The Relationship between Enterprise Risk Management and Cost of Capital

Main Article Content

Muhammad Kashif Shad
Fong-Woon Lai
Amjad Shamim
Michael McShane
Sheikh Muhammad Zahid

Abstract

This paper investigates the effect of enterprise risk management (ERM) implementation on the cost of capital (cost of debt [Cd], cost of equity [Ce], and weighted average cost of capital [WACC]) for the oil and gas industry. The research is conducted using panel data analysis from 2008?2017 for 41 oil and gas companies publicly listed on the Bursa Malaysia. ERM implementation data is collected from company annual reports, while the cost of capital data is obtained from Thomson Reuters DataStream. The results indicate that an increase in the level of ERM implementation reduces the cost of capital, which we argue is one mechanism through which ERM increases firm value. Future research can use our investigation to delve deeper into ERM and value creation topics.

Downloads

Download data is not yet available.

Article Details

How to Cite
Muhammad Kashif Shad, Fong-Woon Lai, Amjad Shamim, Michael McShane, & Sheikh Muhammad Zahid. (2022). The Relationship between Enterprise Risk Management and Cost of Capital. Asian Academy of Management Journal, 27(1), 79–103. https://doi.org/10.21315/aamj2022.27.1.4
Section
Original Articles

References

Abdullah, B. M. H. S., Janor, H., & Hamid, M. A. (2018). High-performance organization and enterprise risk management implementation. International Journal of Business & Management Science, 8(2), 347–368.

Agustini, A. T. (2016). The effect of firm size and rate of inflation on cost of capital: The role of IFRS adoption in the world. Procedia-Social and Behavioral Sciences, 219, 47–54. https://doi.org/10.1016/j.sbspro.2016.04.031

Barreira, A. P., & Rodrigues, P. M. (2005). Unit root tests for panel data: A survey and an application. Estudos II, 665–685. http://hdl.handle.net/10400.1/5244

Baxter, R., Bedard, J. C., Hoitash, R., & Yezegel, A. (2013). Enterprise risk management program quality: Determinants, value relevance, and the financial crisis. Contemporary Accounting Research, 30, 1264–1295. https://doi.org/10.1111/j.1911-3846.2012.01194.x

Beasley, M. S., Clune, R., & Hermanson, D. R. (2005). Enterprise risk management: An empirical analysis of factors associated with the extent of implementation. Journal of Accounting and Public Policy, 24(6), 521–531. https://doi.org/10.1016/j.jaccpubpol.2005.10.001

Berry-Stölzle, T. R., & Xu, J. (2018). Enterprise risk management and the cost of capital. Journal of Risk and Insurance, 85(1), 159–201. https://doi.org/10.1111/jori.12152

Bharathy, G., & McShane, M. (2014). Applying a systems model to enterprise risk management. Engineering Management Journal, 26(4), 38–46. https://doi.org/10.1080/10429247.2014.11432027

Bhatnagar, V. K., Kumari, M., & Sharma, N. (2015). Impact of capital structure & cost of capital on shareholders’ wealth maximization- A study of BSE listed companies in India. Chanakya International Journal of Business Research, 1(1), 28–36.

Bohnert, A., Gatzert, N., Hoyt, R. E., & Lechner, P. (2017). The relationship between enterprise risk management, value and firm characteristics based on the literature. German Journal of Risk and Insurance, 106(3–4), 311–324. https://doi.org/10.1007/s12297-017-0382-1

Bohnert, A., Gatzert, N., Hoyt, R. E., & Lechner, P. (2019). The drivers and value of enterprise risk management: Evidence from ERM ratings. The European Journal of Finance, 25(3), 234–255. https://doi.org/10.1080/1351847X.2018.1514314

Brealey, R. A., Myers, S. C., Allen, F., & Mohanty, P. (2012). Principles of corporate finance. McGraw-Hill Education.

Bromiley, P., McShane, M., Nair, A., & Rustambekov, E. (2015). Enterprise risk management: Review, critique, and research directions. Long Range Planning, 48(4), 265–276. https://doi.org/10.1016/j.lrp.2014.07.005

Bromiley, P., McShane, M., & Rau, D. (2015). Can strategic risk management contribute to enterprise risk management? A strategic management perspective. Routledge Companion on Strategic Risk Management, 140–156. https://doi.org/10.2139/ssrn.2512477

Cao, Y., Myers, J. N., Myers, L. A., & Omer, T. C. (2015). Company reputation and the cost of equity capital. Review of Accounting Studies, 20(1), 42–81. https://doi.org/10.1007/s11142-014-9292-9

Ching, H. Y., & Colombo, T. (2014). Enterprise risk management good practices and proposal of conceptual framework. Journal of Management Research, 6(3), 69–85. https://doi.org/10.5296/jmr.v6i3.5404

COSO (2004). Enterprise risk management framework, committee of sponsoring organizations of the treadway commission, available at: www.erm.coso.org.

