Companies Apply Risk Management For Many Reasons Essay

Companies Apply Risk Management For Many Reasons Essay

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Companies apply risk management for several reasons. Some of these analytical causes include reducing tax payments, lessening financial distress, underinvesting, moderating nonsymmetrical data, diminishing undiversifiable shareholders, managerial risk aversion, alleviating agency costs, and enabling to perform net present value (NPV) projects – where external financing is more expensive than the internal one (McShane, Nair & Rustambekov, 2010; Mayers and Smith, 1982; Stulz, 1984; Smith and Stulz, 1985; Froot, Scharfstein and Stein, 1993; and Myers, 1977).

The idea of risk management is rooted to challenge the “theory of irrelevance propositions” theorized by Modigliani & Miller (1958) which claims that any financing policies and decisions are ineffective under perfect market conditions. Financial scholars and researchers initiated considerable studies on how risk practices affect firms and how imperfect market conditions exist. For example, an early study of Cassidy, Constand and Corbett (1990) reveals that organizing event analysis is a risk management process which is crucial for shareholders. Apart from them, Mackay and Moeller (2007) deliver empirical evidence that risk management is value strengthening (as cited in Serkerci, n.d). Smithson and Simkins (2005) also presented a literature of the value-relevance of risk management by examining ten studies and by the most relevant to this research is the relationship between the firm 's value and risk management. Categorizing the papers in four groups, the first two are for the purpose of investigating effect of managing interest rate and foreign exchange rate on firm value. This group reports a positive relationship between risk management and value of the firm. The las...

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...eved during the long run. In such a ground work, companies who are adopting ERM are expected to compare the changes in the volatility throughout the years. Then, the relationship of ERM and volatility variances can be therefore attained by the values of return on capital and surplus (ROCS), combined ratio (CR), and operating ratio (OR). The said variables, again, are tested for insurance companies.

Waweru and Kisaka (2011) demonstrate enterprise risk management as a strategic plan rather than a corporate governance compliance. In addition, they detect an important correlation between an appointed Chief Risk Officer and the level of enterprise risk management (ERM) on a company. Subsequently, their last settlement strengthens the presence of enterprise risk management (ERM) to the value of companies, especially for those which are listed in the stock exchange.

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