A theory of enterprise risk management

• DOI: https://doi.org/10.1108/CG-02-2018-0092
• Pages: 565-579
• Date: 12 March 2019
• Published date: 12 March 2019
• Author: Håkan Jankensgård
• Subject Matter: Strategy

A theory of enterprise risk management

Håkan Jankensgård

Abstract

Purpose –The purposeof this paper is to develop a theory of enterpriserisk management (ERM).

Design/methodology/approach –The method is to develop a theory for ERM based on identifying the

general risk management problems that it is supposed to solve and to apply the principle of deduction

based on thesepremises.

Findings –ERM consists of risk governance,which is a set of mechanisms that deals with the agency

problem of risk management and risk aggregation, which is a set of mechanisms that deals with the

informationproblem of risk management.

Research limitations/implications –The theory,by identifying the central role ofthe Board of Directors,

encourages further research into the capabilities and incentives of directors as determinants of ERM

adoption. It also encouragesresearch into how ERM adoption depends on proxiesfor agency problems

of risk management,such as a decentralized company structure.

Practical implications –The theory encourages Boardsof Directors to focus on understanding where

the under and over management of risk are likely to be greatest, as opposedto the current practice of

mappinga large number of risk factors.

Originality/value –The theory complements existing theory on corporate risk management, which

revolves around the role of external frictions, by focusing on internal frictions in the firm that prevent

effectiverisk management. It is the first work to delineate ERM vis-a-vis existingrisk theory.

Keywords Board of directors, Enterprise risk management, Risk governance, Economic capital

Paper type Research paper

Enterprise risk management (ERM) is, at a fast clip, establishing itself as the

dominant paradigm of corporate risk management. The past two decades have

witnessed a large increase in the demand for ERM and improved governance of

firms’ risks more generally. Pressure from outside stakeholders has been an important

influence on this development reflecting corporate scandals involving excessive risk-

taking (Gates, 2006).

The distinguishing feature about ERM is that it represents risk management as viewed from

the perspective of the firm’s top executives and directors. It is not about project risk or

investment risk or any particular risk. The perspective taken is rather how to manage the

net, aggregated risk exposures of the entire enterprise and how to frame the firm’s

willingness and capacity to accept suchexposures.

In this paper, I submit a theoretical analysis of ERM. The analytical tools of corporate

finance are used to derive a description of two generalrisk management problems faced by

firms. ERM is proposed as the solution adopted by the firm’s Board of Directors to address

these problems, which revolve around agency and information asymmetries within the firm.

Because of these imperfections, a firm may engage in formal risk management even when

external frictions are absent or fail to use risk management when external frictions are at

hand. The theory therefore complements traditional corporate risk management theory,

which focuses on eliminating the effects of frictions that exist outside the firm, such as taxes

or contracting problems between the firm and other market actors (Smith and Stulz, 1985;

Froot et al., 1993).

Ha

˚kan Jankensga

˚rd is

based at Lunds Universitet,

Helsingborg, Sweden.

Received 18 February 2018

Revised 19 August 2018

7 November 2018

Accepted 7 January 2019

DOI 10.1108/CG-02-2018-0092 VOL. 19 NO. 3 2019, pp. 565-579, ©Emerald Publishing Limited, ISSN 1472-0701 jCORPORATE GOVERNANCE jPAGE 565