Enterprise Risk Management And Its Effects On Firm Performance

Risks exist in the different departments and different operation units of a corporation. By years of operation experiences and the struggles with the potential risks the corporation faced, entrepreneurs and researchers has gradually realized that risks between different departments and operation units are not independent from each others, which means it is very likely to cost more and lead to excessive management if managing these risks separately. The emergence of Enterprise Risk Management (ERM) shows an easy way out for corporations to cope with this problem. It treats the risks that different departments and operation units facing as a cohesive whole, and then analyses the whole risk of the corporation in a systematical way. Last but not the least, ERM suggests that the corporation manages all these risks from the standpoint of the whole corporation but not the specific department or operation unit.Since in the new century, the researches about risk management’s influence on a corporation have almost started from the analysis of relationship of ERM and operation of a firm. And our paper will adopt this method too. Firstly, we construct a proxy variable ERM to measure the level of a corporation’s enterprise risk management according to the four objectives raised by COSO, which are strategic objective, operation objective, reporting objective and compliance objective. Later, we design an empirical research to make out which characteristics of a company have impact on the level of its ERM, in which we use ERM as an explained variable. And we find there does exist some certain impact between ERM and the characteristics which prior researchers focus on in there papers, such as the size of company, the level of leverage, the ratio of independent directors, the type of actual controllers and the ownership concentration. Given the existence of this kind of impact, we can expect that there exists an rational level of ERM for every corporation given the size of company, the level of leverage, the ratio of independent directors, the type of actual controllers and the ownership concentration. To find out this rational level, we make a regression with the sub-sample of the top 80 percent corporations in the ERM and get us a most optimized ERM model. And then we put all the samples into this most optimized model and extract their residuals to measure the gap between the real ERM level and the rational ERM level of each corporation. The absolute value of this gap, ARES, can be used to measure the quality of a corporation’s ERM.In the end, we apply ARES, the proxy variable of the quality of ERM, to analyze the relationship between the quality of ERM and firm performance. We find that the quality of ERM always has a positive correlation with the ratio of gross profit and a negative correlation with the aggregate tax rate of the corporation no matter in which year. What’s more, the profit rate from operation are lower in those corporations who have better ERM quality in good years, but this negative correlation disappears when economy takes a turn. Besides, the quality of ERM and the Return of Asset(ROA) shows a positive correlation in most years expect for the year 2007, in which the economy was most prosperous. Taken as a whole, the overall impact of ERM quality on the ratio of gross profit is negative but its overall impact on the ROA is positive. The conclusions of this paper will add some new proofs for the process of realizing and judging the value of enterprise risk management.