The impact of enterprise risk management on the marginal cost of reducing risk: Evidence from the insurance industry

David L. Eckles, Robert E. Hoyt and Steve M. Miller

Journal of Banking & Finance, 2014, vol. 43, issue C, 247-261

Abstract: We test the hypothesis that practicing enterprise risk management (ERM) reduces firms’ cost of reducing risk. Adoption of ERM represents a radical paradigm shift from the traditional method of managing risks individually to managing risks collectively allowing ERM-adopting firms to better recognize natural hedges, prioritize hedging activities towards the risks that contribute most to the total risk of the firm, and optimize the evaluation and selection of available hedging instruments. We hypothesize that these advantages allow ERM-adopting firms to produce greater risk reduction per dollar spent. Our hypothesis further predicts that, after implementing ERM, firms experience profit maximizing incentives to lower risk. Consistent with this hypothesis, we find that firms adopting ERM experience a reduction in stock return volatility. We also find that the reduction in return volatility for ERM-adopting firms becomes stronger over time. Further, we find that operating profits per unit of risk (ROA/return volatility) increase post ERM adoption.

Keywords: Risk management; Enterprise risk management; Financial institution; Insurance (search for similar items in EconPapers)
JEL-codes: G22 G28 G32 (search for similar items in EconPapers)
Date: 2014
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (39)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:43:y:2014:i:c:p:247-261

DOI: 10.1016/j.jbankfin.2014.02.007

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