Enterprise Risk Budgeting - Bringing Risk Management into the Financial Planning Process

Journal of Applied Finance, Spring/Summer 2009

30 Pages Posted: 28 Jun 2009 Last revised: 1 Jul 2009

See all articles by Alf Alviniussen

Alf Alviniussen

Independent

Håkan Jankensgård

Lund University - Department of Business Administration; Knut Wicksell Centre for Financial Studies

Multiple version iconThere are 2 versions of this paper

Date Written: May 20, 2009

Abstract

Enterprise Risk Management (ERM) is a holistic, integrated approach to managing a company's risks, in contrast to the so-called "silo-approach" prevalent in many firms in which risks are managed independently of each other. Yet for all the risk exposures that are brought under the corporate umbrella in an ERM-initiative, it may be inadequate for addressing the firm’s aggregate risk in terms of the probability of failing to meet important corporate objectives, such as implementing the business plan or protecting debt covenants. In this paper we present a quantitative approach to risk management in the non-financial firm that retains the integrative, enterprise-wide mindset, yet also equips Corporate Management with the ability to evaluate financial distress-probabilities by incorporating ideas related to the concept of a firm's Economic Capital. We term such an effort Enterprise Risk Budgeting (ER-B). ER-B makes possible an ongoing re-assessment of the firm's expected financial position and overall risk profile, and in particular how these change as a result of corporate policy decisions, for example relating to capital expenditure, acquisitions, dividends, and hedging. The transparency created by such a tool increases the likelihood that Management makes sound proactive decisions with respect to its risk profile, rather than reacting to challenging circumstances once they occur. We illustrate using the experiences of Norwegian aluminium producer Norsk Hydro.

Keywords: Enterprise Risk Management, Risk Budgeting, Economic Capital, Risk Measures

JEL Classification: G30, G32

Suggested Citation

Alviniussen, Alf and Jankensgård, Håkan, Enterprise Risk Budgeting - Bringing Risk Management into the Financial Planning Process (May 20, 2009). Journal of Applied Finance, Spring/Summer 2009. Available at SSRN: https://ssrn.com/abstract=1426023

Alf Alviniussen

Independent

No Address Available

Håkan Jankensgård (Contact Author)

Lund University - Department of Business Administration ( email )

Box 117
SE-221 00 Lund, S-220 07
Sweden

Knut Wicksell Centre for Financial Studies ( email )

Box 7080
Lund, SE-220 07
Sweden

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