Abstract
This study investigates whether changes in the quality of risk management are associated with changes in earnings volatility. Our findings are consistent with firms achieving lower earnings volatility by implementing higher quality risk management systems. These results are robust across profit and loss firms, although the economic impact of risk management quality is more pronounced for loss firms. Our results provide evidence as to how companies accomplish market performance through a quality risk management framework, and offer a reason why companies should allocate resources toward risk oversight. In addition, our results also suggest that recent public policy initiatives to improve risk management practices have tangible rather than superficial benefits to external stakeholders.
Introduction
In the wake of the 2008 financial crisis, many observers have asked why companies were not better informed about the risk exposures facing their organizations. As a result, a renewed emphasis on risk oversight has led to several public policy initiatives to address this concern. In a 2008 speech, Ben Bernanke, Chairman of the Federal Reserve, emphasized the importance of strong risk oversight; stating that “effective oversight of an organization as a whole is one of the most fundamental requirements of prudent risk management” (Bernanke, 2008). The 2010 Dodd–Frank Act established the Financial Stability Oversight Council, which monitors financial markets and makes recommendations on heightened standards of risk management. Motivated by these recent policy initiatives, we investigate the association between risk management and earnings volatility. An understanding of this relation is important in determining the true benefits of risk management.
Summary
This study examines whether changes in the quality of risk management are associated with changes in earnings volatility. We utilize SEC proxy statement risk disclosures related to the board’s involvement in risk oversight to capture risk management quality. Our findings are consistent with firms achieving lower earnings volatility by implementing higher quality risk management systems. Results are robust across profit and loss firms, although the economic impact of increases in risk management quality is more pronounced for loss firms.
