Corporate Risk Management in Emerging Markets

Contents

List of Figures

List of Tables

List of Abbreviations

1. Introduction

2. Conventional Corporate Risk Management
2.1 General Definition of Corporate Risk Management
2.2 The Concept of Enterprise Risk
2.3 Types of Corporate Risks
2.3.1 Financial Risks
2.3.2 Non - Financial Risks
2.4 Tools and Techniques of Corporate Risk Management
2.4.1 The Corporate Risk Management Process
2.4.2 Measurements for Corporate Risks
2.4.3 Mitigation of Corporate Risks

3. Corporate Risk Management in Emerging Markets
3.1 An introduction of Emerging Markets
3.1.1 Definition of Emerging Markets
3.1.2 Emerging Markets’ Characteristics
3.1.3 Corporate Risk Types in Emerging Markets
3.2 Corporate Risk Management in Emerging Markets & Developed Markets
3.2.1 The Corporate Risk Management Process
3.2.2 Measurements for Corporate Risks
3.2.3 Mitigation of Corporate Risks

4. Conclusion

References

List of Figures

1. Holistic approach to Corporate Risk Management and Outcome of Risks

2. The Risk Management Process

3. Hedging Currency Risks in China

List of Tables

1. Common Financial Risks of Corporations

2. Common Non-Financial Risks of Corporations

List of Abbreviations

Abbildung in dieser Leseprobe nicht enthalten

Abstract

Managing risks is essential for corporations and has a tremendous impact on their per- formance. However, doing it sufficiently can be challenging, especially in Emerging Markets (EMs). Due to its underdeveloped environment, corporations often face enor- mous difficulties while managing risk in these countries. The purpose of this paper is to outline the issues and differences of corporate risk management in emerging economies compared to Developed Markets (DMs). After a short introduction, the second chapter describes risk management in DMs and gives an overview of common corporate risks. The third chapter characterizes EMs and details its risk management. In that connection, the focus lies on (1) the risk management process, (2) the measurement of risk and (3) the tools and techniques to mitigate risks in EMs. Conclusively, the paper summarizes the main factors for corporations that are fundamental for managing risks in EMs effec- tively.

1. Introduction

Emerging Markets: An acronym for growth, opportunities and high rewards. EMs symbolize bustling, dynamic and thriving economies. These type of countries are char- acterized by high population growth rates and tremendously skilled talents, benefitting from technological expansions and an increase in living standards. They are seen as nations with a bright future and high potential to become an advanced economy in the long term.

Corporations see enormous chances to lower their costs and increase their rev- enue in EMs. Since the majority of the world’s population lives in EMs, they offer tre- mendous potential. Operating successfully in EMs has become a must for multinational enterprises (MNEs). However, in many cases manager highly understate the risks that corporations can face in EMs (Broadman, 2012, p. 44)[7]. An undeveloped infrastruc- ture, violence and crime, corruption, environmental disasters and political instability are only a few characteristics that become challenging for organisations in emerging coun- tries (Hochberg, Klick, & Reilly, 2015)[40]. The Harvard Business Review conducted a survey which showed that the majority of the consulted corporations suffered losses, thus managing risks insufficiently in EMs (Hochberg, Klick, & Reilly, 2015)[40]. On that basis there is the assumption that managing risks is far more complicated in EMs than in DMs.

This paper deals with an overview of managing risks in EMs. It points out the characteristics of risk management in EMs and compares them to DMs. The first chapter deals with the basic definition of corporate risk management and introduces basic types of enterprise risks. Additionally, it covers (1) the risk management process, (2) the measurement of risk and (3) enumerates the most common techniques to mitigate corporate risks. The second chapter gives a brief introduction of EMs and their environment. The chapter proceeds with an overview of exposures in EMs and the examination of (1) the risk management process, (2) t he measurements of risks and (3) the miti gation of risk in Emerging Markets compared to DMs.

The thesis focuses on corporate risk management in EMs and does not consider risk management of capital investments. In that regard enterprises that are headquartered in EMs and enterprises that are based in DMs were taken into account.

