AntigoIN - 2008 - A Relação de Desempenho de Gestão de Risco Eficaz - Explorando o Justificativa Investment-Determinada Empresa

Long Range Planning 41 (2008) 155e176 http://www.elsevier.
com/locate/lrp
The Performance Relationship

of Effective Risk Management:
Exploring the Firm-Specific
Investment Rationale
Torben Juul Andersen
Risk management has traditionally been occupied in eliminated downside exposures. This
paper puts forward the idea of total risk management as the ability to respond to market
factors beyond management control so as to stabilise corporate earnings. This in turn will
lead to enhanced trust by investors and stakeholders and result in enhanced performance.
The paper reports on an empirical study that examines the performance relationship of
total risk management and finds a positive relationship, especially among firms investing in
innovation and those operating in knowledge-intensive industries.
Ó 2008 Elsevier Ltd. All rights reserved.
Introduction
Risk management is considered an increasingly important executive concern but there is limited
empirical evidence regarding the implied performance effects as the associated practices continue
to evolve. While risk management techniques often focus on the elimination of downside expo-
sures, we conceive of total risk management as a general ability to respond to exogenous market
factors beyond managerial control so as to damp the variability of corporate earnings. One argu-
ment in favour of this risk management outcome is that stable earnings reduce the likelihood of
financial distress and make favourably-priced capital accessible for good business propositions.
Another rationale suggests that stakeholder relationships are jeopardised if corporate survival is un-
certain, so a lack of risk management will impose incremental costs on counter-party transactions.
A more recent contribution adopts a resource-based view to suggest that effective risk management
provides incentives for essential stakeholders to invest in assets and competencies that are specific to
the firm, which holds the key to develop responsive business opportunities and gain sustainable
competitive advantage. We analyse the latter reasoning in an empirical study examining the
0024-6301/$ - see front matter Ó 2008 Elsevier Ltd. All rights reserved.
doi:10.1016/j.lrp.2008.01.002
performance relationship of total risk management and explore compliance with the underlying
rationale among firms exemplar to observed outcomes. The study of a large cross-sectional sample
provides general support for the firm-specific investment rationale. We find a positive relationship
between total risk management and corporate performance and observe higher performance
relationships among firms investing in innovation and firms operating in knowledge-intensive
industries where firm-specific investments are particularly important. Incidentally, we fail to find
evidence in support of the two alternative explanations for positive risk management effects.
A string of spectacular corporate failures and dramatic terrorism events over the past decade have
increased the focus on risk management practices to deal with corporate exposures while arguing
for the performance-enhancing effects of these approaches.1 Despite this surge in interest, few em-
pirical studies have attempted to analyse whether the alleged advantages materialise. These attempts
are partially hampered by the complexity of the risk management concept, which incorporates
different practices to reduce downside losses as well as enhancing upside gains in a holistic and in-
tegrative manner. Some firms seem consistently to outperform in changing business environments
but can this be ascribed to effective risk management capabilities? In the high-velocity computer
products industries, commonly used to study strategic responsiveness under turbulent market
conditions, names such as Cisco, Dell and Microsoft often appear as organisations that are success-
ful at managing their market risks and stabilising earnings. However, is the seeming competitive
advantage of such firms associated with effective risk management outcomes, and if so, what can
explain these performance relationships? In this study we address these strategic issues.
Risk management is often perceived as the specific practices imposed to reduce the potential
adverse effects of risk phenomena caused by price volatilities, accidents, political events, supply
chain disruptions, economic developments, etc. These exposures may all have a substantial negative
impact on corporate earnings but represent a wide spectrum of risks that often are dealt with by
different specialists in the organisation. A more holistic perspective is concerned with the corporate
handling of these market risks as well as the business opportunities they may induce. Hence, we
define total risk management as the ability to respond effectively to all exogenous market factors
beyond managerial control so the variability of corporate earnings is damped. This ability includes
practices to reduce downside exposures, such as financial hedging, insurance contracting and man-
agement controls, as well as approaches to enhance upside gains through innovation, responsive
decision-making, redeployment of resources etc.
The risk management focus is reflected in increasing corporate use of derivatives to hedge various
market risks, engagement in insurance covers and adoption of formal enterprise risk management
approaches. However, given the historical motivation for risk management and the emergence of
regulatory requirements, there has been a tendency to emphasise downside risk. In fact, responsive-
ness also relates to an ability to exploit new opportunities that emerge from changing conditions. In
other words, total risk management goes beyond a conventional risk perspective and incorporates
response capabilities that allow the corporation to identify and exploit opportunities as market con-
ditions change and thereby impose a more favourable risk profile.2 Where risk management often is
conceived as procedures that identify and manage downside risk events, other responsive processes
are equally important, such as the development of new business opportunities and the execution of
them to counter and take advantage of evolving competitive scenarios.
Other responsive processes are equally important, such as the

development of new business opportunities and the execution of them
A number of rationales have emerged to substantiate the notion of positive risk management
effects from a more stable earnings development. Effective risk management outcomes arguably
reduce the likelihood of bankruptcy that should lower the average cost of capital and thereby
enhance investment in economically viable projects. Conversely, it is argued that a lack of risk
156 The Performance Relationship of Effective Risk Management

management could jeopardise important stakeholder relationships and impose incremental
contracting costs on counter-party transactions. Finally, the firm-specific investments committed
in interactions between the corporation and its essential stakeholders may be a crucial source of
sustainable competitive advantage and excess rent capacity. As these relational commitments are
unique and hence difficult to diversify, total risk management can become essential to induce
performance-driving firm-specific investments.
In this paper, we examine the firm-specific investment rationale as a plausible explanation for
positive risk management effects and assess this in the context of the two alternative explanations.
One consequence of the firm-specific investment rationale should be that effective risk management
outcomes are associated with superior corporate performance. More interestingly, it should mean
that the performance associations of effective risk management are particularly pronounced among
firms emphasising intellectual capital and innovation where firm-specific investments are impor-
tant. We should also find higher risk management effects among firms operating in different knowl-
edge-intensive industries. These relationships are analysed on a comprehensive cross-sectional
dataset over the five-year period of 1996e2000 and updated case examples are used to explore if
the underlying rationale is consistent with observed managerial behaviour.
The study provides empirical support for the proposition that total risk management is associ-
ated with higher corporate performance. The findings also indicate that differential risk manage-
ment effects exist across selective industrial environments and firms with different levels of
intellectual capital and innovation investment. In the following, we discuss the total risk manage-
ment rationales in more detail and develop central hypotheses. Then we describe the empirical
study construed to test these hypotheses and present the results. The empirical findings point to
representative firms that illustrate how positive risk management outcomes are associated with
firm-specific stakeholder relationships.
Total risk management

An integrative risk management perspective suggests that all important exposures should be
considered by corporate executives including financial prices, defaults, accidents, environmental
hazards, political trends, technology shifts, economic conditions, changing customer needs, com-
petitor moves etc.3 How exactly to achieve this in practice remains controversial. Some proponents
argue that risk integration can be achieved by institutionalising corporate functions around chief
risk officers while others assert that organisations need to retain specialist risk management func-
tions.4 Other more pragmatic approaches suggest that risk management issues should become more
visible in the strategic planning process thus extending formal risk management practices towards
a more holistic focus. However, this is difficult to achieve in practice and the reality is that conven-
tional risk management functions typically are associated with the corporate finance departments
and often fail to incorporate marketing, sales and product development in their risk assessments.5
Because of the integrative nature of total risk management, we do not measure specific use of
derivatives and insurance or adherence to formal practices but focus on the responsiveness of
the organisation as expressed in a superior ability to manage exogenous market risks and stabilise
earnings. This does not mean that formal risk management practices are not considered important
but merely indicates that they do not necessarily constitute a sufficient condition for effective risk
management.
Conventional risk management functions typically are associated with

the corporate finance departments and often fail to incorporate
marketing, sales and product development
Long Range Planning, vol 41 2008 157