COSO (2017). Enterprise risk management integrating with strategy and performance, available at: www.erm.coso.org. (pp. 1–10): Committee of Sponsoring Organizations of the Treadway Commission.

Farrell, M., & Gallagher, R. (2019). Moderating influences on the ERM maturity- performance relationship. Research in International Business and Finance, 47, 616–628. https://doi.org/10.1016/j.ribaf.2018.10.005

Foo, V., Jamal, A. A. A., Karim, M. R. A., & Ulum, Z. K. A. B. (2015). Capital structure and corporate performance: Panel evidence from oil and gas companies in Malaysia. International Journal of Business Management and Economic Research, 6(6), 371–379.

Florio, C., & Leoni, G. (2017). Enterprise risk management and firm performance: The Italian case. The British Accounting Review, 49(1), 56–74. https://doi.org/10.1016/j.bar.2016.08.003

Gatzert, N., & Martin, M. (2015). Determinants and value of enterprise risk management: Empirical evidence from the literature. Risk Management Insurance Review, 18, 29–53. https://doi.org/10.1111/rmir.12028

González, L. O., Santomil, P. D., & Herrera, A. T. (2020). The effect of enterprise risk management on the risk and the performance of Spanish listed companies. European Research on Management and Business Economics, 26(3), 111–120. https://doi.org/10.1016/j.iedeen.2020.08.002

Gordon, L. A., Loeb, M. P., & Tseng, C. Y. (2009). Enterprise risk management and firm performance: A contingency perspective. Journal of Accounting and Public Policy, 28(4), 301–327. https://doi.org/10.1016/j.jaccpubpol.2009.06.006

Hall, B., & Mairesse, J. (2002). Testing for unit roots in panel data: An exploration using real and simulated data. Identification and inference for econometric models. Essays in Honor of Thomas Rothenberg, 451–479. https://doi.org/10.1017/CBO9780511614491.020

Hann, R. N., Ogneva, M., & Ozbas, O. (2013). Corporate diversification and the cost of capital. The Journal of Finance, 68(5), 1961–1999. https://doi.org/10.1111/jofi.12067

Hou, K., van Dijk, M., & Zhang, Y. (2012). The implied cost of capital: A new approach. Journal of Accounting and Economics, 53(3), 504–526. https://doi.org/10.1016/j.jacceco.2011.12.001

Hoyt, R. E., & Liebenberg, A. P. (2011). The value of enterprise risk management. Journal of Risk and Insurance, 78(4), 795–822. https://doi.org/10.1111/j.1539-6975.2011.01413.x

Iswajuni, I., Manasikana, A., & Soetedjo, S. (2018). The effect of enterprise risk management (ERM) on firm value in manufacturing companies listed on Indonesian Stock Exchange year 2010–2013. Asian Journal of Accounting Research, 3(2), 224–235. https://doi.org/10.1108/AJAR-06-2018-0006

Kaplan, R., & Mikes, A. (2014). Towards a contingency theory of enterprise risk management. AAA 2014 Management Accounting Section (MAS) Meeting Paper. https://doi.org/10.2139/ssrn.2311293

Karami, M., Samimi, A., & Ja’fari, M. (2020). Necessity to study of risk management in oil and gas industries (Case study: Oil projects). Progress in Chemical and Biochemical Research, 3(3), 239–243.

Kraus, V., & Lehner, O. M. (2012). The nexus of enterprise risk management and value creation: A systematic literature review. ACRN Journal of Finance and Risk Perspectives, 1(1), 230–261.

Lai, F. W., Azizan, N. A., & Samad, M. F. A. (2011). A strategic framework for value enhancing enterprise risk management. Journal of Global Business and Economics, 2(1), 23–47.

Lai, F. W., & Samad, M. F. A. (2011). Enterprise risk management framework and the empirical determinants of its implementation. International Proceedings of Economics Development & Research. Accessed on 8-23-2020 on Google Scholar.

Lai, F. W., & Azizan, N. A. (2012). Critical review of literature on enterprise risk management and the cost of capital: The value creation perspective. African Journal of Business Management, 6, 3126. https://doi.org/10.5897/AJBM11.2659

Lai, F. W., & Shad, M. K. (2017). Economic value-added analysis for enterprise risk management. Global Business and Management Research, 9(1s), 338–347.

Laisasikorn, K., & Rompho, N. (2014). A study of the relationship between a successful enterprise risk management system, a performance measurement system and the financial performance of Thai listed companies. Journal of Applied Business and Economics, 16(2), 81–92.

