Lundqvist (2015), Why firms implement risk governance–Stepping beyond traditional risk management to enterprise risk management Flashcards
What is Risk Governance?
Risk governance refers to the direction and control of the risk management system. It defines the structure, responsibilities, authority, accountability, rules, and procedures for risk-related decision-making. It’s described as the marriage of corporate governance and risk management.
Why is Risk Governance important?
It addresses agency problems between owners and managers by guiding risk-taking behavior and increasing transparency and stakeholder confidence in the company.
What is Enterprise Risk Management (ERM)?
ERM is a step beyond traditional risk management where additional efforts are made by the firm to unite the risk management process organizationally across internal systems, processes and people. Given that ERM is a composition of traditional risk management and risk governance. Risk governance (=Corporate governance + risk management).
How does ERM differ from traditional risk management?
Traditional risk management is silo-based and informal. ERM is integrated and includes risk governance, formal procedures, and cross-organizational coordination.
What are some components of ERM?
- Risk identification & assessment
- Internal control systems
- Clear risk appetite
- Senior management and board involvement
- Communication and centralized structure
What external factors drive ERM implementation?
- Sarbanes-Oxley Act (2002)
- NYSE standards for audit committees
- SEC disclosure rules
- Pressure from rating agencies (e.g., S&P), regulators, and auditors
What internal factors affect risk governance
- Firm size (positive effect)
- Leverage (negative effect)
- Dividend payments (negative effect)
- CEO presence on board (negative effect)
- Managerial incentives & governance structure
Why is size positively related to risk governance?
Larger firms face higher agency problems and have more resources to implement structured governance mechanisms.
Why is leverage negatively related to risk governance?
Highly levered firms have less free cash flow, so managers have fewer opportunities for self-interest, reducing the need for tight governance.
How do dividends relate to risk governance?
Dividends reduce available cash, thus limiting agency problems and decreasing the need for extra governance. Firms with lower growth options (mature firms) may also be less likely to implement ERM.
How does CEO presence on the board affect risk governance?
CEOs on the board may oppose stricter oversight, leading to lower ERM implementation due to reduced board independence.
What is the feedback effect between risk governance and leverage?
Firms with strong risk governance in one year tend to hold more leverage the following year, suggesting that governance may increase debt capacity.
Why might smaller firms struggle with risk governance?
They often lack the resources or expertise to implement holistic frameworks like ERM effectively
The three main risk problems
