM on cost and revenue efficiency. Interestingly, Grace et al., (2010)
discover how both a Chief Risk Officer(CRO)and risk committee have a significant and positive effect,
however, dependant on the location of a firms, headquarters.
Tahir and Razali’s study (2011) provides an insight into the relation between ERM and firm value
amongst Malaysian public listed companies. Their firm value regression results report a positive
insignificant relationship between ERM and firm value. Thus rejecting previous emphasis on the
importance and benefits of ERM (1.031). Although these results reject previous emphasis on the
importance and benefit of ERM, Tahir and Razali’s (2011) is accompanied by limitations. Focusing on
only one year and specifically in the Malaysian market their findings do not offer an overall
understanding of the relation between ERM and firm value.
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4.13 Concluding Comments
From looking at four specific studies it is noticeable how specific firm characteristics help to enhance
an organizations value through ERM implementation. However,a firms’ size and its available growth
opportunities which writers such as Allayanis and Weston (2001) and Tongli et al., (2005) have
positively assumed to increase a firms’ value under ERM adoption have been rejected. Additionally,
Reinert’s (1994) theory of diminishing return suggests how small companies can also be value creating
without the implementation of ERM. This proves an interesting area for future research. Conflicting
value creating results also show how ERM is still evolving and is at different stages within each
countries (Hoyt and Liebenberg, 2008; Gordon et al., 2009; Pagach and Warr, 2008; Hoyt and
Liebenberg, 2011; McShane et al., 2011; Tahir and Razali, 2011; Grace et al., 2010). Focusing on the
overall key findings, it is evident how ERM does create value within certain parts of firms, albeit in the
U.S or Europe.
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5. Analysis and Critical Discussion.
‘All entities face uncertainty, and the challenge for management is to determine how much
uncertainty to accept as it strives to grow stakeholder vale’ (COSO, 2004).
From the literature review we can assume how the underlying premise of enterprise risk management
(ERM) is how an entity exists to provide some sort of value, and does so being a multi-directional and
iterative process.
ERM encompasses:
1. Improving deployment of capital
2. Reducing operational surprises and losses
3. Enhancing risk response decisions
4. Cross identifying and managing multiple enterprise risks
5. Enhancing risk response decisions
6. Seizing opportunities
In terms of how the findings of this literature review are received all depend on the roles and
responsibilities of individuals.
5.1 Practising Managers
As organizations encounter risk every day and the complexity of risks are increasing, ERM has been
portrayed as a concept which is needed for an organizations survival. Reviewing the literature so far,
practising managers considering ERM must deal with one fundamental question – ‘how much risk is
deemed acceptable in pursuing their objectives?’. Therefore, a primary suggestion for managers is to
accept and develop a risk appetite within their entity.
Senior Management – The reviewed literature has pointed to the importance of chief executives and
chief risk officers (CRO) being the driving forces behind ERM implementation. Although they show
commitment to ERM practises, the literature tells us how in some cases, critical ERM activities are
sometimes ignored.
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In order to keep up with the growing complexity of risks emerging it may be beneficial for the senior
management carry out an ongoing monitoring process. This ongoing procedure of reviewing and
updating an organizations risk appetite helps create an organizational culture which is risk aware and
has organizational goals consistent with the board. Alongside this process, they could periodically
revive their organization’s code of conduct alongside up to date employee training sessions and
feedback mechanisms. This would help continue their organization in a forward direction alongside
their ERM practises
Board of Directors – Finding balance to oversee an organization’s enterprise-wide management as well
as creating value is a primary challenge for the board which is why they must fully understand the state
of the entity’s ERM. The importance of firm specific characteristics has been pointed to throughout the
literature, albeit size, operating country or the complexity of the firm (Beasley et al., 2007). However,
the importance of an organizations’ internal environment has been shadowed to some extent.
An organizations’ internal environment sets the basis for how risks and control of these are addressed
by individuals within the organization. As well as looking to a firm’s externalcharacteristics,the board
may find it beneficial to observe individuals within the organizations. One suggestion for future
research may be to investigate whether the core of a business relies on its people and their individual
attributes? Additionally, communicating a risk appetite for different categories of risk will enable the
board to differ, creating a management philosophy relating specifically to the individual firm and its
culture.
5.2 Academics
The literature review has pointed to correlations between the review studies as well as highlighting
areas which spawn a considerable number of questions and areas which academics may benefit from in
future research.
Firstly, in McShane et al., (2011) study the authors find evidence of a positive relationship between
increasing levels of traditional risk management (TRM) capability, however no additional increase in
value for firms who adopt a higher ERM rating. Firstly, is TRM still applicable to organizations today?
27. 27
What types of organizations work better under TRM or ERM? Why does a strong ERM rating not lead
to higher firm value?
