What Is The Relationship Between Enterprise Risk Management & Corporate Performance?
Despite the proven effectiveness of Enterprise Risk Management (ERM) and the pivotal role of risk management professionals, many companies have yet to fully embrace ERM practices or integrate them into their strategies, policies, frameworks and processes. This reluctance may be attributed to a lack of understanding resulting in the difficulty that some firms face in justifying the time and effort they perceive ERM requires, and are unable to allocate the resources required to make ERM effective. ERM may also lack a champion where it counts; thus, enterprise risk management as a risk management tool remains low on the firm’s priority list.
Perhaps what is required is a demonstration of the clear link between enterprise risk management and a firm’s performance. The consequences of the 2008-2009 global economic crisis offer many examples of how ERM, appropriately applied, could have helped avoid the collapse of established financial bodies like Bear Sterns and Lehman Brothers. Even today, more robust application of ERM and more stringent Board oversight, can nip potential problems in the bud. But how can the corporate value of enterprise risk management gain traction?
Board and management may agree in principle on the need and importance of ERM. In some jurisdictions, there are regulations on this which require that such functions are in place, and compliance may be mandatory. But mere box-ticking because it is compulsory is a short-sighted approach because as businesses expand, more extensive, sophisticated processes and procedures become necessary to deal with the growing complexity that inevitably challenge organisations.
Risk management professionals may therefore want to concentrate first on “plucking the low-hanging fruit” – i.e., applying ERM in the quickest, most expedient manner in order to produce quick results. One way of doing this and demonstrating the effectiveness of ERM is to apply it in one department or unit first, to show that it works in small-scale projects. Success at this level is likely to jump-start awareness of ERM, although acceptance may be slow initially. It can then be replicated to show scalability. Risk professionals working to achieve greater recognition for ERM could also quote other success stories.
These should demonstrate where its application, coupled with Board oversight and improved organisational performance, succeeded in creating value and maintaining the firm’s competitive edge. Research has shown that where Board oversight of ERM was present and consistent, ERM helped the organisation to preserve value. Although other factors, such as the composition of the Board and the skill sets of its members also contributed to better performance, results also pointed to ERM playing a part in enhancing members’ performance. In fact, there was evidence that the larger the organisation, the more it needed ERM.
While internal and external dynamics of an organisation play a part in the effectiveness of ERM, its correct application allows the firm to reduce costs by flagging possible hotspots in a timely manner, and applying suitable mitigative measures. ERM facilitates internal control systems, and helps the business develop a customised strategy for its operations and sustainability, thus enhancing its competitiveness. By identifying risks that could prevent the firm from achieving its objectives, it also points out possible opportunities that could increase the value of the firm.
Knowing where risks lie is crucial to firms in today’s business environment; ERM helps top management identify and deal with different risks according to character and severity. Correctly applied, ERM prepares an organisation for the unexpected, and keeps it flexible – which is pivotal to its sustainability. It lays out options for the best course of action, thus enabling businesses to plan ahead and avoid disruption, or at least decrease its negative impact. In an environment of uncertainty, firms need to be agile and flexible, or risk losing a large chunk of their value that they may not be able to recoup later.
This becomes critical in the light of sustainability and the need to increase shareholder value. For this, firms need to increase – or at least maintain – their competitive advantage. Because ERM practices essentially support decision-making, planning and control, it is a cornerstone of organisational strategy as well. While it helps the firm strategise through risk identification and mitigation, this enhances the firm’s reputation and public image. Board and management need to recognise how these components align, and how indispensable ERM is, in bringing them all together.
Corporate success today does not depend exclusively on financial performance, the reduction of costs or high returns on investment. Although these may be the focus of the organisation’s shareholders, there are also the interests of a wider community of stakeholders to consider. These interests may be primarily non-financial in nature, but they do impact the firm’s bottom line, perhaps not immediately, but in the long term. When it comes to strategising for the future, integrating ERM practices with long-term planning can result in reductions in cost, more efficient operational management and accurate documentation.
Board and management need to be aware of how ERM is capable of moving the firm towards gains in competitive advantage, which reflect favourably on corporate performance. Besides increasing the value of the business, ERM also aligns risk management and organisational strategy. While it identifies the various risks that confront the firm, it also points out which could possibly be leveraged to the firm’s advantage. Firms are always looking to increase shareholder value; this dovetails with a major objective of ERM.
Improving capital efficiency by correctly allocating resources; informing decision-making by identifying high-risk, high-exposure areas; suggesting mitigative measures – all boost confidence in the firm’s management capabilities, and shore up support for its continued corporate performance. More than that, it builds investor confidence, and demonstrates to shareholders and stakeholders alike that the organisation is sound, and likely to continue being so because it is ably managing its risks.