Nonetheless, the increasing emphasis on risk management has evolved in conjunction with
a rapid growth in derivatives. According to periodic reporting from the Bank for International
Settlements, the amount of outstanding derivative contracts has been increasing exponentially
over the past decades and now has a size comparable with the global debt market. Close to one third
of outstanding derivatives have corporate counterparts, i.e. derivatives are not just esoteric instru-
ments juggled by fancy financial intermediaries but are used to manage the risk exposures of mul-
tinational enterprises.6 Derivative instruments of different shades can be conceived as insurance
contracts based on different market-related indices and can be used to hedge against fluctuations
in various market prices. However, derivatives can also be construed to deal with more unusual
exposures, such as economic indicators, business portfolios, loss indices, CO2 emissions, etc.,
that capture different exogenous risk factors. The insurance sector provides numerous mechanisms
to cover against loss events that are beyond management control and together with various deriv-
atives these risk-transfer markets may serve to counter the adverse effects of many types of hazards
and market-based risks. Similarly, adherence to enterprise risk management and associated internal
control systems can be seen as a kind of self-insurance aimed at dealing with various operational
risks.7 Hence, corporate capital reserves, insurance contracts, derivative securities and management
controls can be conceived as complementary hedging mechanisms and sources of financial capital
that provide cover for risk effects that escape managerial discretion.8
The operational exposures are related to internal conditions and processes in the organisation
although they may be affected by market-related phenomena and environmental hazards. These
risk factors may include operational disruptions, technological breakdowns, human errors, fraud,
legal risks, disclosure risks, etc. One way organisations try to cope with these types of exposure
is to standardise organisational processes to avoid mistakes and impose corporate policies that in-
crease preparedness in case of adverse events. Contingency planning may outline possible responses
to identified organisational scenarios and updated management control systems can identify ad-
vance warning signals and thereby reduce situations of error and misconduct. Various attempts
at process standardisation and certification are often adopted to streamline activities and thereby
reduce deficient performance outcomes. Contingency planning and management control systems
can also be devised to monitor environmental developments and assess strategic outcomes in the
context of changing market conditions. In this way, strategic planning and control processes can
complement managerial actions in ways that enhance corporate responsiveness to exogenous risk
events and damp the variability of economic performance.9
Changing political, social and competitive conditions can exert significant influences on corpo-
rate performance and constitute important risk factors. Some of the most important exogenous
risks include technological innovations and competitor moves that may impact the strategic posi-
tion of the corporation and its future earnings potential.10 These exposures often bound in specific
organisational circumstances that also may require unique responses specific to the individual firm.
Such responses can be conceived as development of new business opportunities built around firm-
specific assets and capabilities accessible to the corporation. Business opportunities in effect consti-
tute alternative strategic options that can extend the corporate action space and thereby increase
strategic responsiveness. Hence, dealing with these kinds of strategic exposures that often are
hard to quantify arguably requires that risk management concerns become an integral part of
the environmental analyses in the strategic planning process to ensure that responsive initiatives
are considered.11
Table 1 provides an overview of the corporate risk exposures discussed above. Conventional risk
management (RM) practices have typically focused on the containment of economic risks and
environmental hazards where exposures can be covered in derivative and insurance markets. The
enterprise risk management (ERM) approaches also consider operational risks within an integrative
framework often implemented in conjunction with internal auditing and control systems. The total
risk management (TRM) perspective introduced here considers all risk categories from a more
holistic perspective, including strategic risks where the pursuit of upside potential is as important
as counteracting downside losses.

Table 1. Classification of risk exposures and responses
Risk categories Risk factors Risk management tools
Competitor moves Strategic intent
New regulations Innovation/creativity
Strategic Policial events Business opportunities
Social changes Response capabilities
risks: Changing taste Environmental scanning
New technologies Information systems
Malfunction Corporate values/culture

Operational Process disruptions Finance/accounting/auditing
TRM Adminstrative errors
Technology breakdown
Management control systems
Continuous learning/lean
risks: Compliance failure Total quality management
Legal exposures Certifications
General demand
ERM Economic Price relations
Structural flexibilities
Foreign exchange Portfolio diversification
risks: Interest rates Financial derivatives
Commodity prices Leading/lagging of payments
RM
Natural catastrophes Insurance contracts
Hazards: Man-made disasters
Terrorism events
Risk-transfer and financing
Risk mitigation efforts
Casualties Preparedness/exercises
The emergence of strategic risks can be ascribed as imperfections in resource and output markets
where organisations have different abilities to mobilise and deploy resources in ways that generate
valuable products and services. Accordingly, total risk management can be facilitated by corporate
development investments that convert potentially valuable resources into new responsive actions
that exploit changing market conditions. This reasoning goes straight to the heart of the
resource-based view. According to the resource-based view of the firm, sustainable competitive
advantage beholds to organisations where managers are able to recognise and deploy unique re-
sources and thereby create excess returns for the firm because the resources hold future promise
in the market.12 Hence, the uniqueness of valuable resources relates to the firm’s ability to identify,
develop and nurture resource endowments with promising future market potentials that nobody
else is able to recognise, and doing so on an ongoing basis. This ability to identify valuable resources
may depend on the exchange of ideas among internal members of the firm as well as with contacts
outside the firm. As resources and competencies are developed further to shape the eventual
business opportunities, the relationships between employees, managers, suppliers, partners and cus-
tomers will play an important role. In these interactions, the counterparts engage human efforts and
intellectual capacity towards the particular business concepts promoted by the firm. The counter-
parting organisations may structure their activities to meet the needs of the corporation and make
supportive infrastructure investments. In short, they commit resources in firm-specific investments
that are geared specifically towards the unique corporate engagement where the firm’s value-
creating capacity will depend on such commitments.
In the development of business opportunities, the choice of investments made in new operational
processes, product features, service elements, supportive technologies, etc., becomes important as
the means to explore future return possibilities for the firm. Accordingly, the corporation must in-
vest in ongoing search for new resource advantages supported by creative interaction with various
stakeholders to retain competitive advantage. These investments in innovation are the backbone for
the creation of new business opportunities that can provide strategic flexibility in turbulent market
environments. Hence, a conscious innovation strategy, where investment in research and develop-
ment of new products and services is used to search for market opportunities and refine competen-
cies, can be an important precondition for effective risk management. By uncovering the potential
for future business opportunities, the range of alternative actions available to the corporation will
increase and the extended strategic action space should improve the ability to exploit new market
conditions and respond effectively in a changing competitive landscape. Hence, risk management
capabilities supported by development investment may allow the corporation to react to exposures

imposed by economic, operational and strategic risks that are beyond the scope of conventional
mitigation, risk-transfer and management control procedures.
Investments in innovation are the backbone for the creation of new

business opportunities that can provide strategic flexibility in turbulent
markets
Risk management effects
Total risk management reflects organisational abilities to cope with risk factors that expose the
corporate earnings potential to significant adverse impacts but also cater to the upside potential
of new opportunities. That is, we may look upon total risk management as a set of processes aimed
at achieving dual outcomes: conventional risk management practices seek to eliminate downside ex-
posures while development initiatives seek to gain higher returns from new opportunities (Figure 1).
Enterprise risk management practices are supposed to guarantee the quality and consistency of in-
ternal processes so as to avoid potential loss events but should also consider possibilities for process
improvements that enhance efficiencies. However, tighter and more streamlined processes may
increase the loss potential from disruptive events just as innovative development investments may
extend downside exposures. In other words, the dual aims of a more holistic risk management focus
may lead to higher performance levels with a risk distribution characterised by fatter tails of
downside outcomes that can be eliminated by more conventional risk-transfer techniques.
As a firm becomes better at curbing the adverse effects of exogenous events and responding to
changing environmental conditions it will be less sensitive to the economic consequences of market
fluctuations in general. Hence, a firm that demonstrates effective risk management should be better
at adapting to variations in the environmental context and as a consequence should exhibit lower
earnings variability. Several rationales have been suggested to explain why positive economic
performance can derive from effective risk management practices. Here we will discuss three
prominent theoretical explanations for positive risk management effects.
Lower average cost of capital

A more stable earnings development should reduce the perceived business risk of the firm and
increase the likelihood that the corporation remains solvent and intact as a going concern. For
(possible distributions of performance outcomes in an individual firm with and without effective
risk management capabilities)
Frequency
Enhance upside gains through
f(p)
development of responsive
business opportunities
Normal distribution Skewed distribution with ‘fat tail’

(performance outcomes are influenced by various
(performance outcomes are random)
risk management practices)
Eliminate downside exposures

through mitigation, risk-transfer,
and internal control processes
_ _
P1 P2 Performance (p)
Figure 1. Total risk management (limit downside risk and exploit upside potential)

a creditor, such a firm represents a lower risk and therefore more debt should be made available at
a lower cost. For an equity holder, the firm constitutes a lower bankruptcy risk, i.e., the chance that
the paid-in capital will be lost is more remote and the prospects for future dividends and capital
gains are higher. The lower vulnerability of earnings projections should induce potential equity in-
vestors to make capital available at lower required rates of return. As a consequence, the average
cost of capital, comprised of a combination of debt and equity, should be reduced and made avail-
able in larger quantities. Lower financing costs must spill over into lower interest payments and
improved economic performance while increased availability of capital may increase performance
as the firm has a strong portfolio of viable business opportunities for investment.13
Higher contracting costs

While investors may be well positioned to modify their portfolios of listed corporate securities, the
same flexibilities may not be afforded to other important stakeholders in the firm, such as cus-
tomers, suppliers, partners and employees. In fact, the portfolio modification argument does not
hold for investors in thinly-traded companies with low market liquidity either, because trading
can affect prices and lead to excessive transaction costs. The argument only applies to publicly-
traded companies and clearly does not hold for long-term owners of privately-held firms. Conse-
quently, if the firm is ignorant about how it manages various exogenous risks, it is likely to affect its
important stakeholder relationships, as it becomes a more vulnerable counterpart to many essential
business transactions where goods, services and human efforts are exchanged. As a consequence,
contractual counterparts to business transactions should be inclined to require additional compen-
sation to engage into such ‘‘risky’’ commercial encounters. For example, suppliers may sell goods at
a slight premium, on shorter credit terms or, in extreme situations, purely on a cash-in-advance
basis. Alliance partners may withhold essential information because they are uncertain about the
longevity of the relationship and key employees may be reluctant to commit additional efforts to
jobs that could turn out to be temporary. Together, these cost elements may add up to substantial
aggregate expenditures for firms that ignore their risk management obligations or are unable to
manage them effectively.14
If the firm is ignorant about how it manages various exogenous risks, it

is likely to affect its important stakeholder relationships
Enhancing firm-specific investment

