Abstract
We investigate the effects of adopting enterprise risk management (ERM) on the performance and risks of European publicly listed insurance firms. Using a dataset for 24 years, we report new results which show that ERM adopters realize significant ERM premiums after controlling for other covariates and endogeneity. Several firm characteristics such as size, opacity, and the choice of external monitoring agents such as auditors are significant determinants of adopting ERM. We fill a gap in the literature by assessing the impact of adopting ERM on firm risks and report new findings for our sample, which show that ERM adopters effectively reduce firm total and systematic risks and, to a greater extent, idiosyncratic risk. Firm-level variables such as size, leverage, dividend payments events, and diversification impact firm total risk. Insurers use corporate events such as dividend payments to signal information about reducing risk. Industry and international diversification reduce firm total risk and idiosyncratic risk, respectively.
Highlights
Dividend payment events are negatively associated with idiosyncratic risk, which is consistent with the signaling argument discussed above
The results show that international diversification reduces idiosyncratic risk, which is consistent with rational expectations
We find that the determinants of enterprise risk management (ERM) adoption in our sample include firm financial variables such as leverage, opacity, and size and variables that identify leading monitoring agents who provide credit ratings and auditing services
Summary
Enterprise risk management (ERM) provides a holistic approach for identifying, evaluating, managing, and mitigating risks at the enterprise level. Organizations of the Treadway Commission (COSO) defined ERM as: “process, effected by an entity’s board of directors, management and other personnel, applied in a strategy setting and across the enterprise, designed to identify potential events that may affect the entity, and manage risk to be within its risk appetite, to provide reasonable assurance regarding the achievement of entity objectives” (COSO 2004). Bohnert et al (2019) indicate that ERM activities in insurance firms are relevant to implementing Solvency II requirements, especially Pillar 2, and these activities enhance firm value. Other studies find that ERM reduces the cost of capital (Berry-Stölzle and Xu 2018), stock return volatility (Eckles et al 2014), and firm solvency levels (Nguyen and Vo 2020)
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