A Conceptual Framework for Value Enhancing Enterprise Risk Management

Enterprise risk management (ERM) is a new management concept fast ascending the corporate agenda globally. Its relevancy and popularity as a management technique are abetted by the changing business practices and burgeoning regulatory requirements on risk management. The shift in paradigm in heightened risk awareness in the wake of several high profile and deep impact corporate governance scandal and financial mismanagement cases as well as increased terrorist threat on the physical assets of organizations has compelled firms to be more pro-active in addressing risk issues. ERM is defined as the process of identifying and analyzing risk from an integrated, company-wide perspective. It is a structured and disciplined approach in aligning strategy, processes, people, technology and knowledge with a purpose of evaluating and managing the uncertainties the enterprise faces as it creates value. It focuses risk management function from primarily defensive to increasingly offensive and strategic in nature. However, the neo-classical finance theory (NCFT) postulates that firm-specific risk is irrelevant and that only the covariance of the firm’s asset returns to the market portfolio which is measured by the beta in the capital asset pricing model (CAPM) matters. This suggests that implementation of ERM is of no value to firms. This notion is in stark contrast to the phenomena of increased acceptance of ERM by industry practitioners. As such, we propose an ERM framework to theorize a model capturing the causal relationships of the risk that strategically associated with firms’ business performance and cost of capital. We highlight the notion of managing firms’ unsystematic (specific) risk via an enterprise risk management framework that leads to the enhancement of shareholders’ value. The mechanism through which firms’ value enhancement takes place is by developing a strategic conceptualization of risk premium.