If the corporate bankruptcy risk is high, important stakeholders may be reluctant to make longer-
term commitments to the firm in the unique relationships that are important for the firm’s ability
to create value. Firm-specific investments commit resources towards activities carried out between
particular counterparts that are valuable in these specific interactions and thereby constitute
a potential loss or risk exposure if the resources must be used for other business purposes. Such
a situation may arise, for example, if the firm is unable to honour a prior commitment or fails
to engage into an agreed interaction with another organisation. In this case, the counterpart
must divert resources it committed to the firm-specific relationship for other uses. Effective risk
management will reduce the likelihood that such situations of relational unfulfilment arise and im-
pose losses on the firm’s essential stakeholder groups. Hence, risk management can also constitute
an encouragement to the firm’s important stakeholders to commit resources in important firm-
specific investments. The firm-specific investments can, for example, comprise development of
customised production or specialised technologies applied in products and services offered in
knowledge-intensive businesses. These kinds of firm-specific investments made by employees, sup-
pliers, customers and partners constitute a class of resources that are often valuable, rare, hard to

imitate and substitute and, therefore, may provide the basis for creating superior economic value
that constitutes a sustainable competitive advantage for the firm.15
Hence, total risk management can lead to lower bankruptcy risk and thereby reduce the expo-
sures embedded in the firm’s relational engagements with customers, suppliers, partners, managers,
employees, etc. A lower risk level should encourage various counterparts among essential
stakeholders to invest in the firm-specific resources needed to furnish valuable longer-term business
relationships. These arguments lead to the following hypothesis.
Hypothesis 1. Firms that demonstrate total risk management are associated with higher perfor-
mance outcomes
Innovation, knowledge, and intellectual capital

Firms can create superior performance and gain sustainable competitive advantage through deploy-
ment of valuable, rare, inimitable, unsubstitutable, firm-specific resources.16 Hence, this strategic
rationale entails a widespread dependence on investment in firm-specific resources as the corpora-
tion engages in innovative and knowledge-intensive business activities supported by human-based
intellectual capital. Organisational knowledge can be embedded in asset structures, operational pro-
cesses and business policies but often resides as deep insights acquired and maintained by individ-
uals in different parts of the firm. From a resource-based view, these diverse sets of knowledge can
constitute firm-specific resources that may lead to sustainable competitive advantage. The ability to
utilise knowledge diversity for organisational advantage has been discussed as combinatory capabil-
ities, corporate knowledge transfer, global knowledge management, etc.17 Hence, innovative firms
that operate in knowledge-intensive industries focused on advanced technologies, such as computer
products and different knowledge-based services, should be more dependent on the deployment of
firm-specific resources.
Innovative business environments may comprise technology-driven manufacturing industries,
such as computer products, measuring instruments, pharmaceutical equipment, etc. Business
activities with a high focus on advanced technologies depend on firm-specific investments made
by essential stakeholders to ensure that specialised knowledge can be applied in the relationships
with customers, suppliers, partners, managers and employees. Knowledge-based services include
auditing, consulting, engineering, programming, software development, etc. These types of profes-
sional activities also require that essential stakeholders make investments in firm-specific competen-
cies that, in turn, may support innovative behaviours that constitute the basis for creating
sustainable competitive advantage.
The pursuit of innovation is intended to generate new products, services and processes and
generally introduce new creative ways of doing things in the organisation. Emphasis on ongoing
innovation requires commitment to research and development efforts that depend on essential
stakeholder relationships and crave on the deployment of unique firm-specific resources. Innova-
tion constitutes an effort to develop new business opportunities that can provide a basis for sustain-
able competitive advantage. Investment in innovation can provide the firm with more business
opportunities that provide flexibility of choice and thereby enhance strategic responsiveness.
In a knowledge-based economy, the intellectual capital of the firm is considered an essential
element of corporate value creation.18 That is, human capital, as opposed to physical assets and
financial resources, is perceived as the most important building block of contemporary business ac-
tivities, which means that large value discrepancies can arise between the market value of a business
and the value of the underlying assets. The relationship between the corporate market valuation and
the accounting value of productive assets, as expressed in the market to book ratio, may typically
show ratios around 2:1 to 3:1 and frequently reach ratios above 8:1 or higher. This difference be-
tween market value and asset value can to a large extent be ascribed to the future value-creating
potential of human knowledge and associated competencies. Human-based knowledge and the re-
lated intellectual capital is a necessary condition for an organisation’s ability to identify valuable
resources and appropriate them for commercial use. As intellectual capital resides with individuals,

it thrives on human interaction where new ideas are exchanged, diverse perspectives uncovered,
market conditions interpreted, product features adapted, etc. In this process, the firm engages its
own employees as well as individual contacts among suppliers, customers and partners around
firm-specific investments and these specialised stakeholder relationships are essential for the
organisation’s value-creating potential.
If the firm is poor at responding to various exogenous risks, the likelihood of bankruptcy
increases, which will provide a disincentive for important stakeholders to engage in firm-specific in-
vestments that would tie them closer to important innovation and development efforts in the firm.
Conversely, effective risk management capabilities will reduce the reluctance among key stakeholders
to make longer-term commitments to the corporation in unique relationships that are important for
the firm’s sustainable value creation. Indeed, a well-managed corporation that demonstrates an abil-
ity to counter changing market conditions in a challenging business environment may attract unique
working and institutional relationships. Hence, effective risk management can encourage important
stakeholders to commit resources in firm-specific investments as transactional counterparts and
thereby enhance the firm’s ability to earn excess rents. Given the particular importance of firm-spe-
cific investments in innovative, human-based and knowledge-intensive industries, the implied per-
formance effects of total risk management should be particularly important among firms operating
in these business environments. These arguments lead to the following hypotheses.
Hypothesis 2. Total risk management has a higher positive association with performance outcomes
among firms investing in innovation
among firms operating in knowledge-intensive businesses
among firms with higher levels of intellectual capital.
Effective risk management capabilities will reduce the reluctance

among key stakeholders to make longer-term commitments
Methodology
The empirical study is based on a sample of large US-based firms operating across four-digit SIC-
code industries including Fortune 500 companies, Stern-Stewart Performance Top 1,000 companies
and the 1,000 largest companies in Compustat based on market capitalisation. These sources
produced a final sample of 1,386 companies with financial information available from Compustat.
Corporate performance
Performance was measured by return on assets (ROA), calculated as net income as a percentage of
average assets for the period, and return on investment (ROI), calculated as net income as a percent-
age of invested capital including paid-in capital, retained earnings and long-term debt. These
performance measures constitute dependent variables in our analyses as is common in other
organisational studies, which increases comparability of results.
Organisational size
Firm size represents prior performance and may reflect availability of organisational slack that
could affect risk management capabilities and corporate performance outcomes. Hence, firm

size, measured as the natural logarithm of total assets, to correct for positive skew in the data was
included as a control variable in the regression analyses.
Industry effects
It is well known that different competitive environments may lead to systematic differences in
corporate performance levels across industries.19 Therefore, we conducted analyses of performance
levels across various industrial sectors to identify the influence of industry effects. On this basis, we
eventually included dummy variables representing industrial environments showing significant
influences on corporate performance levels. These variables reflect the business sectors of primary
industries [SIC: 100-1731], manufacturing [SIC: 2000-3990], transportation services [SIC: 4011-
4731], telecommunication [SIC: 4812-4899] and retail companies [SIC: 5200-5990]. The regression
coefficients of these dummies capture the relative differences in performance levels across distinct
industrial environments.20
Total risk management

