Firm-specific Risk Research Articles

Strategic Navigation of Firm-Specific Risks: A Comprehensive Analysis of Corporate Finance Challenges and Solutions

Abstract: This paper delves into the multifaceted nature of firm-specific risks (FSRs) within corporate finance, highlighting operational, financial, and strategic risks as pivotal challenges confronting companies across industries. Through detailed examinations of scenarios ranging from regulatory hurdles in the pharmaceutical industry to cyber threats in retail and currency fluctuations impacting multinational corporations, this study elucidates the intricate web of internal and external factors contributing to FSR. Furthermore, it explores the critical role of corporate governance, emphasizing board structure, transparency in financial reporting, and robust internal controls in effectively managing these risks. By integrating advanced data analytics and risk modeling with comprehensive risk management frameworks, the paper showcases strategies for identifying, assessing, and mitigating FSRs, thereby enhancing corporate resilience and strategic agility. This analysis not only contributes to the academic discourse on risk management but also offers practical insights for practitioners aiming to fortify their organizations against the unpredictability of the business landscape.

Crowd-sourced CEO approval and turnover

This study examines how employee approval ratings of CEOs improve the predictability of turnover. Using the crowd-sourced reviews from Glassdoor, we find that CEOs with high employee approval are less likely to be removed, even after a poor performance. The decrease in turnover–performance sensitivity is particularly strong when the relative importance of employees is greater in industries of higher intangible asset intensity and in states with strong employee protection. Firms with higher CEO approval subsequently show improved performance and lowered firm-specific risk. We highlight the role of employees as a key stakeholder in predicting CEO turnover, consistent with the value creation view of stakeholder capitalism.

Firms’ cost structure and stock return volatility

PurposeThis paper proposes a framework to identify a pattern in the relationship between firms’ cost structure (i.e. fixed versus variable) and their volatility in stock returns.Design/methodology/approachOur empirical analysis is based on a panel data regression where we use an extended sample period and a time-series regression-based elasticity measure of operating leverage.FindingsWe document significantly higher systematic risk among firms with large fixed costs, a conclusion which confirms theoretical predictions of earlier studies. In new findings, we document high firm-specific risk and high stock return volatility among firms with a fixed cost structure.Originality/valueThe paper fills a gap in the literature by examining the effect of cost structure using various operating leverage measures and other control measures for firm characteristics on idiosyncratic risk. Studies that seek to explain firms’ systematic risks are numerous; conversely, there are relatively fewer studies on the determinants of firms’ specific risks.

Energy-Related Uncertainty and Idiosyncratic Return Volatility: Implications for Sustainable Investment Strategies in Chinese Firms

This study examines the impact of energy-related uncertainty on idiosyncratic volatility (IVOL) in Chinese firms, leveraging data from the Shanghai and Shenzhen stock exchanges between 2007 and 2022. Utilizing the Energy-Related Uncertainty Index (EUI) and the Fama–French five-factor model, we analyze a comprehensive dataset of 20,998 firm-year observations to understand how macroeconomic uncertainties specific to the energy sector influence firm-specific risk. Our findings reveal that a one-unit increase in the EUI is associated with a 5.1% rise in idiosyncratic volatility across all firms, underscoring the significant impact of energy-related uncertainty on firm-specific risks. The effect is more pronounced in energy-related firms, where a one-unit increase in the EUI leads to a 6.4% increase in IVOL, compared to a 3.7% increase in non-energy-related firms. By incorporating industry-wise, heterogeneity, and phase-based analyses, our findings reveal significant variations in the EUI’s impact across energy and non-energy sectors. State-owned enterprises, firms with high ownership concentration, and smaller firms are more vulnerable to energy uncertainties. Additionally, the effect of the EUI on IVOL is more pronounced during periods of high uncertainty. These insights have important implications for sustainable investment strategies, risk management, and policymaking, providing a deeper understanding of the intricate dynamics of energy markets in fostering sustainable economic growth and development.

Research on the risk effects of accounting information disclosure

Drawing upon accounting-based asset pricing model and insights from theories of information asymmetry and cognitive psychology, this study investigates the risk implications of accounting information disclosure from dual perspectives: firm-specific risk and market risk. Our findings reveal a positive association between earnings management and both firm-specific and market risk effects of accounting information, underscoring the presence of post-disclosure risk effects. Heterogeneity analysis further uncovers the moderating roles of factors such as accounting firm size, company tenure, and regional economic growth in firm-specific risk effects, while corporate governance structures influence market risk effects. This study enriches the theoretical literature on accounting information and risk effects.