2. Conventional Corporate Risk Management

This chapter outlines the basic definition of corporate risk management and introduces common types of corporate risks. It continues with an overview of the risk management process, the measurement of risk and tools for risk mitigation in developed countries.

2.1. General Definition of Corporate Risk Management

“ Risk comes from not knowing what you ’ re doing. ”

- Warren Buffett

Corporate risk management, also often referred to as Enterprise risk management (ERM), defines the “overall risk management approach to business risk” (D'Arcy, 2001, p. 1)[17]. According to Merna & Al Thani (2008, p. 2)[56], the main purposes of corporate risk management are (1) the identification of risk, (2) “ analysis of risks specific to the organisation ” and (3) to address the exposures in a compelling manner.

Meulbroek (2004, p. 57)[52] identifies the main aim of corporate risk man- agement as “ maximising shareholder value ”. Hampton (2015, p. 20)[31] specifies the aim and determines the following business needs as motives for implementing an ERM:

(1) survival, (2) stability, (3) fiduciary responsibility, (4) ethics and (5) observing regu lations. Thus, every company needs to survive; it is essential to identify dangers that can damage the business. Furthermore, it is easier to achieve a stable business by knowing its risks. Additionally, an ERM helps a company’s stakeholder to know their fiduciary responsibility and creates creditability (Hampton, 2015, p. 21)[31]. Moreover, regulations and guidelines like, e.g. from the Financial Reporting Council require companies to control their risks and to improve their risk management standards constantly (Financial Reporting Council, 2014, p. 1)[22].¹

In literature, corporate risk management is determined to be a new model for managing risks of an organisation (Olson & Wu, 2008, p. 3)[65]. Established in the mid-1990s, corporate risk management emerged through failures of high-profile com- panies that were managing their risk within each individual department and business unit (Dickinson, 2001, p. 360)[18]. Such a “silo approach to risk management” causes that enterprise-wide risk might not be identified or managed correctly (Sweeting, 2011, p. 3)[71]. Figure 1 illustrates the possible risk outcomes on each level of an organisa- tion and helps to understand that risk management is seen as a holistic system within an enterprise.

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Figure 1: Holistic Approach to Corporate Risk Management approach and outcome of risks Note: Own description on basis of Merna (2003, p. 90)[54]

On a corporate level, the management deals with long-term risks including a low level of detail, whereas the risk management on a strategic business level and a project level involves short-term risks with a high level on detail. Consequently, these various ap- proaches to risk management are summarized as ERM (Merna & Al-Thani, 2008, p. 3) [56]. For this reason, according to Steinberg et al. (2004, p. 2)[78] risk management is an integral part of the management’s duties, which has an effect on the overall entity’s performance. That goes in line with Yener (2010, p. 506)[92], who adds, that “ERM offers companies strategically more effective risk management” and decreases costs.

2.2 The Concept of Enterprise Risk

The word ‘risk’ was included into the English language “in the mid seventeenth centu- ry” and finds its origin in the Arabic and Latin language (Merna & Al-Thani, 2008, p. 9) [56]. In today’s literature, “‘risk’ has a number of meanings, and it is important to avoid ambiguity when risk is referred to” (Sweeting, 2011, p. 1)[71] . Wharton (1992, p. 41) [89] points out that over the years the key proposition changed from an uncertain reac- tion to a situation or determination that describes the possibility for an unwanted result, caused through an undesirable event. Steinberg et al. (2004, p. 2)[78] agrees to Whar- ton’s definition and states that “events with a negative impact represent risks, which can prevent value creation or erode existing value”. In contrast, Merna & Al-Thani (2008, p. 4)[56] say that it is important that risks should not always be considered threats. De- pending on the situation and a well-functioning risk management, risk can even be considered an opportunity (Merna & Al-Thani, 2008, p. 4)[56]. Agreeing with that Culp (2002, p. 15)[8] states: “in general, the conceptual perspective on risk varies with the perspective”. However, in literature the most common definition of risk is an event that leads to financial losses (Culp, 2002, p. 15)[8].