Common risk measures capture variability in earnings or cash flows over time as indicators of
firm risk where high variability indicates difficulty in managing the firm’s risk exposures. By im-
plication, the inverse of this indicator reflects an ability to manage the corporate risks. However,
the risk management indicators constitute aggregate measures without any relationship to the ex-
ternal market conditions the firm is exposed to. Therefore, a more appropriate risk management
measure arguably should relate the firm’s ability to damp earnings variability to the variability of
the environmental context the firm is responding to in its risk management efforts. Total risk
management was conceived as the extent to which the firm is able to cope with exogenous market
risks and stabilise the corporate earnings development over a period of time. As a changing market
environment is influenced by various economic, operational and strategic risk factors affecting the
ability to sell products and services, the variability in firm sales over time constitutes a reasonable
indicator of the implied market risks. Hence, total risk management was calculated as the standard
deviation of annual net sales during 1996e2000 divided by the standard deviation of economic
returns (ROA and ROI) during the same period to capture the firm’s ability to damp the effects
of environmental variability imposed by exogenous risk factors. These measures are consistent
with the definition of total risk management. To account for potential differences in risk
management environments, the measures were standardised within industries identified by their
two-digit SIC codes.
We further validated the measures by comparison with the pure measures of market risk, deter-
mined as the standard deviation in corporate sales, and firm risk, determined as the standard de-
viation in economic returns (ROA, ROI).21 Market risk and firm risk are significantly and positively
correlated (r ¼ 0.963, p < 0.001) and both risk measures are significantly and negatively correlated
with corporate performance (r ¼ 0.182, p < 0.001 and r ¼ 0.169, p < 0.001 respectively), which
provides convergent validity for the risk measures. Market risk indicates variability in sales as af-
fected by exogenous risk factors while firm risk indicates earnings variability after the corporate
risk management practices have dealt with the exogenous market influences. The risk management
measure is calculated as market risk divided by firm risk. Hence, the level of market risk in relation
to the level of firm risk over the same time period provides a rough indication of the firm’s ability to
damp the earnings effects of exogenous market risks. Even though risk management effectiveness is
determined by the relative size of the two risk measures, it is significantly and positively correlated
with corporate performance (r ¼ 0.203, p < 0.001), i.e., total risk management appears as a distinct
construct from the common risk measures. This provides divergent validity of the risk management
measure.
Innovation
As is common practice, innovation was measured by R&D intensity determined as all costs incurred
by the firm to develop new products and services divided by total sales.22

Knowledge-intensive industry dummies
Knowledge-intensive manufacturing includes four-digit SIC-code industries chosen from among
the group of manufacturing firms [SIC: 2000-3990]. These selected industries include pharmaceu-
tical preparations [SIC: 2834], biological diagnostics [SIC: 2836], industrial machinery [SIC: 3559],
computer and office equipment [SIC: 3570-3579], electrical equipment [SIC: 3600-3669], semicon-
ductors [SIC: 3674], aircraft engines [SIC: 3724], laboratory apparatuses [SIC: 3821] and analytical
instruments [SIC: 3826] that are deemed particularly dependent on specialised knowledge. Hence,
we introduced a dummy variable, knowledge products, that takes the value of 1 if the firm operates in
these industries and 0 otherwise. This applied to 227 firms making up 16.6 per cent of the total
sample.
Knowledge-based services comprise newspapers and publishing [SIC: 2711], security and com-
modity brokers [SIC: 6200], advertising [SIC: 7310], computer programming [SIC: 7370], prepack-
aged software [SIC: 7372], engineering services [SIC: 8711], accounting and auditing [SIC: 8721]
and management consulting [SIC: 8742].23 Hence, we introduced another dummy variable, knowl-
edge services, taking the value of 1 if the firm operates within these industries and 0 otherwise. This
selection identified 166 firms constituting 12.1 per cent of the total sample.
Market-book ratio
The market to book ratio reflects the relationship between the market value of the firm as a going
concern and the asset value of the assets that support the underlying business activities. The rela-
tionship between market value and asset value is often conceived as a fundamental indicator of the
extent to which human-based intellectual capital drives value creation in the organisation. The ratio
was calculated as the market value of outstanding stock divided by the book value of the firm’s
reported equity position.
Financial leverage
Financial leverage affects the business risk of the firm and is considered a general risk management
tool that may affect risk management effectiveness and performance and, therefore, this variable
was included as a control variable in the regression analyses.24 Financial leverage was measured
as long-term debt divided by total equity at year-end. In this study, we consider the variable as
an industry contingency because financial leverage may be affected by specific conditions in the
business environment. Hence, the measure was standardised within industries identified by two-
digit SIC codes to capture firm divergence to industry peers.
In line with practice in comparable studies, the measures of corporate performance, total risk
management, innovation and financial leverage were averaged over the five years from 1996 to
2000 to eliminate spurious year-on-year effects over the period of study.25
The hypotheses were tested in multiple regression analyses. The regressions used the economic
performance measures, i.e., five-year average ROA and five-year average ROI, as dependent variables
and measures of risk management and the interaction terms between risk management, innovation,
knowledge-intensive industry dummies and the market to book ratio as independent variables.
The regressions were tested for possible outlier effects and multicollinearity. Datasets causing
prediction errors in excess of three times the standard deviation were excluded from the sample
in a sequential manner to observe changes in regression coefficients. While the exclusion of datasets
had no material effect on the analytical results, the outliers were not included in the results reported
here, which are based on a sample size of 1,369 companies. No multicollinearity problems were
registered and VIF factors did not exceed 3.4, which is well below the level indicating potential
multicollinearity problems.26
Results
Statistics and correlation coefficients on the complete dataset are reported in Table 1. The total
strategic risk management measures are significantly positively correlated with the corporate

Table 2. Descriptive statistics and correlation analysis (n [ 1,369)
Mean S.D. 1 2 3 4 5 6 7 8 9
1. Average ROA 4.254 5.687 e e e e e e e e e

2. Average ROI 7.547 8.735 0.872** e e e e e e e e
3. Organisational size 7.846 1.598 0.034 0.079** e e e e e e e
4. Innovation 1.710 2.441 0.112** 0.070** 0.073** e e e e e e
5. Knowledge products 0.170 0.372 0.136** 0.067* 0.130** 0.371** e e e e e
6. Knowledge services 0.120 0.327 0.044 0.071** 0.210** 0.004 0.166** e e e e
7. Market-book ratio 1.511 2.284 0.238** 0.184** 0.326** 0.281** 0.281** 0.259** e e e
8. Financial leverage 0.000 1.000 0.162** 0.165** 0.170** 0.049 0.017 0.017 0.152** e e
9. Total risk 0.000 1.000 0.167** 0.212** 0.561** 0.030 0.022 0.023 0.113** 0.120** e
management (ROA)
10. Total risk 0.000 1.000 0.187** 0.201** 0.530** 0.036 0.016 0.014 0.086** 0.105** 0.964**
management (ROI)
*p < 0.05; **p < 0.01.
performance measures, organisational size and financial leverage but negatively correlated with the
market to book ratio. We also note that innovation, knowledge products and the market to book
ratio as proxies of firm-specific investment conditions are positively correlated. As appears, the risk
management measures and financial leverage have been standardised within the two-digit SIC-code
classification whereas all the other variables included in the study are based on their absolute values
(Table 2).
The results of the hierarchical multiple regression analyses are reported in Tables 3 and 4. The
regression coefficients of strategic risk management on both performance measures are significant
and positive (Model II) and thus provide support for Hypothesis 1. Hence, firms that demonstrate
effective risk management outcomes are found to be associated with higher corporate performance.
The regression coefficients of the interaction term between innovation and risk management on
both performance measures are significant and positive (Model III), which supports Hypothesis
2. That is, total risk management has a higher positive association with corporate performance
among firms that emphasise investment in innovation. The regression coefficients on the interac-
tion terms between the knowledge-intensive industry dummies and risk management on both per-
formance measures are significant and positive (Model IV), i.e., Hypothesis 3 is supported. Hence,
total risk management has a higher positive association with corporate performance among firms
that operate in knowledge-intensive manufacturing industries and knowledge-based service sectors.
Finally, the regression coefficients on the interaction term between the market to book ratio and
risk management on both performance measures are significant and positive (Model V) and
thus provide support for Hypothesis 4. Therefore, total risk management has a higher positive as-
sociation with performance outcomes among firms with high market valuations compared with the
value of their productive assets, which indicates that total risk management has particular perfor-
mance effects in organisations that rely on human-based intellectual capital.
Discussion
There has been a shortage of empirical studies assessing the implied performance effects of effective
risk management capabilities. Part of the explanation for this shortfall relates to the difficulty of
developing appropriate and consistent measures of risk management. Conventional risk manage-
ment perspectives have been skewed towards approaches seeking to eliminate downside exposures
even though it is recognised that risky environments also represent upside potential to responsive
organisations.27 Efforts are being devoted to consider the role and importance of flexible structures,
responsiveness and strategic renewal supported by an evolving conceptual framework around the

Table 3. Results of regression analyses [standardised regression coefficients] (n [ 1,369)
Performance ROA
Model I II III IV V
Organisational size 0.103** 0.044 0.047 0.058+ 0.069*

