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

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

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.

Suggested Citation

  • Eckles, David L. & Hoyt, Robert E. & Miller, Steve M., 2014. "The impact of enterprise risk management on the marginal cost of reducing risk: Evidence from the insurance industry," Journal of Banking & Finance, Elsevier, vol. 43(C), pages 247-261.
    • Handle: RePEc:eee:jbfina:v:43:y:2014:i:c:p:247-261
    DOI: 10.1016/j.jbankfin.2014.02.007
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    More about this item

    Keywords

    Risk management; Enterprise risk management; Financial institution; Insurance;
    All these keywords.

    JEL classification:

    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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