Academic journal article Academy of Accounting and Financial Studies Journal

Determinants of Risk Management Committee Formation: An Analysis of Publicly-Held Firms

Academic journal article Academy of Accounting and Financial Studies Journal

Determinants of Risk Management Committee Formation: An Analysis of Publicly-Held Firms

Article excerpt

INTRODUCTION

The role of board of directors in risk oversight has begun to catch the attention of market participants following the reform of corporate governance in early 2000s. One of the responses to this growing expectation is the embrace of enterprise risk management (ERM) to enhance board's ability and effectiveness to oversee the portfolio of company risks in a robust way. Several corporate governance codes and guidelines such as The Combined Code (2008) further suggest that the use of board committees may be the most effective way to assist boards in discharging their risk oversight responsibility. Following this, risk management committee is emerging as one of the important board-level monitoring committees in most leading companies.

This newly evolving committee has the responsibility for reviewing risk management strategies, policies and measurement methodologies; identifying and managing of strategic business risk across the company as well as ensuring the adequacy and functionality of the risk management system (IRM, AIRMIC & Alarm, 2002). Several risk management committee structures have been adopted by market players starting with the audit committee structure (known as audit and risk management committee) to the separate board-level risk management committee (Brown, Steen & Foreman, 2009).

A large number of prior studies in the West have explored the influence of board structures and company characteristics on the implementation of ERM and the formation of various monitoring committees. No study to date, however, has investigated the development and structure of risk management committees in developing market. Thus, this study seeks to fill a gap in risk management research by analyzing the factors associated with the formation of risk management committees, in terms of board and company attributes.

This study contributes to the extant literature by providing initial exploratory empirical evidence on risk management committees in developing countries where the adoption is still voluntary. The analyses, from a sample of 796 publicly-held firms, suggest that risk management committee is positively associated with board size, outside directorships, company size and leverage. The results also indicate that board size is positively associated with separate risk management committee, while outside directorships is positively associated with combined risk management committee.

HYPOTHESES

Presence of Independent Directors

According to Fama and Jensen (1983), independent directors have incentive to maintain and enhance their reputational capital by increasing the quality of monitoring. They are expected to prefer comprehensive risk management structure in order to complement their monitoring responsibilities. Also, independent directors have no economic or social ties to the company and its management. They are free of any economic conflicts of interest. This enables them to question management's decisions more actively (Anderson & Reeb, 2004). Accordingly, the following set of hypotheses is made:

H1(a) The proportion of independent directors on the board is positively associated with the existence of a risk management committee.

H1(b) The proportion of independent directors on the board is positively associated with the existence of

a separate risk management committee.

CEO Duality

An independent Chairman is seen to be more vigilant and conscientious in executing board monitoring function with the intention of protecting his personal reputation in business community (Fama & Jensen, 1983). Pagach and Warr (2008) discover that ERM has become a control mechanism implemented by the board to offset the risk taking incentive of the CEO. A risk management committee thus provides independent Chairman a greater focus and capacity to better assess and manage potential risks that may attack the company. …

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