Primary industries 0.061* 0.040 0.016 0.018 0.019
Manufacturing 0.222** 0.199** 0.151** 0.154** 0.145**
Transportation services 0.055* 0.046+ 0.036 0.039 0.037
Telecommunication 0.144** 0.152** 0.170** 0.167** 0.168**
Retail companies 0.138** 0.112** 0.100** 0.100** 0.081**
Innovation 0.037 0.027 0.005 0.010 0.018
Knowledge products 0.002 0.015 0.014 0.002 0.018
Knowledge services 0.067* 0.020 0.014 0.003 0.008
Market-book ratio 0.209** 0.202** 0.225** 0.241** 0.312**
Financial leverage 0.154** 0.156** 0.149** 0.147** 0.137**
Total risk management (ROA) e 0.231** 0.220** 0.142** 0.183**
Innovation*risk management e e 0.164** 0.131** 0.077**
Knowledge products*risk management e e e 0.091** 0.023
Knowledge services*risk management e e e 0.143** 0.081**
Market-book*risk management e e e e 0.244**
Multiple R2 0.153 0.187 0.211 0.230 0.269
Adjusted R2 0.146 0.180 0.203 0.221 0.260
F-significance 0.000 0.000 0.000 0.000 0.000
+
p < 0.10; *p < 0.05; **p < 0.01.
concept of dynamic capabilities often supported by individual case studies.28 Other recent quanti-
tative studies have demonstrated that specific use of derivatives is associated with lower sensitivity
to changes in market prices while studies adopting general risk measures, such as corporate cash
flow volatility, find a positive association to market returns, etc.29
Here we introduce a more holistic risk management measure indicating the firm’s ability to cope
with economic, operational and strategic exposures and damp effects of exogenous market influ-
ences to stabilise the earnings development. We argue that effective risk management constitutes
more than hedging market exposures through financial derivatives, covering for hazards by engag-
ing in insurance contracts and reducing operational disruptions through internal controls. Total
risk management also comprises development activities that allow the firm to respond effectively
to strategic risks, including competitor moves, technology shifts, political events, etc., many of
which are hard to quantify and even foresee. For this reason, there is a need to make an extended
definition of total risk management and devise reasonable measures of this construct that can be
used for empirical studies of the implied performance relationships.30 We adopt this approach
to analyse the overarching question whether effective risk management outcomes have positive
performance relationships and assess the plausibility of the firm-specific investment rationale
embedded in the handling of strategic exposures through development of business opportunities
that gain upside potential.
Hence, the reported results are consistent with the proposition that effective risk management
capabilities reflected in the ability to damp the impact of exogenous risk factors and reduce
variability in corporate earnings have significant positive performance effects. We also wanted to
investigate the proposition that these risk management effects are associated with an ability to
facilitate investment in firm-specific relationships among essential stakeholders. Many stakeholder

Table 4. Results of regression analyses [Standardized regression coefficients] (n [ 1,369)
Performance ROI
Model I II III IV V
Organisational size 0.209** 0.103** 0.088** 0.077* 0.077*

Primary industries 0.019 0.004 0.014 0.011 0.011
Manufacturing 0.142** 0.124** 0.089* 0.093** 0.086*
Transportation services 0.027 0.020 0.014 0.016 0.014
Telecommunication 0.170** 0.176** 0.187** 0.185** 0.186**
Retail companies 0.103** 0.084** 0.078** 0.077** 0.064*
Innovation 0.033** 0.023 0.010 0.003 0.012
Knowledge products 0.014 0.026 0.003 0.017 0.027
Knowledge services 0.093** 0.060* 0.055+ 0.044 0.040
Market-book ratio 0.189** 0.179** 0.200** 0.206** 0.249**
Financial leverage 0.177** 0.179** 0.172** 0.170** 0.162
Total risk management (ROI) e 0.179** 0.173** 0.100** 0.130**
Innovation*risk management e e 0.148** 0.108** 0.069*
Knowledge products*risk management e e e 0.114** 0.061*
Knowledge services*risk management e e e 0.102** 0.051+
Market-book*risk management e e e e 0.179**
Multiple R2 0.141 0.163 0.183 0.197 0.219
Adjusted R2 0.134 0.156 0.175 0.188 0.210
F-significance 0.000 0.000 0.000 0.000 0.000
+
p < 0.10; *p < 0.05; **p < 0.01.
groups are unable to diversify the firm-specific exposures they incur by engaging in closer interac-
tions with the firm, e.g., managers, employees, customers, suppliers, alliance partners, etc. Hence,
effective risk management leads to positive performance outcomes because it reduces the vulnera-
bility of essential stakeholders as they engage in unique value-creating transactional relationships
with the firm. These relationships constitute the foundation for the organisation’s value-creating
capacity and the ability to sustain competitive advantage associated with the firm-specific invest-
ments made by key stakeholders and thereby gain an upside advantage from business opportunities
in a changing market environment.
The results from this study corroborate this theoretical rationale as the interaction between risk
management and innovation that builds on the commitment of firm-specific resources and speci-
alised knowledge is associated with higher performance outcomes. Accordingly, we find the perfor-
mance relationship of total risk management to be considerably higher in knowledge-intensive
industries characterised by emphasis on research and development and high market to book valu-
ations. Hence, firms operating in high-technology and advanced specialty areas, such as computer
products, semiconductors, pharmaceuticals, diagnostic instruments, aircraft engines, etc., have sig-
nificantly higher benefits from effective risk management capabilities compared with other firms.
Firms operating in knowledge-based services in businesses such as auditing, consulting, engineer-
ing, computer programming, prepackaged software, etc. show similar risk management benefits.
Whereas the results from the regression analyses are consistent with the firm-specific investment
rationale and provide support for all the associated hypotheses, it is also interesting to consider the
extent to which the two alternative explanations for performance effects seem to be at play. The first
explanation suggests that a smoother earnings development as a result of effective risk management
capabilities reduces the potential bankruptcy risk and, therefore, will lead to lower financing costs

for the corporation. To assess whether this is the case, we looked at the correlation coefficients
between the industry-standardised risk management measures and the weighted average cost of
capital for the corporation over the five-year period of study. However, the two correlation coeffi-
cients, while positive, were not statistically significant. Looking further at the correlation between
the risk management measures and the average corporate cost of debt over the period, the corre-
lation coefficients were slightly negative but not statistically significant. In conclusion, we do not
find empirical evidence to refute the financial capital cost rationale but it also fails to explain the
benefits of total risk management.
The second explanation suggests that a smoother earnings development as a result of effective
risk management capabilities reduces the potential bankruptcy risk and, therefore, will lead to lower
contractual costs in various counter-party transactions. As a low-risk corporation is more likely to
live up to its contractual obligations, the compensation charged for the related risk exposures will
supposedly be lower. To assess whether this is the case, we looked at the correlation coefficients
between the risk management measures and the average corporate sales, general and administrative
expenses (SGA) over total sales during the period of study. The SGA cost base includes a range of
expenses associated with the running of a business enterprise and as such also incorporates costs
related to many stakeholder relationships. For example, the level of sales expenditures will be
affected by relationships to wholesalers, retailers, customers, etc., and administrative costs will be
affected by relationships to managers, specialists, employees, etc. We find negative and statistically
significant correlations between risk management and the SGA ratio. However, this might relate to
a size effect as the risk measures used in this study are based on standard deviations as opposed to
coefficients of variance. Hence, we performed regression analyses using the SGA ratio as the depen-
dent variable and the risk management measures as the independent variables while including or-
ganisational size as control variable. In these analyses, the regression coefficients on the risk
management measures are negative but not statistically significant, i.e., organisational size is the
prime driver of the lower cost ratio. In conclusion, the empirical evidence does not confirm the
contracting cost rationale as an explanation for total risk management benefits.
Given the seemingly robust findings supporting the firm-specific investment rationale as an un-
derlying explanation for the positive performance relationship of total risk management, we now
turn to the large cross-sectional sample to identify firms that are representative of the reported re-
sults. These corporate entities are examined to assess whether their managerial behaviours are con-
sistent with a firm-specific investment rationale in support of essential stakeholder relationships.
Corporate evidence
The large cross-sectional database analysed in this study provides a basis for identifying firms that
constitute positive and negative examplars of the observed risk management phenomena during the
period of study. However, given the turbulence of contemporary business environments, corpora-
tions can also change in their ability to manage different exogenous risk factors over time. There-
fore, while this study is based on data for the five-year period 1996e2000, things may have altered
since then as a consequence of changing market conditions, mergers and acquisitions, corporate
restructuring activities and other managerial interventions.
Corporations can also change in their ability to manage different

exogenous risk factors over time
For example, the markets for information technology products were booming in the late 1990s
but were affected adversely by the bursting of the IT bubble in 2000/2001. Cisco Systems and Dell
Computer figure as good risk management performers in the computer products industries during
1996e2000 (Figure 2). However, Cisco was hit by the collapsing demand for internet-related