Say on Pay Laws and Insider Trading

ABSTRACT We examine whether mandatory adoption of say on pay increases executives’ incentives to engage in insider trading to compensate for the negative impact of say on pay on the value of their explicit compensation packages. Our empirical design exploits the staggered adoption of say on pay laws across 14 countries over the 2000–2015 period. We find that mandatory adoption is associated with a material increase in insider trading profits, especially in firms where executive pay is most affected. The increase in insider trading profits is driven mostly by more frequent and larger profitable insider sales, consistent with executives’ desire to reduce their greater exposure to firm-specific risk while increasing their trading profits. Overall, our results highlight the importance of considering potential effects on insider trading incentives when designing compensation reforms and when assessing their effectiveness. Data Availability: All data used in the paper are available from cited public sources. JEL Classifications: G30; G34; G38; J33; K22; M12; M16.

Does Idiosyncratic Risk Have a Significant Impact on Return Probability? A Case Study of Borsa Istanbul 100 Stocks

Most asset pricing models ignore idiosyncratic risk, or firm-specific risk, while it is one of the most critical determinants of asset pricing and stock returns. In this paper, we investigate the impact of idiosyncratic risk on the returns of stocks traded on the Borsa Istanbul using six different fixed effect panel tobit and four different fixed effect panel logit regression models. The results of logit models suggest that as idiosyncratic risk increases, probability of positive stock returns also increases. Furthermore, an increase in a stock's market sensitivity has a negative effect on the probability of positive returns, while an increase in the market-to-book ratio, firm size, and market return has positive effects on returns. In all models, the explanatory variables, including idiosyncratic risk, market-to-book ratio, firm size, and market return, have a positive effect on returns, except for the model where negative values of dependent variable are censored at zero.

To protect or to hide-an investigation on corporate redacted disclosure motives under new FAST act regulation

China adopted amendments allowing companies to redact filings without prior approval in 2016. Leveraging this change as a quasi-nature experiment, we explore whether managers utilize redacted information to withhold bad information in the more lenient regulatory environment. Our investigation uncovers a significant shift in managerial behavior: Since 2016, managers incline to employ redactions to obscure negative news rather than safeguarding proprietary data. Furthermore, we find that the poorer firm performance and a higher cost of equity are associated with the redacted disclosures after 2016, suggesting that investors perceive an increase in firm-specific risk attributed to withholding bad news through redactions.

경제 불확실성이 감사보고서의 발행을 지연시키는가?

[Purpose]This study examines the relationship between macro－uncertainty and audit report lag. Also, it analyzes whether this relationship manifests differentially when considering audit hours by rank and auditor characteristics. [Methodology]For analysis, we use a sample of listed firms for the period from 2014 to 2019. Audit report lag was proxied by the number of days from the fiscal year－end to the audit report date. Macro－uncertainty was measured using the volatility index VKOSPI provided by KRX. [Findings]The analysis yields the following results. Firstly, it confirms an increase in audit report lag under high uncertainty. This could be interpreted as auditors increasing audit efforts in response to a rise in audit workload under uncertainty. Secondly, the relation between uncertainty and audit report lag becomes more pronounced in subsamples where audit hours put into by junior and senior staff are high. Thirdly, the relationship between uncertainty and audit report is stronger for Big4 and industry specialist auditors. This could be interpreted as auditors with higher reputation risk or litigation risk allocating relatively more audit effort in response to increased audit risks under uncertainty. [Implications]Despite previous research indicating that uncertainty reduces audit fees and audit hours, this study’s results suggest that reduced audit fees or audit hours does not necessarily imply a decrease in audit effort. Our results provide insight to investors and auditors in providing evidence that increased audit report lag may be due to external environmental factors rather than an increase in firm－specific risk factors.

Political affiliation, cash flow volatility, and debt maturity in China

Using a large dataset with over half a million observations for 161 thousand Chinese firms, we examine the role of political affiliation on the debt maturity of firms experiencing varying levels of financial volatility. Our findings indicate that politically affiliated firms have reduced capacity to adjust their debt maturity when firm-specific risk rises. Furthermore, we demonstrate that this effect is stronger for firms affiliated with local levels of government relative to central levels. We argue that political affiliation can play a disciplining role in environments where credit is controlled by the state and politicians’ careers depend on local economic performance.

Does analysts’ industrial concentration affect the quality of their forecasts?

We examine the association between financial analysts’ industrial concentration and the quality of their earnings forecasts. We find that analysts’ forecast quality, measured by forecast accuracy, forecast informativeness, and forecast timeliness, is positively associated with analysts’ industrial concentration on firm coverage, suggesting that allocation of effort and resources to the concentrated industries helps promote the quality of earnings forecasts. We also find that the positive relation of analysts’ industrial concentration with forecast accuracy and informativeness (forecast timeliness) is more (less) pronounced for firms faced with fiercer industrial product market competition, higher firm-specific risk, and/or higher information opacity. Overall, our results highlight the importance of analysts’ industrial concentration in contributing to the quality of their earnings forecasts.

