Chair or Co-Chair
Dr. Divesh Sharma, Kennesaw State University
Committee Member or Co-Chair
Dr. Mark S. Beasley, North Carolina State University
Dr. Marcus Caylor, Kennesaw State University
Utilizing available information about ERM practices within organizations disclosed by boards of directors in annual proxy statements filed with the U.S. Securities and Exchange Commission (SEC), this study expands the understanding of the value of disclosure of board-level ERM oversight information in proxy statements. The study first creates a board-level ERM engagement index (BODERMX) to identify aspects of board engagement in the ERM efforts disclosed by companies. Development of this index will present opportunities to future researchers to conduct empirical ERM-related research as information about firms’ ERM is costly to obtain. The study next examines associations between the extent of board engagement in ERM as measured by the index and (i) volatility of earnings, (ii) firm valuation, and (iii) the pricing of audit services by external auditors measured as outcomes.
After coding ERM disclosures of companies in the S&P 500 for 2010 to 2014, the final sample consists of 2,264 company-year observations used to create the BODERMX. The results of the volatility of earnings regressed on BODERMX are significant and negative, suggesting that more robust board-level ERM practices are associated with less earning volatility. Interestingly, while it has been theorized that ERM may be associated with less volatility in earnings, the study finds that investors appear to not value the benefits of more robust board-level risk oversight since the association between BODERMX and firm valuation (Tobin’s Q) is significant and negative. The evidence suggests investors might be perceiving additional board-level ERM implies greater risks facing the firm and/or investors may prefer to manage investment risk at the portfolio level. Additional analysis of the relationship between Tobin’s Q (TQ) and the individual practices that comprise BODERMX suggests that investors value strategic use of ERM, consistent with resource dependence theory, but do not value additional ERM governance, consistent with the cost/benefit rationale of agency theory. Finally, the study finds that the association of BODERMX and current year audit fees is not significant., suggesting that the extent of engagement by the board of directors in risk oversight does not affect the pricing of audit services Additional analyses indicate that investors and auditors, in particular, value specific aspects of the firm’s ERM processes differently, depending on whether the focus of ERM is on strategy execution (consistent with resource dependence theory) versus risk governance (consistent with agency theory). These findings taken together indicate that various stakeholders utilize ERM information in different manners.