Industrial Machinery and Computer Products [SIC: 3510-3590]
20
Cisco Dell
EMC
15
Sun Microsystems
10
Return on Assets
Hewlett-Packard
-5
Emulex Silicon-Graphics
-10
-15
0 1 2 3 4 5 6 7 8 9 10
Risk Management
Figure 2. The strategic risk management e performance relationship
equipment and posted a substantial one-time restructuring charge that affected the reported net
income for 2001. Cisco has subsequently adapted to the changing conditions and returned to pre-
vious earnings trajectories. Throughout this adaptation process, Cisco has maintained a ‘‘passionate
focus on the needs of . key stakeholders e customers, partners, employees, and shareholders’’.31
At the same time, Cisco has relied on its ‘‘ability to continuously innovate and lead the market in
terms of products and systems offerings’’ as an essential way of responding to the new market
conditions.
Dell Computer has maintained the momentum over the subsequent five-year period 2001e2005.
Being a champion of the direct business model, Dell is often considered the epitome of a stakeholder
manager. A basic idea of the direct model is that close customer contacts make the organisation
understand the changing customer needs. This stakeholder perspective is expressed in the compa-
ny’s policy statements: ‘‘We believe in creating loyal customers by providing a superior experience
at a greater value’’ and ‘‘we believe our continued success lies in teamwork and the opportunity
each team member has’’.32 In contrast, the relatively poor risk management performers in the sam-
ple displayed a lack of ability to apprehend changing customer needs and as a consequence suffered
from declining sales and erratic earnings.
Microsoft emerges as another risk management champion in the industry for prepackaged soft-
ware products during the period of study (Figure 3). Microsoft expresses a similar stakeholder focus
as it claims that: ‘‘Providing value to customers means not only building great products, but also
listening carefully to customers, responding quickly.’’ This focus extends to internal stakeholders
with a view to using the unique and firm-specific skills of its employees. Contrast these proactive
stakeholder perspectives with some of the poor risk management performers that remained highly
product-focused, unable to use their stakeholder relationships and adapt to the market changes.
The pharmaceutical products industry is another innovation-driven and knowledge-intensive in-
dustry where success is synonymous with development investments and uncertain long-term return
prospects. In this business environment Abbott Laboratories, Johnson & Johnson and Pfizer figure
among the high-risk management performers over the period (Figure 4). These firms have market
activities in pharmaceutical products, instruments and services and seem to share some common
characteristics in their emphasis on stakeholders. That is, they all express a strong commitment
to develop their essential stakeholder relations and associated firm-specific knowledge. In the words
of Abbott Laboratories: ‘‘We have a responsibility to advance our business objectives, engage our
stakeholders . and exercise our influence to make a productive contribution to society.’’ An ex-
amination of Johnson & Johnson’s credo reflects a similar stakeholder concern as it states that:
‘‘customers’ orders must be serviced promptly and accurately . our suppliers and distributors

Prekackaged Software Products [SIC: 73720]
25
Oracle
Adobe Microsoft
20
15
Return on Assets
10
Computer Associates
Siebel Systems
5
-5 Micromuse
-10
Manugistics
-15
Inktomi
-20
0 1 2 3 4 5 6 7 8
Risk Management
must have an opportunity to make a fair profit and . we are responsible to our employees’’. At
Pfizer we observe a similar emphasis on fundamental stakeholder relationships: ‘‘We want to
become the world’s most valued company to patients, customers, colleagues, investors, business
partners, and the communities where we work and live’’.
While these well-known company names illustrate effective risk management performers over the
period 1996e2000, other firms have shown waning risk management effectiveness. Hewlett Packard
(HP) ranks among the high performers during 1996e2000 but has fallen somewhat off this track in
subsequent years as it embarked on the megamerger with Compaq in 2001. This merger created
conflicts among HP’s key shareholder groups and after its implementation imposed a monstrous
one-time restructuring charge on 2002’s earnings. While the company officially has heeded its
original emphasis on customer loyalty and market leadership, the proposed cost synergies from
the merger caused management to divide the organisation into ‘‘customer-facing’’ and ‘‘product
generation’’ entities. Hence, the need to realise promised cost savings in the wake of the merger
seemed to dilute the previous corporate emphasis on customer-driven innovation. Similarly,
Pfizer’s acquisition of Pharmacia to create the world’s largest pharmaceutical company caused
Pharmaceutical Products [SIC: 2834]

20
Abbott Merck
Johnson & Johnson
15
Pfizer
10
Return on Assets
5
ICN Pharmacia
0
-5
-10
ICOS
-15
VERTEX
-20
0 1 2 3 4 5 6 7 8 9 10
Risk Management

a one-time merger-related charge in 2003, although the company seems poised to regain its
previous performance trajectory.
Merck for long figured as an effective risk management performer but was hit by information
about the adverse health effects of its Vioxx arthritis and pain medicine, which eventually caused
the firm to withdraw the product from the market. This illustrates the significance of customers
and the community as essential stakeholders in the pharmaceutical industry where breaches of trust
can severely impact performance. The turbulent past of ICN Pharmaceuticals provides an extreme
example of these negative effects. The former chairman and CEO of the company was charged by
the SEC in the mid-1990s for giving misleading market information about the status of ICN’s
ribavirin drug. This debacle continued as the company posted poor results, eventually causing
management to restructure and rename the continuing firms during 2001.
These examples of representative firms extracted from the total cross-sectional sample and
described within their specific industrial environments confirm the importance of stakeholder
relationships as central elements of corporate wealth creation and the ability to create and sustain
competitive advantage. The circumstances ascribed to the effective risk management performers are
quite consistent with the stakeholder perspective and thereby provide some validity to the firm-
specific investment rationale as an enabler of business opportunities that may countervail strategic
risks. The examples illustrate that firm-specific investment in closer stakeholder relationships is re-
lated to superior performance, which enforces the argument for maintaining good risk management
capabilities to retain and nurture those value-creating relationships. Similarly, we observe that the
focus on stakeholder relationships, e.g., with customers, suppliers and employees, is instrumental
for the organisation’s ability to stay proactive in the face of changing market conditions.
The implications for management practice is that executives should incorporate a wider spec-
trum of exposures in corporate risk assessments to also include important strategic risk factors
and consider business development efforts as a way to increase responsiveness and exploit upside
potential. The development and execution of business initiatives are important to counteract
environmental threats and exploit opportunities where investment in firm-specific stakeholder
relationships is an essential value-enhancer. While the firm-specific investment rationale is impor-
tant to achieve upside gains, particularly for corporations operating in R&D-based and knowledge-
intensive industries, adherence to conventional risk management practices to reduce excessive
downside losses from economic and operational exposures remains important.
Concerns and limitations

There might be some causality issues at play in this study as it could be argued that high perfor-
mance creates slack resources that in turn enhance the firm’s ability to respond to risk events,
i.e., a reverse causality. However, slack resources deriving from good performance outcomes will
be posted in the form of retained earnings as net income is reinvested into the firm and, therefore,
would affect the capital structure. Since the regressions control for organisational size as well as
financial leverage, we are not so concerned with this potential confounding effect of slack resources.
Furthermore, as the firm has ample means to modify the capital structure through borrowing,
redemption, new issues, stock repurchase, etc., the argument of a passive one-way relationship
from corporate performance to slack resources does not appear convincing.
It has been argued that effective risk management decreases earnings variability and the volatility
of corporate cash flows, which in turn should encourage investment in innovation. We further ar-
gue that investment in innovation extends the strategic action space available to the corporation,
which enhances the ability to react to strategic risks. However, we cannot determine the exact cau-
sality in this relationship between total risk management and innovation but suggest that they con-
stitute contemporaneous phenomena and self-reinforcing processes. This may speak to the dynamic
nature of total risk management whereby effective risk management leads to higher performance
outcomes, while higher performance provides the means for excess liquidity that can be invested
in innovation, which in turn can enhance the corporate risk management capabilities, and so forth.

The study has adopted a more holistic risk management measure to reflect the firm’s overall abil-
ity to manage various exogenous risk factors. While this is quite consistent with recent attempts in
the finance field to devise general risk management measures, e.g., determined by corporate cash
flow volatility, the various organisational activities that support this capability are not detailed.
In other words, we show that total risk management seems to matter and that the underlying per-
formance rationale is the corporate ability to strengthen value-creating stakeholder relationships
and thereby exploit upside potential. The case examples corroborate this firm-specific investment
rationale. While the study indicates that effective risk management is related to innovation and
human-based knowledge, it does not detail the underlying total risk management processes. Hence,
there is room for more detailed case analyses to identify how different organisational processes may
support effective risk management capabilities beyond the scope of derivatives, insurance, manage-
ment controls, etc. We show in this study, that effective risk management capabilities should also
include the ability to counter and respond to harder-to-quantify strategic risks and not just prac-
tices to reduce economic and operational exposures. Nonetheless, our case examples illustrate that
high-performing strategic risk managers, in addition to their stakeholder management skills, also
are good at handling financial exposures, insurance hazards and operational risks while the poor
performers often displayed shortcomings in these basic risk management competencies as well.
The implications of the findings are manifold. The study confirms that the stakeholder-based
firm-specific investment logic is consistent with the data extracted from a large cross-sectional cor-
porate sample and that total risk management, therefore, can have a significant influence on the
ability to create sustainable competitive advantage and gain excess returns. While the positive
risk management outcomes are universal, they apply specifically to corporations operating in
knowledge-intensive businesses characterised by high levels of intellectual capital. In addition,
the risk management benefits accrue specifically to firms that emphasise investment in innovation
that can increase strategic responsiveness and risk management capabilities. Therefore, while the
positive performance effect of total risk management applies universally across industries, risk man-
agement is especially important to firms thriving on knowledge-based innovation as the means to
nurture valuable firm-specific investment.
Conclusions
Based on a large cross-sectional sample, the study demonstrates that the ability of integrative risk
management capabilities to reduce earnings variability in the face of diverse economic, operational
and strategic risks is associated with superior economic performance. The positive performance
relationships of such a holistic approach to risk management are more pronounced among firms
operating in knowledge-intensive industries and companies emphasising investment in research
and development. Hence, the evidence is consistent with the proposition that effective risk manage-
ment encourages valuable firm-specific investment by essential stakeholders and allows the firm to
exploit opportunities as well as guard against downside exposures.
Acknowledgements
An earlier version of this paper benefited from comments offered by participants at the Copenhagen
Conference on Strategic Management and by Richard Bettis and Charles Baden-Fuller in particular.
I am indebted to the very constructive feedback provided by the anonymous reviewers and an
engaged review process that have contributed to a greatly improved manuscript.
References
1. Numerous sources have emerged in recent years that promote the benefits of risk management practices.
See, for example A. Berry and J. Phillips, Enterprise risk management: pulling it together, Risk
Management 45(9), 53e58 (1998); C. Clarke and S. Varma, Strategic risk management: the new

