ERM

The purpose of the essay is to discuss how clients use enterprise risk management system (ERM), which is developed by the committee on sponsoring organizations (COSO). The paper will start by explaining what an ERM system is and how it can help the clients to control risk. In the end, the paper will conclude with how the client uses the ERM system to evaluate and respond to risk.

ERM is defined by ERM framework as a process that is adopted by the management, personnel, and board of directors to assess the events that may lead to risks, control risk and reduce it to be within risk-taking or risk-bearing capacity and to provide reasonable assurance that the company’s objectives will be met (Ballou & Heitger, 2005). The goal of the COSO framework is to bring standardization and create a benchmark for risk management. They try to establish best practices that can be followed by everyone.

ERM is being applied to all industries. ERM helps the Board of Directors to reduce the risks associated and manage the same. In a business model, the ERM is being applied for business planning, execution, monitoring, and adapting. The internal control of the business help in objective setting, event identification, and risk assessment.

The ERM helps the clients to meet its goals and objectives. It assures that the business is following ethical and responsible behavior leading to a safe and transparent environment (Beasley, Branson & Hancock, 2009). ERM also helps in identifying the risk appetite of the company, which acts as a tool for managing risk, risk and opportunity identification, treatment of risks, reporting, and compliance (Ballou & Heitger, 2005). ERM and Internal control are two frameworks that can work together or in isolation. Both, however, enhances the leadership by working on governance, which helps in the optimal achievement of the mission.

Enterprise Risk Management further helps the clients to decrease financial distress costs within their firms. Through the reduction of costly financial distress, ERM helps increase the expected value of the business. The increase in value is a result of a reduction in the deadweight costs and the rise in the firms’ debt capacity that then benefits the business through tax shields and reduced agency costs of excess free cash flow.

A practical approach to ERM is by making ERM simple for the clients and making them comfortable with it. For this approach, a building block approach is used. The approach focuses on implementing the ERM across the eight interrelated components: Internal environment, objective setting, event identification, risk assessment, risk response, control activities, information and communication, and lastly, monitoring (Ballou & Heitger, 2005). These steps in ERM must be followed by each entity, which will help to successfully and efficiently apply ERM. The approach places emphasis on using the entity-wide approach across all four categories: strategic, operations, reporting, and compliance.

The risk process cycle is identifying risk and sorting them into categories, developing assessment criteria, assessing the risks, any complementary risks associated with the preceding risk, prioritizing the risks as per the impact or other factors, and responding to risks. The Board and Senior Management play a very important role in ERM and looking at how the management is approaching the ERM entity-wide level. The management is accountable to the board, and the insight of the board to assess risk depends on their understanding of the organization’s goals and objectives. The board can work with management to assess risk in the following four areas: Discussing the risk-taking capability and management philosophy on risk; secondly, understanding ERM practices; thirdly, review the risks that comes as a portfolio with identified risk and lastly, be aware of the important risks and their responses (Beasley, Hancock, & Branson, Strengthening Enterprise Risk Management for Strategic Advantage, 2009).

The use of ERM to evaluate and respond to various risks in business starts with first establishing a balance between the risk appetite and risk tolerance of the firm. In this case, the organization must consider the risks that are most acceptable and which will help it reach its goals. Risk tolerance is a tactical and operational approach that the firm must use before engaging in the risks associated with its business activities. The application of risk tolerance acts as a guide for the operating units of the firm as they implement the concept of risk appetite in the spheres of their operations.

The ERM structure plays a crucial part in the assessment of the risks in business organizations by classifying them appropriately. The classification involves identifying them as either low-risk tolerance, very low-risk tolerance, or high-risk tolerance. Low-risk tolerances are those risks that the company allows for only limited risk appetite due to the nature of their sensitivity. For instance, the operational tolerance in aerospace supplies for products that contain defects is zero risk tolerance. This assessment indicates that these are risks that are not worth exploiting because they can affect the operations of the company significantly.

ERM further identifies and classifies various risks differently depending on the firm in question. One of the most common forms of classification is the generic classification of risks that constitutes economic, environmental, political, technology, and personnel risks. Following this classification, the firm uses the ERM to communicate the breadth of its risk appetite to its employees based on the current risks. This helps the stakeholders to respond appropriately to the available risks by noting the need to exercise risks up to acceptable levels. Doing so ensures greater judgment and improved risk management within the organization.

Finally, ERM evaluates and responds to risks through the creation of a risk-aware culture, which emanates from the top management of the firm. The risk-aware culture helps ensure that the stakeholders of the firm have a better grasp of the risk appetite and tolerance of the firm. They have a clear idea of that which is acceptable, whether with regards to ethical behavior or pursuit of various objectives or encountering too much risk in trying to achieve the right objectives.

References

Frigo, L. M., & Anderson, J. R. (2011). Embracing enterprise risk management: Practical approaches for getting started. Durham, NC: Committee of Sponsoring Organization of the Treadway Commission.

Rittenberg, L., & Martens, F. (2012). Enterprise risk management: Understanding and Communicating risk appetite. Durham, NC: Committee of Sponsoring Organization of the Treadway Commission.

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