Last Updated 19 Dec 2022

Enterprise Risk Management and Firm Performance

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Abstract

In recent days, the market competition across all industries has been on the rise. Additionally, the number of risks likely to face the businesses has also been on the rise. As such, many firms have focused lots of their resources on developing measures that will help them overcome the risks is any of them emerged. Also, the firms have invested lots of their resources in ensuring that they perform well irrespective of the market situation. As such, this research paper aims at examining how the use of Enterprise risk management (ERM) practices relates to the firm performance. Besides, the research paper will seek to establish the different ways in which the ERM can impact on the performance of different firms, more so the small market enterprises in the developing countries. The research paper will conduct and qualitative and quantitative. Further, the research will try to establish how competitive advantage that arises from ERM can influence the success of a firm. Additionally, the research paper will examine the essence of financial literacy in implementing the ERM practices in motivating the performance of the business.

Introduction

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According to (Arena et al., 2010), businesses have continuously faced competitive market threats which have prompted them to develop attention on Enterprise risk management (ERM). As such, few studies such as (Florio, & Leoni, 2017) believes that ERM directly affects the performance of a given firm. Some researchers on their part believe that different internal factors impact how ERM and firm performance relates. In trying to establish the relationship between firm performance and ERM, researchers have focused primarily on the developed countries while paying less attention to the businesses in the emerging economies. Also, few empirical studies on how ERM and firm performance relates. Therefore, in helping understand the relationship between ERM and firm performance, this study seeks to take a case example of Small market enterprise (SME) performance and study how ERM affects the development of Competitive advantage (CA). Additionally, this study aims at examining the role of financial literacy in the ERM and firms performance.

Enterprise Risk Management involves the practices that a particular organization or industry have developed to manage the risks that may emerge as well as utilize every opportunity that will help it achieve its primary goals as explained by (Yang, Ishtiaq, & Anwar, 2018). Therefore, ERM is expected to help reduce costs that may arise as a result of financial distress, the shocks in the financial markets, and also help in the process of making business decisions. In the present era, ERM is essential in that it helps in controlling the internal systems of a business. However, the implementation of ERM requires a lot of resources. Due to this, many SMEs are unable to adopt ERM practices (Yang, Ishtiaq, & Anwar, 2018).

The risk management theory shows that the reduction of the accounting costs in business helps in the enhancing the performance of the firm thus proving that competitive advantage is the backbone of ERM. Previous studies such as (Krause, & Tse, 2016) demonstrates that ERM is very vital in enhancing competitive advantage as well as the firm’s performance. As such, this research suggests that ERM is an internal factor that helps lower the cost of running a business and increases the value of the products. This suggestion is in line with the Resource-Based View theory which involves the business reducing its financial costs as a way of enhancing its competitive advantage. Other studies such as (Arena et al., 2010) argues that the ERM practices depend on the behavior of the manager. This can, in turn, affect the competitiveness and performance of a firm.

ERM and Firm Performance

ERM practices are vital in exposing the risks that are likely to face business. Also, the ERM practices create room for the business to manage the risks that may emerge. Additionally, it provides the firms with a room to enhance its values. As such, (Yang, Ishtiaq, & Anwar, 2018) argues that ERM helps improve the profitability of a firm by lowering the costs involved in running the business as well as enhancing the value of the business. A study by (Krause, & Tse, 2016) reveals that firms that implement that have ERM practices in place have a higher firm performance than those that do not have the methods. Also, the study shows that firms with ERM practices in place earn more than those that lack. It is therefore evident that there exists a strong relationship between ERM and firm performance as proven by (Krause, & Tse, 2016).

Competitive Advantage and ERM

The success, as well as the failure of many businesses, lies on the strategies and the processes established to run the firm. Also, the ability of the business to cope up with the emerging market issues depends on the procedures that have been set to run the business. As such, (Yang, Ishtiaq, & Anwar, 2018) argues that the implementation of ERM strategies is inevitable. The ERM system and processes outline the measures that need to be adopted in case of any situation in the industry. Therefore, the ERM is vital to the business for both the financial and the non-financial performance of the business. In almost all cases, the management of the firm is mandated to strategize and plan on behalf of the company and hence the need to be well informed of the ERM practices. Additionally, (Yang, Ishtiaq, & Anwar, 2018) states that when the management is informed of the ERM practices, it is likely to develop a competitive advantage which will in return translate to the success in the business. The development of the Competitive advantage would also mean that few risks are likely to affect the business. It is therefore evident that there exists a relationship between ERP and the competitive advantage and hence the firm performance (Fraser, Simkins, & Narvaez, 2014).