competitive edge, Long Range Planning 32, 414e424 (1999); J. W. DeLoach, Enterprise-wide risk manage-
ment, Financial Times-Prentice Hall, London (2000); J. Lam, Enterprise risk management: from incentives
to controls, Wiley, New Jersey (2003).
2. These kinds of management practices have invariably been referred to in the literature as ‘strategic
response capabilities’ R. A. Bettis and M. A. Hitt, The new competitive landscape, Strategic Management
Journal 16, 7e19 (1995); ‘dynamic core competencies’ M. Lei, M. A. Hitt and R. A. Bettis, Dynamic core
competencies through meta-learning and strategic context, Journal of Management 22, 549e569 (1996);
and ‘dynamic capabilities’ D. J. Teece, G. Pisano and A. Shuen, Dynamic capabilities and strategic
management, Strategic Management Journal 18, 509e533 (1997).
3. These rationales are extended from, e.g. K. D. Miller, A framework for integrated risk management in
international business, Journal of International Business Studies 23, 311e331 (1992); K. D. Miller,
Economic exposure and integrated risk management, Strategic Management Journal 19, 497e514
(1998); K. D. Miller and H. G. Waller, Scenarios, real options and integrated risk management, Long
Range Planning 36, 93e107 (2003).
4. See, for example A. P. Liebenberg and R. E. Hoyt, The determinants of enterprise risk management:
evidence from the appointment of chief risk officers, Risk Management and Insurance Review 6, 37e52
(2003); A. E. Kleffner, R. B. Lee and B. McGannon, The Effect of corporate governance on the use of en-
terprise risk management: evidence from Canada, Risk Management and Insurance Review 6, 53e73
(2003).
5. For recent studies on corporate risk management practices, refer to e.g. K. Andersen and A. Terp, Risk
management, in T. J. Andersen (ed.), Perspectives on strategic risk management, CBS Press, Copenhagen,
27e46 (2006); P. W. Schrøder, Impediments to effective risk management, in T. J. Andersen (ed.),
Perspectives on strategic risk management, CBS Press, Copenhagen, 65e88 (2006); P. Henriksen and
T. Uhlenfeldt, Contemporary enterprise-wide risk management frameworks: a comparative analysis in
a strategic perspective, in T. J. Andersen (ed.), Perspectives on strategic risk management, CBS Press,
Copenhagen, 107e130 (2006).
6. See, for example R. M. Stulz, Risk management & derivatives, Thomson South-Western, Mason, Ohio
(2003); T. J. Andersen, Global derivatives: a strategic risk management perspective, Pearson Education-
Harlow, England (2006).
7. See, for example M. Power, The risk management of everything: rethinking the politics of uncertainty,
Demos, London (2004).
8. For a presentation of the underlying ‘insurative’ model, see P. A. Shimpi, Integrating risk management
and capital management, in P. A. Shimpi (ed.), Integrating corporate risk management, Swiss Re New
Markets, New York (1999); For further discussion of the topic, see also C. L. Culp, The art of risk
management: alternative risk transfer, capital structure, and the convergence of insurance and capital markets,
Wiley, New York (2002).
9. These perspectives draw from a rather broad literature including S. B. Sitkin, K. M. Sutcliffe and
R. G. Schroeder, Distinguishing control from learning in total quality management: a contingency per-
spective, Academy of Management Review 16, 537e564 (1994); R. Simons, Performance measurement
and control systems for implementing strategy, Prentice Hall, Upper Saddle River, New Jersey (2000);
T. J. Andersen, Strategic planning, autonomous actions and corporate performance, Long Range Planning
33, 184e200 (2000).
10. See, for example A. J. Slywotzky and J. Drzik, Countering the biggest risk of all, Harvard Business Review
83(4), 78e88 (2005).
11. The arguments for integrating risk management in strategy are also advanced in S. Chatterjee,
R. M. Wiseman, A. Fiegenbaum and C. E. Devers, Integrating behavioural and economic concepts
of risk into strategic management: the twain shall meet, Long Range Planning 36, 61e79 (2003).
12. These aspects of the resource-based view are discussed in J. B. Barney, Strategic factor markets: expecta-
tions, luck, and business strategy, Management Science 32, 1231e1241 (1986); J. B. Barney, Firm resources
and sustained competitive advantage, Journal of Management 17, 99e120 (1991).
13. The increased availability of favourably-priced capital should enhance the firm’s ability to engage in
positive net present value projects and thereby eliminate potential under-investment problems. See, for
example S. C. Myers, Determinants of corporate borrowing, Journal of Financial Economics 5, 147e175
(1977); S. C. Myers, The capital structure puzzle, Journal of Finance 39, 575e592 (1984); This has been
used as a prime argument for positive performance effects of risk management as outlined in K. A. Froot,
D. S. Scharfstein and J. C. Stein, Risk management: coordinating corporate investment and financing

policies, Journal of Finance 48, 1629e1658 (1993); K. A. Froot, D. S. Scharfstein and J. C. Stein, A frame-
work for risk management, Harvard Business Review 72(6), 91e102 (1994); The reinvestment rationale is
discussed in various finance textbooks, e.g. Z. Bodie, A. Kane and A. J. Marcus, Essentials of investment
(4th ed.), McGraw-Hill, New York (2001); W. F. Sharpe, G. J. Alexander and J. V. Bailey, Investments
(6th ed.), Prentice-Hall, New Jersey (1999).
14. The contractual cost arguments are discussed and tested in K. D. Miller and W. Chen, Risks and firms’
costs, Strategic Organization 1, 355e382 (2003); inspired, among others, by previous contributions in con-
tract theory, arguing that contractual agreements consider compensation for risk, e.g., A. A. Alchian and
H. Demsetz, Production, information costs, and economic organization, American Economic Review 62,
777e795 (1972); and finance, arguing that bankruptcy risk increases various firm costs, e.g., C. W. Smith
and R. Stultz, The determinants of firms’ hedging policies, Journal of Financial and Quantitative Analysis
20, 391e405 (1985).
15. These arguments are advanced in H. Wang, J. B. Barney and J. J. Reuer, Stimulating firm-specific invest-
ment through risk management, Long Range Planning 36, 49e59 (2003); incorporating insights from the
literature on the resource-based view and finance, e.g. B. Cornell and A. C. Shapiro, Corporate stake-
holders and corporate finance, Financial Management 16, 5e14 (1987) among others.
16. For an updated version of strategic applications of these resource-based principles see, for example
J. B. Barney, Gaining and sustaining competitive advantage (2nd ed.), Prentice Hall, Upper Saddle River,
New Jersey (2002).
17. For discussions of these concepts see, for example R. M. Grant, Toward a knowledge-based theory of the
firm, Strategic Management Journal 17, 109e122 (1996); B. Kogut and U. Zander, Knowledge of the firm,
combinative capabilities, and the replication of technology, organization, Science 3, 383e397 (1992);
K. M. Eisenhardt and J. A. Martin, Dynamic capabilities: what are they?, Strategic Management Journal
21, 1105e1121 (2000); R Mudambi, Knowledge management in multinational firms, Journal of Inter-
national Management 8, 1e9 (2002); K. Desouza and R. Evaristo, Global knowledge management strate-
gies, European Management Journal 21, 62e67 (2003).
18. See, for example R. S. Kaplan and D. P. Norton, Strategic learning and the balanced scorecard, Strategy &
Leadership 24(5), 18e24 (1996); K. E. Sveiby, The new organizational wealth: managing and measuring
knowledge based assets, Berrett-Koehler, San Francisco (1997); J. Roos, Intellectual capital, New York
University Press, New York (1998).
19. For discussions of industry effects refer to, e.g. M. E. Porter, How competitive forces shape strategy, Harvard
Business Review 57(2), 137e145 (1979); M. E. Porter, Competitive strategy, Free Press, New York (1980).
R. Rumelt, How much does industry matter?, Strategic Management Journal 12, 167e185 (1991).
20. This constitutes a frequently used method to control for industry effects on performance in organisational
research, e.g. M. Kotabe, S. S. Srinivasan and P. S. Aulakh, Multinationality and firm performance: the
moderating role of R&D and marketing capabilities, Journal of International Business Studies 33,
79e97, (2002) and many other studies. Alternative methods used from time to time is to normalise
the performance variable within smaller industry segments to capture corporate performance compared
with industry peers and include an industry performance variable that excludes the firm itself, to control
for peer industry effects, e.g. J. J. Reuer and M. J. Leiblein, Downside risk implications of multinationality
and international joint ventures, Academy of Management Journal 43, 203e214 (2000) However, adopting
these alternative methods do not materially alter the results reported in this study.
21. Different measures of firm risk have been advanced in the literature where the standard deviation in re-
turn on assets has emerged as a predominant indicator, e.g. R. M. Miller and P. Bromiley, Towards
a model of risk in declining organizations, Organization Science 7, 524e543 (1990) Alternative risk man-
agement measures could be adopted, e.g., using coefficients of variation instead of standard deviation to
reduce potential size effects or capturing market risk as variability in errors around the linear sales forecast
to eliminate the influence of sales growth and trend lines. Using these alternative measures in the analyses
do not lead to material changes in the results reported here.
22. Sometimes R&D intensity is standardised within the industry to capture the emphasis on innovation com-
pared with peers in the firm’s own industry, e.g. J. P. O’Brien, The capital structure implications of pursuing
a strategy of innovation, Strategic Management Journal 24, 415e432 (2003) This was not done in the current
study but adopting such a standardised variable in the analyses does not materially change the reported results.
23. These knowledge-based services correspond to the business sectors identified in F. J. Contractor,
S. K. Kundu and C. A. Hsu, Three-stage theory of international expansion: the link between multination-
ality and performance in the service sector, Journal of International Business Studies 34, 5e19 (2003).