A second observation from the literature review is the continuous evolving nature of ERM (Frigo and
Anderson, 2011; Hoyt and Liebenberg, 2011; Farrell and Gallagher, 2015). It was suggested how a
firms’ complexity on both an industrial and international level would increase ERM implementation
amongst organizations. However, studies from Hoyt and Liebenberg (2011) and Farrell and Gallagher
(2015) show the inability of ERM being implemented acrossdifferentborders. Therefore,studying what
restricts the success of ERM across international boundaries may prove valuable as well as focusing on
what factors push ERM to continuously evolve.
A main observation and suggestion for academics to consider is the conducting of studies which are
located elsewhere than the U.S. The majority of the studies used for this narrative literature review
focus largely within the U.S.,and although the inclusion of Paape and Spekle (2011), Tahir and Razali
(2011) add a European and Asian perspective, we are not grasping the overall impact of ERM. In order
to understand what ERM fully entails, studies must be conducted elsewhere within the world.
5.3 Policy Makers
In terms of what has been spoken about throughout the literature review and how these findings create
implications for policy makers, one of the main observations is how ERM is a continuously developing
which will continue to evolve in the coming years.
Turning attention specifically to the UK and the result of the referendum it can be suggested how policy
makers should begin adaptive planning for various Brexit scenarios. One key risk issue AON (2016)
has pointed to for policy makers relates to programme responses. The British pound has already been
recognised to have depreciated plunging to its lowest level immediately after Brexit. This being the
lowest after three decades,describing the consequences for the realeconomy as comparable only to the
financial crisis of 2007-2008 (Economia, 2016a). Yet, Lannoo (CEO, Centre for European Policy
Studies) has claimed an advantage of the referendum is policymakers in other EU member states will
receive clearerBritish positions, in terms of EU action (Economia, 2016b). If policies are able to evolve
28. 28
along with ERM in response to Brexit, UK industries will have a chance of coping with the exit from
the European market. Overall, it is difficult to relate implications of the literature review for policy
makers on a global scale, however we are able to allude to some of the ramifications for UK policy
makers in terms of Brexit.
29. 29
6. Conclusion.
The increasing complexity and unpredictability of the current economic environment is a daily reminder
of the vast amount of risks organizations are now facing. Reviewing the literature on what influences
organizations to carry out ERM the following six factors are seen as dominant; firm size, firm
complexity, internal influences, type of industry, auditor influence/ ownership and regulatory influence.
Despite the vast available publications on ERM, those detailing the effectiveness of the concept are still
in a pre-paradigmatic state. Writers like, Miccolis and Shah (2000) and Stroh (2005) have pointed to
both financial and non-financial value implications for organizations adopting ERM.
Being able to selectspecific studies helped to identify gaps in presentresearch.Itis noticed how smaller
entities are somewhat ignored when it comes to effective ERM, therefore future research would be
beneficial in this area. Secondly, the study by McShane et al., (2011) which uses Standard and Poor’s
(2005) maturity model discovered how ERM was not value creating, with traditional risk management
(TRM) being more beneficial. As well, Grace et al., (2010) study hints at ERM being more valuable
alongside a Chief Risk Officer (CRO) and the location of a firms’ headquarters. As this was the only
study to pick up on this, ERM literature would benefit from future research in this area.
Alongside these gaps were also limitations. The majority of the literature swayed more towards the US
meaning the review is largely based on how US organizations are implementing and dealing with ERM.
This is not to say how other countries are facing less risks, as proven by the UK’s recent decision to
leave the EU (Veysey,2016). There were studies which added a European and Asian perspective to the
review (Paape andSpeklé, 2011; Tahir and Razali, 2011). The majority of the studies used in this review
carried out linear regression models and maximum likelihood methods. Even though this is not a major
limitation, reducing methodological diversity may have led to a parsimonious conclusion of ERM.
30. 30
7. Learning Statement.
‘Unless [we] develop the practise critical reflection, [we] stay trapped in unexamined judgments,
interpretations, assumptions, and expectations’ (Larrivee, 2000).
Developed by Mezirow (2000), transformational learning places emphasis on how we make meaning
(and decisions to act) from experience. Critical reflection is therefore an essential part of this process.
Critically reflecting the SBA processallows an opening up of newperspectives and choices about ERM
implementation and as well as enabling and understanding of how socially dominant assumption of the
concept can be socially restrictive at times (Fook, 2010). Under the climate of ‘reflective discourse’,
which includes access to accurate information, ability to weigh evidence and assess arguments
objectively as well as being open to other perspectives, the effectiveness of my critical reflection has
been maximised. Primarily, when selecting the subject of enterprise risk management (ERM), the
majority of articles recognised the need for this concept in response to the level of risk organizations
are now exposed to. It was interesting to discover then, a drop in ERM publications because of the
emphasized importance and need for ERM up until this point. Observations like the ones made by Choi
et al., (2015) were however, useful, driving a deeper investigation of ERM.
Being the first opportunity to investigate ERM, it was difficult to understand who the prominent writers
were in order to enhance the value of this literature review. Using Choi et als., (2015) paper asa starting
point it was then more clear to which writers work I should be looking to include. Secondly, being
described as an ‘umbrella concept’ it was easy to become diverted on what should be more focused on
and confused with certain terms. (Power, 2009). For example, the types of risks which a specific ERM
practise addresses.While this is important to understand, this literature mainly sought to revolve around
the overall impact of ERM on firm value, not specifics.
