The Impact of Enterprise Risk Management on the Marginal Cost of Reducing Risk: Evidence from the Insurance Industry

43 Pages Posted: 18 Apr 2014

See all articles by David L. Eckles

David L. Eckles

University of Georgia - Department of Insurance, Legal Studies, Real Estate

Robert E. Hoyt

University of Georgia - C. Herman and Mary Virginia Terry College of Business

Steve Miller

USF Sarasota-Manatee

Date Written: April 16, 2014

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.

Keywords: Risk management; Enterprise Risk Management; Financial Institution; Insurance

JEL Classification: G22; G28; G32

Suggested Citation

Eckles, David L. and Hoyt, Robert E. and Miller, Steve, The Impact of Enterprise Risk Management on the Marginal Cost of Reducing Risk: Evidence from the Insurance Industry (April 16, 2014). Journal of Banking and Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2425904

David L. Eckles

University of Georgia - Department of Insurance, Legal Studies, Real Estate ( email )

Athens, GA 30602-6254
United States

Robert E. Hoyt

University of Georgia - C. Herman and Mary Virginia Terry College of Business ( email )

Athens, GA 30602-6255
United States
706-542-4290 (Phone)
706-542-4295 (Fax)

Steve Miller (Contact Author)

USF Sarasota-Manatee ( email )

Sarasota, FL
United States

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