Lechner, P., & Gatzert, N. (2017). Determinants and value of enterprise risk management: Empirical evidence from Germany. The European Journal of Finance, 1–27. https://doi.org/10.2139/ssrn.2735050

Lintner, J. (1965). The valuation of risk assets and the selection of risky investments in stock portfolios and capital budgets. The Review of Economics and Statistics, 47(1), 13–37. https://doi.org/10.2307/1924119

Luppino, R., Hosseini, M. R., & Rameezdeen, R. (2014). Risk management in research and development (R&D) projects: The case of South Australia. Asian Academy of Management Journal, 19(2), 67–85.

Manurung, S. D. (2014). The influence of capital structure on profitability and firm value (A study on food and beverage companies listed in Indonesia stock exchange 2010–2012 period). Jurnal Administrasi Bisnis, 7(2).

Mayers, D., & Smith, C. Jr. (1987). Corporate insurance and the underinvestment problem. Journal of Risk and Insurance, 54(1), 45–54. https://doi.org/10.2307/252881

McShane, M., Nair, A., & Rustambekov, E. (2011). Does enterprise risk management increase firm value? Journal of Accounting, Auditing & Finance, 26(4), 641–658. https://doi.org/10.1177/0148558X11409160

McShane, M. (2018). Enterprise risk management: History and a design science proposal. The Journal of Risk Finance, 19(2), 137–153. https://doi.org/10.1108/JRF-03-2017-0048

Marotta, A., & McShane, M. (2018). Integrating a proactive technique into a holistic cyber risk management approach. Risk Management and Insurance Review, 21(3), 435– 452. https://doi.org/10.1111/rmir.12109

Meidell, A., & Kaarbøe, K. (2017). How the enterprise risk management function influences decision-making in the organization–A field study of a large, global oil and gas company. The British Accounting Review, 49(1), 39–55. https://doi.org/10.1016/j.bar.2016.10.005

Modigliani, F., & Miller, M. H. (1958). The cost of capital, corporation finance and the theory of investment. The American Economic Review, 48(3), 261–297.

Mohamad, N. E. A. B., & Saad, N. B. M. (2012). Cost of capital-The effect to firm value and profitability performance in Malaysia. International Journal of Academic Research in Accounting, Finance and Management Sciences, 2(4), 54–63.

Monda, B., & Giorgino, M. (2013). An ERM maturity model. Enterprise Risk Management Symposium. https://doi.org/10.2139/ssrn.2198944

Nair, A., Rustambekov, E., McShane, M., & Fainshmidt, S. (2014). Enterprise risk management as a dynamic capability. Managerial and Decision Economics, 35(8), 555–566. https://doi.org/10.1002/mde.2641

Pagach, D., & Warr, R. S. (2010). The effects of enterprise risk management on firm performance. Working Paper, North Carolina State University. https://doi.org/10.2139/ssrn.1155218

Pittman, J. A., & Fortin, S. (2004). Auditor choice and the cost of debt capital for newly public firms. Journal of Accounting and Economics, 37(1), 113–136. https://doi.org/10.1016/j.jacceco.2003.06.005

Poyraz, O., Canan, M., McShane, M., Pinto, A., & Cotter, T. (2020). Cyber assets at risk: Monetary impact of U.S. personally identifiable information mega data breaches. The Geneva Papers on Risk and Insurance - Issues and Practice, 45(4), 616–638. https://doi.org/10.1057/s41288-020-00185-4

Pranesh, V., Palanichamy, K., Saidat, O., & Peter, N. (2017). Lack of dynamic leadership skills and human failure contribution analysis to manage risk in deep water horizon oil platform. Safety science, 92, 85–93. https://doi.org/10.1016/j.ssci.2016.09.013

Sax, J., & Andersen, T. J. (2019). Making risk management strategic: Integrating enterprise risk management with strategic planning. European Management Review, 16(3), 719–740. https://doi.org/10.1111/emre.12185

Saeidi, P., Saeidi, S. P., Sofian, S., Saeidi, S. P., Nilashi, M., & Mardani, A. (2019). The impact of enterprise risk management on competitive advantage by moderating role of information technology. Computer Standards & Interfaces, 63, 67–82. https://doi.org/10.1016/j.csi.2018.11.009

Saeidi, P., Saeidi, S. P., Gutierrez, L., Streimikiene, D., Alrasheedi, M., Saeidi, S. P., & Mardani, A. (2020). The influence of enterprise risk management on firm performance with the moderating effect of intellectual capital dimensions. Economic Research-Ekonomska Istraživanja, 34(1), 122–151. https://doi.org/10.1080/1331677X.2020.1776140

Shad, M. K., & Lai, F. W. (2015a). A conceptual framework for enterprise risk management performance measure through economic value added. Global Business and Management Research, 7(2), 1–11.