FIRM-SPECIFIC RISK, GROWTH OPTIONS, AND INNOVATION RENT

The greater the firm-specific risk, the more valuable are the innovative opportunities underlying the growth options, and the greater the innovation rent. We examine whether firm-specific risk drives the firm’s innovation rent. We find that the firm-specific risk positively moderates the association between firm innovativeness and firm surplus. Innovation rent is the change in firm surplus per unit change in the knowledge capital (accumulated R&D stock). The firm surplus is the excess market value of the firm over shareholder expectations. We further examine whether the growth options embedded in the firm’s assets mediate the association between firm innovativeness and firm surplus. Growth options positively mediate the association between knowledge capital and firm surplus. The firm-specific risk enhances the value of innovative opportunities underlying the firm’s growth options that are exercised such that the firm earns a value surplus. Our results are consistent with the strategic rent model and emerging behavioural theory.

The Nexus Between Information Asymmetry and Liquidity of Stock: Evidence from the Indian Market

This study intended to explore the influence of informational asymmetry on stock liquidity in India. After controlling for the effects of firm-specific risk and investor sentiment, the results show that informational asymmetry, as measured by the delay factors has a significant positive association with illiquidity, indicating that market liquidity decreases with less transparency and a high level of informational asymmetry. The results also show that investor sentiment has a significant association with illiquidity, whereas firm-specific risk and illiquidity seem to have no noticeable relationship. The empirical results are validated using a dynamic panel-data approach, with two-stage GMM and remain robust. Theoretically, this study extends the existing literature on liquidity by offering new evidence from a prospective market like India. In practical terms, the findings of this study would help the stock exchange regulators and other regulatory bodies to strengthen the process of information dissemination and sensitise market participants and investors by maintaining a smooth flow of information. JEL Codes: G11, G12, G4, G32

Precautionary motive or private benefit motive for holding cash: Evidence from CEO ownership

This study examines how CEO ownership affects the motivation of firms to hold cash. We document a monotonic and positive relationship between CEO ownership and cash holdings. The effect is more pronounced for firms with higher firm-specific risk and larger external financing costs, suggesting that CEO ownership encourages firms to hold more cash as precautionary savings. However, we find no evidence that CEO ownership leads to cash hoarding in firms with weak corporate governance. Moreover, we show that firms with high CEO ownership and excess cash holdings have more capital expenditures and R&D expenses but do not have higher dividend payments and share repurchases. Nonetheless, shareholders’ perceived value of cash increases with CEO ownership, indicating that shareholders place a positive value on high levels of cash holdings associated with CEO ownership in the context of growing investment prospects. Overall, our findings support the notion that firm ownership aligns the interests of CEOs and shareholders, rather than encouraging managers to extract private benefits through hoarding cash.

Does corporate risk management lead to risk mitigation and firm performance? Evidence from Asian emerging markets

PurposeThis study aims to verify the significance of Andersen (2008) corporate risk management (CRM) framework in Asian emerging markets (AEMs) to control firm risk and improve firm performance.Design/methodology/approachThe cross-sectional analyses are performed on a sample of 4,609 firms across nine Asian emerging countries using 2SLS estimation technique.FindingsThe empirical findings show that the adoption of CRM not only enhances firm performance by increasing the firm ability to capitalize on the market opportunity but also plays a significant role in reducing firm risk. The findings of this study assert that by institutionalizing risk management practices into an integrated CRM framework, the firm can reap multiple benefits by maintaining better contractual agreements and strategic partnerships with key stakeholders.Originality/valueThe study shifts the focus of CRM away from Western countries toward AEMs, which has been afflicted by high risks and uncertainties. The effectiveness of CRM against firm risk is established by dividing firm risk into firm-specific risk and systematic risk. Furthermore, this study also establishes that CRM not only leads to high returns but also reduces firm operational and production costs. Overall, the study provides a compelling argument to implement CRM for improving organizational performance and managing risks in a strategic and integrated manner. The findings are also relevant to risk management practitioners, as well as to academicians interested in the broader fields of corporate finance and strategy.

