Enterprise Risk Budgeting: Bringing Risk Management into the Financial Planning Process

15 Pages Posted: 4 Dec 2015

Multiple version iconThere are 2 versions of this paper

Date Written: November 23, 2015

Abstract

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.

Suggested Citation

Alviniussen, Alf and Jankensgard, Hakan, Enterprise Risk Budgeting: Bringing Risk Management into the Financial Planning Process (November 23, 2015). Journal of Applied Finance (Formerly Financial Practice and Education), Vol. 19, No. 1&2, 2009, Available at SSRN: https://ssrn.com/abstract=2694744

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