2.3 Types of Corporate Risks

According to Sweeting (2011, p. 93)[71] it is crucial to prioritize the risks of an enterprise, because of their high number. Furthermore, he reports that the exposures depend on the corporation itself and its industry. It is obvious that new risks occur over time and others disappear. Therefore no list can consider all exposures (Merna & Njiru, 1998, p. 128)[53]. According to Sullivan & Fragnière (2007, p. 21-22)[70] corporate exposures are dividable into financial risks and non-financial risks.

Financial risks usually have a direct impact on the monetary performance of an enterprise, whereas non-financial risks have a major influence on the overall business activity in the first place (Merna & Al-Thani, 2008, p. 128-130)[56]. The following paragraphs will introduce common types of financial and non-financial risks.

2.3.1 Financial Risks

As Merna & Al-Thani (2008, p. 128)[56] report in their book, financial risks affect the financial performance of an enterprise. They consist of several types of exposure asso- ciated with finance and actions that have a direct impact on the financial performance of a company (Merna & Al-Thani, 2008, p. 126)[56]. Mostly caused by external events, they lead to (1) reduced cash flow, (2) reduced market value and (3 ) reduced account- ing income (Fraser & Simkins, 2010, p. 322)[23]. Table 1 lists and defines common financial risks that companies face in industrially developed countries are summarized in the following list.

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Table 1: Common Financial Risks of Corporations

Summing up, it is evident that the list could enumerate several more risk types, although they are not the most common. For instance, Hampton (2011, p. 2)[32] reports that each MNE faces on average 800 financial risks “across all business units”.

2.3.2 Non-Financial Risks

Exposures that don't have a direct impact on the cash flow of a firm and are not mone- tary in the first place are associated as non-financial risks (Merna & Al-Thani, 2008, p. 130)[56]. Furthermore, Sullivan and Fragnière (2007, p. 22)[70] define non-financial risk as interruptions of the business. Next, table 2 lists and defines common non- financial risks.

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Table 2: Common Non-Financial Risks of Corporations

All in all, these listed types of exposures are presently the common corporate risks. It is important to note that living in a fast moving and globally connected world there are types of risks that are not definable or won’t be assessed by enterprises (Shah & Ramamoorthy, 2013, p. 434)[75].

2.4 Tools and Techniques of Corporate Risk Management

2.4.1 The Corporate Risk Management Process

The enterprise risk management process can be determined through different frame- works that summarize each step for a constant and successful approach to the manage- ment of enterprise risks (Olson & Wu, 2008, p. 8)[64]. The International Organization for Standardization (2009)[40] defines a risk framework as a “set of components that provide the foundations and organizational arrangements for designing, implementing, monitoring, reviewing and continually improving risk management throughout the or- ganization“. The process runs throughout the company constantly and is supervised by the management board (Olson & Wu, 2010, p. 7)[65]. There is a wide range of risk management frameworks developed by individual advisory firms and public committees like the EU² (Davis, 2010, p. 45)[16]. The frameworks serve as guidelines and regula- tions for the ERM process (Guled, Dange, & Chawan, 2012, p. 487)[24]. Figure 2 shows the ERM process and describes systematically how to cope with the exposures in a structured manner.

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Figure 2: The Risk Management Process Note: Own description on basis of Buehler, Freeman, & Hulme (2008, p. 23)[3]

The phase of Corporate Risk Diagnostic (CRD) includes the identification of relevant corporate exposures (Buehler, Freeman, & Hulme, 2008, p. 23)[3]. In that connection, Shenkir & Walker (2007, p. 10)[76] list useful identification tools as (1) SWOT - Analy- sis³, (2) scenario analysis⁴ or (3) giving out risk questioners and surveys to stakehold- ers.

[...]

¹ All premium-listed companies at the LSE are expected to meet the UK Government Code, which is overseen by The Financial Reporting Council and includes the application of the Enterprise Risk Management Process (Financial Reporting Council, 2014, S. 1)[22].

² Solvency II is an EU Directive that was developed as a risk management framework (Doff, 2008, p. 1)[19].

³ A SWOT- Analysis defines a detailed overview of a business’ strengths, weaknesses, opportunities and threats (Murray-Webster, 2010, p. 88)[60].

⁴ A Scenario Analysis is an assessment of potential events and „used extensively to make projections for the future” (The Econmoic Times, 2015)[84].