Enterprise Risk

Overview


Enterprise risk refers to the measurement and management of risk as faced by a company. One of the primary sources of risk, is financial risk which is detailed in the financial risk corner.

However, enterprises face non financial risks as well. The measurment of these risks is more difficult than financial risk (which is difficult in itself). This corner discusses non financial risk management techniques.

Steps to Enterprise Risk


There are many frameworks for managing enterprise risk (see resources above). The following represents a simple and common set of steps.

Addressing Risk


There are generally three ways to address a risk once it has been identified. That is, after a risk has been identified, or when monitoring risk, after it has been deemed to have been elevated, there are three options for how to deal with the risk.

  • Accepting Risk: The first choice is to merely accept the risk. Even though nothing is being done to address the risk, the risk has been identified up to management who is know explicitly aware of the risk.
  • Mitigating Risk: is the process of finding ways to lessen the risk, or possibly the impact of the risk. One way to mitigate risk is to hedge, that is, create an opposite exposure to the risk that nets out the impact.
  • Risk Transfer: is the process of finding a third party willing to bear a giving risk, usually for a fee. The classic example of risk transfer is the purchasing of insurance against the risk. Risk transfer can create new risks that need to be monitored. In particular, when buying insurance, the insuror could become insolvent prior to having to pay a claim. Hence, buying insurance adds an element of credit risk to a company's books.

Enterprise Risk and Industry Structure


The structure of an industry (in terms of the cost structure, competitors and consumers, see Porters Five Forces) can have an impact on the risks that an enterprise will face.

In particular, a firm with high fixed costs faces elevated risk when there is a downturn in the economy or consumer spending. In such a case, the firm cannot just decrease costs through lower production. (That is, the firm faces a set of fixed costs that will not go away as production decreases)

Industries with high fixed costs often face fierce competition during a downturn (assuming the presence of competitors) as companies try to grab market share in order to cover its fixed costs. It is often critical for an enterprise to plan ahead of downturns
  • Move fixed costs to variable costs, where possible
  • Build a capital buffer
  • Have a strategic plan to garner market share in a downturn

Enterprise Risk in Financial Firms


Enterprise risk is more complex when dealing with financial firms. The theory has been developed in both banking and insurance industries and is generally subsumed under different names, depending on the industry.

In both cases, the objective is determine how much capital is needed in order to create an appropriate buffer to financial losses. Both industries are highly regulated, and the size of their capital buffer is a key interest of regulators.

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