ERM, Firm Performance and Competitive Advantage

Firm performance depends on various factors. Key among the elements is a competitive advantage. A study by (Yang, Ishtiaq, & Anwar, 2018) reveals that a competitive advantage can be achieved by lowering the costs involved in ensuring that the business runs effectively. In the same study, (Yang, Ishtiaq, & Anwar, 2018) argues that implementing an ERM helps to reduce the operational, management as well as any other cost associated with running the business. In striving to achieve a competitive advantage. Additionally, a business can achieve competitive advantage by making its products different from those of its competitors. Competitive advantage is very vital for a firm especially in a case where the industry is very competitive. As such, in businesses where the ERM system is implemented, the business is likely to achieve a competitive advantage which will, in turn, boost the performance of the firm. For instance, most of the Chinese companies have in the present days embarked on attaining a competitive advantage by adopting cost-based strategies which are achieved by implementing the ERM system. Further, (Yang, Ishtiaq, & Anwar, 2018) argues that empirical evidence shows that the competitive advantage is an essential aspect in determining the performance of the company.

Financial Literacy, ERM and Competitive Advantage

One of the primary ways in which firms achieve competitive advantage is by implementing the ERM. However, a study by (Krause, & Tse, 2016) reveals that it is not always the case that the ERM will ensure the company achieves the competitive advantage. The study further argues that there is a dire need to ensure that the management can facilitate the achievement of the firm’s targets as well as the ERM system. With this understanding, (Krause, & Tse, 2016) explains that it is necessary to ensure that the management has adequate financial literacy. Besides, the study states that the ERM system employed by any given firm should incorporate the necessary financial policies.

Discussion

Studies have been conducted in the past with the aim of examining what role is played by the ERM on the performance of different firms more so the SMEs. In this part, the findings obtained by various studies will be discussed. This discussion will, therefore, help to understand what other studies have found out in regards to the topic at hand.

First, qualitative research conducted (Yang, Ishtiaq, & Anwar, 2018) showed that there was a significant impact of ERM on the performance of SMEs. In the finding, the study revealed that many of the firms that registered market success employed the ERM practices and also the formal business policies. The study, therefore, concluded that the performance of different firms has a close relationship with ERM practices (Fraser, Simkins, & Narvaez, 2014).

Secondly, (Yang, Ishtiaq, & Anwar, 2018) found out that ERM affects the competitive advantage. This can be attributed to the fact that the ERM helps to lower the various costs involved in ensuring that the business runs effectively. The competitive advantage on its hand helps to enhance the performance of the business. As a consequence of this, the firm can gain cost-based competitive advantage thus favoring the suggestion by previous studies that stated that there existed a relationship between ERM and competitive advantage and hence firm performance.

Also, (Yang, Ishtiaq, & Anwar, 2018) found out that the success of a firm does not solely depend on ERM practices. In its empirical analysis, the study found out that financial literacy is significant in the success of the business as well. As such, the study found it necessary to have financial literacy incorporated with the ERP practices to enhance the performance of the firm.

Conclusion

In conclusion, this research paper examines the relationship of ERM and the firm performance as well as how the ERM affects the firm performance considering the case of SMEs. In so doing, the research paper has borrowed heavily on the research by (Yang, Ishtiaq, & Anwar, 2018) which was conducted in Pakistan and involved an analysis of data from 304 small market enterprises. The research paper mainly used a qualitative method to gather the information needed to support its argument. From this, we can conclude that ERM is very significant in the performance of any firm. It reduces the operational cost, management cost as well as any other cost that may arise. The ERM framework also comes out as a better way of gaining a competitive advantage and hence superior business performance. To further ensure that the ERM practices yield better results for any given firm, we can conclude that it is necessary to merge the practices with the financial policies that would help reduce the chances of the emergence of any financial risk. Lastly, we can conclude that businesses that are managed by financial literate individuals and also implement the ERM practices are likely to register a good performance whether the market is stable or turbulent.

References

  1. Arena, M., Arnaboldi, M., & Azzone, G. (2010). The organizational dynamics of enterprise risk management. Accounting, Organizations and Society, 35(7), 659-675.
  2. Florio, C., & Leoni, G. (2017). Enterprise risk management and firm performance: The Italian case. The British Accounting Review, 49(1), 56-74.
  3. Yang, S., Ishtiaq, M., & Anwar, M. (2018). Enterprise Risk Management Practices and Firm Performance, the Mediating Role of Competitive Advantage and the Moderating Role of Financial Literacy. Journal of Risk and Financial Management, 11(3), 35.
  4. Krause, T. A., & Tse, Y. (2016). Risk management and firm value: recent theory and evidence. International Journal of Accounting and Information Management, 24(1), 56-81.
  5. Fraser, J., Simkins, B., & Narvaez, K. (2014). Implementing enterprise risk management: Case studies and best practices. John Wiley & Sons.

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