Enterprise Risk Budgeting - Bringing Financial Management into the Financial Planning Process
Author
Summary, in English
Enterprise Risk Management (ERM) is a holistic, integrated
approach to managing a company’s risks, in contrast to the
so-called “silo-approach” prevalent in many firms in which
risks are managed independently of each other. Yet for all the
risk exposures that are brought under the corporate umbrella
in an ERM initiative, it may be inadequate for addressing the
firm’s aggregate risk in terms of the probability of failing to
meet important corporate objectives, such as implementing
the business plan or protecting debt covenants. In this paper
we present a quantitative approach to risk management in
the non-financial firm that retains the integrative, enterprisewide
mindset, yet also equips corporate management
with the ability to evaluate financial distress-probabilities
by incorporating ideas related to the concept of a firm’s
Economic Capital. We term such an effort Enterprise
Risk Budgeting (ERB). ERB makes possible an ongoing
reassessment of the firm’s expected financial position and
overall risk profile, and in particular how these change as a
result of corporate policy decisions, for example relating to
capital expenditure, acquisitions, dividends, and hedging. The
transparency created by such a tool increases the likelihood
that management makes sound proactive decisions with
respect to its risk profile, rather than reacting to challenging
circumstances once they occur. We illustrate using the
experiences of Norwegian aluminium producer Norsk Hydro.
approach to managing a company’s risks, in contrast to the
so-called “silo-approach” prevalent in many firms in which
risks are managed independently of each other. Yet for all the
risk exposures that are brought under the corporate umbrella
in an ERM initiative, it may be inadequate for addressing the
firm’s aggregate risk in terms of the probability of failing to
meet important corporate objectives, such as implementing
the business plan or protecting debt covenants. In this paper
we present a quantitative approach to risk management in
the non-financial firm that retains the integrative, enterprisewide
mindset, yet also equips corporate management
with the ability to evaluate financial distress-probabilities
by incorporating ideas related to the concept of a firm’s
Economic Capital. We term such an effort Enterprise
Risk Budgeting (ERB). ERB makes possible an ongoing
reassessment of the firm’s expected financial position and
overall risk profile, and in particular how these change as a
result of corporate policy decisions, for example relating to
capital expenditure, acquisitions, dividends, and hedging. The
transparency created by such a tool increases the likelihood
that management makes sound proactive decisions with
respect to its risk profile, rather than reacting to challenging
circumstances once they occur. We illustrate using the
experiences of Norwegian aluminium producer Norsk Hydro.
Department/s
Publishing year
2009
Language
English
Publication/Series
Journal of Applied Finance
Volume
19
Issue
1/2
Document type
Journal article
Publisher
Financial Management Association International (FMA)
Topic
- Business Administration
Status
Published
ISBN/ISSN/Other
- ISSN: 1534-6668