Enterprise Risk Management Adoption and Managerial Incentives

Enterprise Risk Management (ERM) is the approach of managing all risks faced by a firm in an integrated, holistic fashion. This research analyzes factors that influence a firm's decision to start an ERM program. Our comprehensive survey data of German property-liability insurance companies allows us to construct direct measures of ERM program adoption and ERM quality. We find that negative changes in past firm performance increase a firm's probability to adopt ERM and are accompanied by significant improvements in the quality of a firm's risk management process. Furthermore, these effects are stronger for firms that would be expected to have relatively high forced CEO turnover rates after periods of bad performance, supporting the prediction of the career concerns view and consistent with managerial incentives generally. Skilled managers concerned about keeping their jobs should reduce the volatility of a firm's earnings after a period of poor performance, and ERM adoption can help achieve that goal.