ABSTRACT
Major corporate failures and volatile market conditions have intensified the focus on corporate risk management as the means to deal with turbulent business conditions where the ability to respond effectively to often dramatic environmental changes is considered an important source of competitive advantage. However, surprisingly little research has analyzed the presumed advantages of effective risk management or assessed important antecedents of the underlying risk management capabilities. Here we present a comprehensive study of risk management effectiveness and the relationship to corporate performance based on panel data for more than 3,400 firms with over 33,500 annual observations during the turbulent period 1991–2010. Determining effective risk management as the ability to reduce earnings and cash flow volatility, we find significant positive relationships to lagged performance measures after controlling for industry effects and company size. We also find that availability of slack resources and investment commitments affect the risk management capabilities and their relationship to performance.
Strategic risk management has become a mantra in executive board rooms following the corporate scandals and financial crises of recent years. There is general awareness that the ability to deal effectively with major risk events is an important aspect of strategic management (e.g., Miller, 1998; Wang, Barney and Reuer, 2003). However, we are not sure whether the adopted risk management practices truly lead to superior outcomes and, if so, what the essential drivers of effective risk handling are (e.g., Beasly, Pagach and Warr, 2008; Liebenberg and Hoyt, 2003; Pagach and Warr, 2011). In reality, there is limited evidence on the proposed benefits from effective risk management capabilities and it is unclear what the implications are for governance, management practice, and strategy conduct in general (Power, 2009; Smithson and Simkins, 2005). So, while risk management has assumed a central executive focus, little is known about the strategic effects and how potential effects may be derived.
The ability to adapt to changing conditions is considered beneficial for organizations and has a long tradition in social science (e.g., Levinthal and March, 1981; March, 1988). Strategic response capabilities allow firms to adjust to abrupt environmental changes, and strategic renewal facilitates organizational adaptation (Agarwal and Helfat, 2009; Bettis and Hitt, 1995). The dynamic capabilities construct suggests that observant and innovative organizations respond better to changing 422conditions (Teece, 2007; Teece, Pisano and Shuen, 1997) where knowledge exploration identifies opportunities that can adapt the way the firm operates (Damodaran, 2008). That is, maintaining sufficient slack for investing in opportunities can enhance responsiveness and thus support effective risk management (Andersen, 2009). However, these rationales are fairly unexplored and represent a promising area for empirical studies. To this end, we investigate the performance outcomes of effective risk management and its antecedents drawing on panel data from more than 3,400 firms with over 33,500 data points during the turbulent period 1991–2010.
In the following we first review literature streams related to strategic risk management and provide an overview of the few empirical studies conducted to date. Then we develop a model of risk management effectiveness linked to investment intensity and available slack and conduct a number of preliminary empirical tests. We find initial support for positive value creation effects from effective risk management capabilities and indications that these effects are associated with availability of slack resources and investment in opportunities. These findings are presented and implications for future research enhancements are discussed.