Another major difficulty of carrying out this review was understanding statistical results gathered to
find either correlations or anomalies. In particular papers from McShane et al., (2011) and Pagach and
Warr (2008). Even though both provided key findings, understanding their coefficients and combining
these to other studies proved challenging. Difficulty was further contributed to with there being only
four papers which focused on the same firm specific characteristics and ERM value. This meant
31. 31
conclusions were hard to draw, especially there has been an open approach to assessing differing
arguments and perspectives throughout this thesis.
Looking at these difficulties, a number of recommendations have been developed. Firstly, the goal of
the literature reviewwould be changedfrom surveying the state of the knowledge of ERM to developing
a theory of ERM (Baumeister and Leary, 1997). Doing so would help propose a novel theory of ERM.
Included in this would be an investigation into the differing types of risk an organization faces; inherent
risks, residual risks and diversifiable risks (Henry and Simkins, 2007). This would also help to finish
on a specific conclusion.
In terms of who will benefit from this narrative literature review, I would hope future employers would
be at the forefront.Future careerpathswas one main reason ERM was chosen to be reviewed. By taking
time to delve deep into various studies and understand the evolution of ERM, I aspire to show future
employers the passion I possess for risk management. Finishing the review on how the recent Brexit
move will affectERM,I also wish to show how I am a forwardthinking individual on the topic of ERM.
Alongside future employers, I hope to prove to myself how by taking the time and effort to understand
a never encountered concept, I am able to conduct myself in a professional manner when it comes to
discussing ERM with others. Furthermore, for future students interested in the subject of ERM, I would
hope my narrative review would be a good introduction into the world of ERM.
32. 32
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9. Appendix.
9.1 Appendix 1:
Traditional Risk Management Enterprise Risk Management
Individual hazards Viewed in the context of business strategy
Risk identification and assessment Risk portfolio development
Focus on discrete risks Focus on critical risks
Risk limits Risk optimization
Risks with no owners Defined risk responsibilities
9.2 Appendix 2:
Author Date Type Focus
Hoyt and
Liebenberg
2003 Quantitative including
26 firms in the US
Looks at determinants of ERM adoption
including firm size, firm industry, average
leverage, earnings volatility, stock price
volatility, financial opacity, average insitutional
ownership and subsidiaries countries.
Kleffner, Lee
and
McGannon
2003 Qunatitative influcing
118 firms in Canada
Examines the use of ERM including the
charasteristics associated with the use, obstacles
when implementing ERM and the role of
corporate governance guidelines.
Beasley et al 2005 Quantitative including
123 firms in the US
Influential factors on extent of ERM adoption
including presence of CRO, board of directiors,
firm industry, firm country, firm size and audtor
firm type.
Hoyt and
Liebenberg
2008 Quantitative including
275 insurance firms in
the US
Estimates the effect of ERM on Tobin’s Q for
firm value for publicly traded insurers in the
US.
Paape and
Spekle
2011 Quantitative including
825 organizations in
the Netherlands
Examines the extent of ERM implementation
and the factors which are associated with cross-
sectional differences in the level of ERM
adoption.
Pagach and
Warr
2008 Quantitative including
138 firms in the US
Inspects charasteristics of firms who hire chief
risk officer (CRO).
Eckles, Hoyt
and Miller
2014 Quantitative including
354 insurance firms in
the US
Focus on the insurance industry to test whether
practising ERM reduces firms’ cost of reducing
risk.
Gottwald and
Mensalh
2015 Quantitative including
134 valid repsonses
from North America
Investigates implementation across several
industries and in organizations of various sizes.
Including the role of a CRO, presence of an
audit committee (AC) and the support of top
management (TM).
Farrell and
Gallagher
2015 Data from Risk and
Insurance
Management Society
Risk Maturity Model
with 225 unique
respondents
Analyzes valuation implications of ERM
maturity.
38. 38
Ping and
Muthuveloo
2015 Quantitative including
103 questionnaires in
Malaysia
Focuses on the implementation of ERM on firm
performance of Public Listed Companies
(PLCs).
9.3 Appendix 3:
ERM Engagement = f (Size, Institutional Ownership, Diversification, Industry, etc.)
9.4 Appendix 4:
MB = Market Value of Equity/ Book Value of Equity
RD = Research and Development Expense / Total Assets
9.5 Appendix 5:
Qit = α+β 1ERM+β 2SIZE+β 3LEVERAGE+β 4SALESGROWTH+β 5ROA+β 6DIVIDENDS+β
7BETA+ε it
Where i represents the company and t the time (years 2002-2011).
9.6 Appendix 6:
COSO Four Objectives
1. Strategy: high-level goals, aligned with and supporting the organization’s mission.
2. Operations: effective and efficient use of the organization’s resources.
3. Reporting: reliability of the organization’s reporting system.
4. Compliance: organizational compliance with applicable laws and regulations.