Shad, M. K., & Lai, F. W. (2015b). Enterprise risk management and firm performance validated through economic value-added factors. International Journal of Economics and Statistics, 3, 148–154.

Shad, M. K., & Lai, F. W. (2019). Enterprise risk management implementation and firm performance: Evidence from the Malaysian oil and gas industry. International Journal of Business and Management, 14(9), 47–53. https://doi.org/10.5539/ijbm.v14n9p47

Shad, M. K., Lai, F. W., Fatt, C. L., Klemeš, J. J., & Bokhari, A. (2019). Integrating sustainability reporting into enterprise risk management and its relationship with business performance: A conceptual framework. Journal of Cleaner Production, 208, 415–425. https://doi.org/10.1016/j.jclepro.2018.10.120

Shad, M. K., Lai, F. W., Shamim, A., & McShane, M. (2020). The efficacy of sustainability reporting towards cost of debt and equity reduction. Environmental Science and Pollution Research, 27(18), 22511–22522. https://doi.org/10.1007/s11356-020-08398-9

Sharfman, M. P., & Fernando, C. S. (2008). Environmental risk management and the cost of capital. Strategic Management Journal, 29(6), 569–592. https://doi.org/10.1002/smj.678

Sharpe, W. F. (1964). Capital asset prices: A theory of market equilibrium under conditions of risk. The Journal of Finance, 19(3), 425–442. https://doi.org/10.1111/j.1540-6261.1964.tb02865.x

Shetty, S., McShane, M., Zhang, L., Kesan, J. P., Kamhoua, C. A., Kwiat, K., & Njilla, L. L. (2018). Reducing informational disadvantages to improve cyber risk management. The Geneva Papers on Risk and Insurance-Issues and Practice, 43(2), 224–238. https://doi.org/10.1057/s41288-018-0078-3

Sithipolvanichgul, J. (2016). Enterprise risk management and firm performance: Developing risk management measurement in accounting practice. PhD dissertation, University of Edinburgh.

Silva, J. R., Silva, A. F. D., & Chan, B. L. (2019). Enterprise risk management and firm value: Evidence from Brazil. Emerging Markets Finance and Trade, 55(3), 687–703. https://doi.org/10.1080/1540496X.2018.1460723

Spr?i?, D. M., Žagar, M. M., Ševi?, Ž., & Marc, M. (2016). Does enterprise risk management influence market value–A long-term perspective? Risk Management, 18(2–3), 65–88.

Spr?i?, D. M., Kožul, A., & Pecina, E. (2017). Managers’ support–a key driver behind enterprise risk management maturity. Zagreb International Review of Economics and Business, 20(s1), 25–39. https://doi.org/10.1515/zireb-2017-0003

Standard & Poor (2005). Evaluating the enterprise risk management practices of insurance companies. Standard & Poor Ratings Direct. 1–17. Retrieved 8 May 2021 from https://www.actuaries.org.uk/system/files/field/document/insurancecriteria.pdf

Tabachnick, B. G., & Fidell, L. S. (2007). Using Multivariate Statistics. Pearson Education: United States.

Tasmin, R., & Muazu, H. M. (2017). Moderating effects of risk management function on determinants of enterprise risk management implementation in Malaysian oil and gas sector: A conceptual framework. Journal of Technology Management and Business, 4(2).

Waweru, N. M., & Kisaka, E. S. (2013). The effect of enterprise risk management implementation on the value of companies listed in the Nairobi Stock Exchange. Journal of Applied Finance and Banking, 3, 81–105. https://doi.org/10.2139/ssrn.1907248

Weber, O., Scholz, R. W., & Michalik, G. (2010). Incorporating sustainability criteria into credit risk management. Business Strategy and the Environment, 19, 39–50. https://doi.org/10.1002/bse.636

Yapa Abeywardhana, D. (2015). Capital structure and profitability: An empirical analysis of SMEs in the UK. Journal of Emerging Issues in Economics, Finance and Banking (JEIEFB), 4(2), 1661–1675.

Zakaria, S. (2017). The use of financial derivatives in measuring bank risk management efficiency: A data envelopment analysis approach. Asian Academy of Management Journal, 22(2), 209–244. https://doi.org/10.21315/aamj2017.22.2.8

Zou, X., Isa, C. R., & Rahman, M. (2017). Valuation of enterprise risk management in the manufacturing industry. Total Quality Management & Business Excellence, 30(11–12), 1389–1410. https://doi.org/10.1080/14783363.2017.1369877