Portfolio Optimization of Technology Companies in Malaysia: An Application of Fuzzy TOPSIS-Mean-Absolute Deviation Approach

Selecting and weighting the companies are the main processes in portfolio optimization. It is important to select and determine the companies' weights in constructing the optimal portfolio. In this paper, we propose a two-phase Mean-Absolute Deviation (MAD) model in portfolio optimization of technology companies in Malaysia. In the first phase, the companies’ financial performance is determined and ranked with Fuzzy Technique for Order of Preference by Similarity to the Ideal Solution (TOPSIS). Selection of the good financial performance companies can minimize the influence of firm-specific risk in minimizing the risk of the portfolio at the expected return. In the second phase, the optimal portfolio is generated by weighting the selected companies with MAD model. The results indicate that the investors can minimize the portfolio risk to achieve the expected return with the two-phase MAD model. The significance of this paper is to contribute to the development of portfolio optimization by integrating the Fuzzy TOPSIS and MAD approaches.

Financial reporting quality of ESG firms listed in China.

Given the growing importance of environmental protection in China, this study investigated the determinants of the financial reporting quality of environmental, social and governance (ESG) firms listed in China. The quality of financial reporting shows how informative the accounting numbers are for decision-making. Because business outlook can influence financial reporting quality, this study examined predictable, moderately predictable and unpredictable business outlooks. The study randomly selected 100 firms from the 2021 China ESG Top 500 Outstanding Enterprises published by the Sina Finance ESG Rating Centre and then analysed those firms in 2018, 2019 and 2020. It investigated determinants (financial health, governance and earnings management), controlling for the influence of known variables (firm age and firm-specific risk) on financial reporting quality measured as accruals quality and earnings smoothness. Ordinary robust least square regression was conducted. Financial health had a negative influence, but governance variables and earnings management did not affect financial reporting quality. Firm-specific risk had a positive effect, but firm age did not influence financial reporting quality. Changes in business outlook had no impact on the determinants' effect on financial reporting quality. The study found that ESG firms did not engage in earnings management and aggressively manage earnings, pointing to ethical behaviour. This is the first study to contribute to understanding the financial reporting quality of ESG firms listed in China. It examined different business outlooks to understand ESG firms' behaviour towards financial reporting quality. The findings invite replicable studies outside China to understand the contextual validity and reliability of the financial reporting quality of ESG firms, and to investigate the effect of determinants not examined in this study.

Understanding the Firm Specific Risk Premium

Abstract We seek to determine whether a firm specific risk premium (FSRP) exists for private firms. We show that private equity investors price firm specific risk as part of establishing the expected rate of return hurdle rate. Our research is based on survey data constructed by the Private Capital Markets Project. We decompose the rate of return into its component parts-market risk premium, size premium, liquidity premium and firm specific risk premium (FSRP). We find that on average PE FSRP varies between zero and six percent. These findings indicate that the cost of capital buildup used in valuing private firms should include a premium for firm specific risk unless facts and circumstances suggest otherwise.

IMPACT OF CEO CHARISMA ON FINANCIAL PERFORMANCE: EVIDENCE FROM INDONESIAN FIRMS

Charisma is a personal characteristic of a person that makes others view them as a leader. Some prior studies on CEO charisma and financial performance found a positive relationship between CEO charisma and their firm’s performance, especially during conditions of uncertainty. This study seeks to find the impact of CEO’s charisma on Indonesian firms’ financial performance, using firm risk as the uncertainty condition. This study picked some firms from IDX80 because the firms in that index are believed to have a higher market capitalization and more known by the public, thus giving the possibility of more news coverage. CEO’s charisma is calculated by doing text analysis on articles discussing these CEOs. Firm performance measures used were ROA and Tobin’ s Q. This study used firm risk measured from beta and epsilon of CAPM as a moderating variable to find whether firm risk act as a moderator to increase the effect of CEO’s charisma on firm performance. Panel data regression was used to determine relationship between the variables. This study found a positive and significant relationship between charisma and firm performance when Tobin’s Q was used as a dependent variable and firm-specific risk was included in the regression. However this study found no significant moderating variable by firm risk on the relationship between CEO charisma and firm performance.

The Effect of Firm-Specific Risk and Macro Economic Factors on The Performance of Islamic and Conventional Bank

The performance of Islamic banks still fluctuates every year and even their performance ratios are still below the BI standard per bank. The purpose of this research is to evaluate the impact of firm-specific risk (credit risk, liquidity risk and operational risk) and macroeconomic factors (inflation, GDPG and unemployment) on the performance of Islamic commercial banks and conventional banks (ROA) in Indonesia. Comparison of Islamic banks with conventional banks is made because of differences in the respective banking operations/systems. The research uses quantitative research methods with secondary data on Islamic and conventional banking recorded at BI and OJK for the 2017-2021 period. The result in Islamic banks, only the credit risk variable and operational risk II variable have a significant negative effect on the ROA of Islamic banks. The other four variables have no effect on the performance of Islamic banks. In conventional banks, operational risk II variables, inflation and GDP have a significant effect on conventional bank ROA. The other three variables have no effect on the performance of conventional banks.