24. See, for example C. L. Culp, The risk management process: business strategy and tactics, Wiley, New York
(2001); L. Muelbroek, The promise and challenge of integrated risk management, Risk Management and
Insurance Review 5, 55e66 (2002).
25. This approach is consistent with previous studies, such as R. L. Simerly and M. Li, Environmental
dynamism, capital structure and performance: a theoretical integration and an empirical test, Strategic
Management Journal 21, 31e50 (2000); J. J. Reuer and M. J. Leiblein, Downside risk implications of
multinationality and international joint ventures, Academy of Management Journal 43, 203e214 (2000).
26. See, e.g., L. A. Aiken and S. G. West, Multiple regression: testing and interpreting interactions, Sage, New-
bury Park, CA (1991); D. G. Kleinbaum, L. K. Kupper, K. E. Muller and A. Nizam, Applied regression anal-
ysis and other multivariate methods (3rd ed.), Duxbury Press, Pacific Grove, CA (1998).
27. See, for example R. R. Moeller, COSO enterprise risk management: understanding the new integrated ERM
framework, Wiley, Hoboken, NJ (2007).
28. This work is influenced by the evolving literature on dynamic capabilities, e.g. C. E. Helfat and
R. S. Raubitscheck, Product sequencing: co-evolution of knowledge, capabilities and products, Strategic
Management Journal 21, 961e980 (2000); S. G. Winter, The satisficing principle in capability learning,
Strategic Management Journal 21, 981e996 (2000); C. E. Helfat and M. A. Peteraf, The dynamic
resource-based view: capability lifecycles, Strategic Management Journal 24, 997e1010 (2003); M. Zollo
and S. G. Winter, Deliberate learning and the evolution of dynamic capabilities, Organization Science
13, 339e351 (2002); C. E. Helfat, S. Finkelstein, W. Mitchell and M. A. Peteraf, Dynamic capabilities:
understanding strategic change in organizations, Sage, Newbury Park, CA (2006).
29. See, for example B. Minton and C. Schrand, The impact of cash flow volatility on discretionary investment
and the costs of debt and equity financing, Journal of Financial Economics 54, 423e460 (1999); H. Shin
and R. Stulz, Shareholder wealth and firm risk, National Bureau of Economic Research (2000); G. Allayninis
and J. Weston, The use of foreign currency derivatives and firm market value, Review of Financial Studies
14, 243e276 (2001); C. Smithson and B. J. Simkins, Does risk management add value? A survey of the
evidence, Journal of Applied Corporate Finance 17(3), 8e17 (2005).
30. One shortcoming of a more holistic risk management definition is the difficulty of outlining the compre-
hensive risk management process in minute detail because an integrative approach considers a complex
amalgam of practices and techniques that together contribute to limit different downside exposures and
increase responsiveness to various opportunities. Conversely, it makes little sense to assess the effect of one
specific practice when effective risk management arguably can be ascribed to a multitude of practices
combined to deal with a wide diversity of firm-specific exposures. Nonetheless, it does seem important
to consider all corporate risk factors, including strategic risks, and incorporate business development
and responsiveness practices as essential ways to avoid emerging threats and exploit opportunities with
upside potential.
31. The company information and supportive quotes used to characterise the representative firms chosen
from the sample are extracted from annual reports and other publicly-available information.
32. Even with these positive risk management prospects, Dell has been affected by periodic quality breaches
among key suppliers, which illustrates the importance of managing the firm-specific relationships in
essential stakeholder relationships e Press release: Dell to recall 4m batteries, Aug 14 (2006). As Dell
has continued to expand its market reach, the celebrated ‘direct model’ has also shown some
shortcomings in its ability to assimilate customer needs in the mass markets for private individuals
and households.
Biography
Torben Juul Andersen is a Professor at the Copenhagen Business School associated with the Center for Strategic
Management & Globalization. His research interests include corporate strategy development, effective strategy-
making processes and strategic risk management issues. He is author of several books on multinational risk
management and his research has appeared in publications including Strategic Management Journal, Journal of
Management Studies, Journal of Business Research and Journal of International Management. ta.smg@cbs.dk

AntigoIN - 2008 - A Relação de Desempenho de Gestão de Risco Eficaz - Explorando o Justificativa Investment-Determinada Empresa

Enviado por

Dados do documento

Título original

Direitos autorais

Formatos disponíveis

Compartilhar este documento

Compartilhar ou incorporar documento

Opções de compartilhamento

Você considera este documento útil?

Este conteúdo é inapropriado?

Direitos autorais:

Formatos disponíveis

AntigoIN - 2008 - A Relação de Desempenho de Gestão de Risco Eficaz - Explorando o Justificativa Investment-Determinada Empresa

Enviado por

Direitos autorais:

Formatos disponíveis

Long Range Planning 41 (2008) 155e176 http://www.elsevier.

The Performance Relationship

Other responsive processes are equally important, such as the

156 The Performance Relationship of Effective Risk Management

Total risk management

Conventional risk management functions typically are associated with

Long Range Planning, vol 41 2008 157

158 The Performance Relationship of Effective Risk Management

Malfunction Corporate values/culture

Long Range Planning, vol 41 2008 159

Investments in innovation are the backbone for the creation of new

Lower average cost of capital

Normal distribution Skewed distribution with ‘fat tail’

Eliminate downside exposures

160 The Performance Relationship of Effective Risk Management

Higher contracting costs

If the firm is ignorant about how it manages various exogenous risks, it

Enhancing firm-specific investment

Long Range Planning, vol 41 2008 161

Innovation, knowledge, and intellectual capital

162 The Performance Relationship of Effective Risk Management

Effective risk management capabilities will reduce the reluctance

Long Range Planning, vol 41 2008 163

Total risk management

164 The Performance Relationship of Effective Risk Management

Long Range Planning, vol 41 2008 165

1. Average ROA 4.254 5.687 e e e e e e e e e

*p < 0.05; **p < 0.01.

166 The Performance Relationship of Effective Risk Management

Organisational size 0.103** 0.044 0.047 0.058+ 0.069*

Long Range Planning, vol 41 2008 167

Organisational size 0.209** 0.103** 0.088** 0.077* 0.077*

168 The Performance Relationship of Effective Risk Management

Corporations can also change in their ability to manage different

Long Range Planning, vol 41 2008 169

Figure 2. The strategic risk management e performance relationship

170 The Performance Relationship of Effective Risk Management

Figure 3. The strategic risk management e performance relationship

Pharmaceutical Products [SIC: 2834]

Figure 4. The strategic risk management e performance relationship

Long Range Planning, vol 41 2008 171

Concerns and limitations

172 The Performance Relationship of Effective Risk Management

Long Range Planning, vol 41 2008 173

174 The Performance Relationship of Effective Risk Management

Long Range Planning, vol 41 2008 175

176 The Performance Relationship of Effective Risk Management

Você também pode gostar

Organisational size 0.209 0.103 0.088** 0.077* 0.077*