Introduction
Tennessee Sunshine Inc. is a mid-sized Tennessee company that specializes in creating exotic sauces from imported fruits and vegetables. The CEO Bill Stooksbury saw the pressing need to institute an enterprise risk management program in the company and has asked the firm’s financial analyst to prepare a report to brief the firm’s executives on this topic. In this case study, the concepts of enterprise risk management, the various components of an ERM framework, the reasons risk manage might increase the corporation’s value, the description of risk events, and how companies can reduce these risks are discussed.
Also, the case study contains illustr4ations on how the use of forward contracts and future contracts can reduce exchange…show more content… What are six reasons risk management might increase the value of a corporation?
There are several reasons risk management might increase the value of a firm. Risk management allows corporations (l) to increase their use of debt, (2) to maintain their capital budget over time, (3) to avoid costs associated with financial distress, (4) to utilize their comparative advantages in hedging relative to the hedging ability of individual investors, (5) to reduce both the risks and costs of borrowing by using swaps, and (6) to reduce the higher taxes that result from fluctuating earnings. Managers may also want to stabilize earnings to boost their own compensation (Brigham & Ehrhardt, 2014).
According to McShane, Nair, and Rustambekov (2011), enterprise risk management (ERM) has emerged as a construct that overcomes limitations of silo-based traditional risk management (TRM), but there are mixed findings on the relationship between ERM and firm performance. Using Standard and Poor’s risk management rating, they found that firm values are positively related to increasing levels of TRM capability but there is no additional increase in value for firms achieving a higher ERM rating (McShane, Nair, & Rustambekov,…show more content… The components of the COSO ERM framework. The eight components of the COSO ERM framework define the way for an organization to manage its risks.
Components 1 and 2: International environment and objective setting. These relate to a company's culture and mission. including its workplace environment, attitude towards risk, goal-setting process, and identification of its risk appetite, the amount of risk that it is willing to take (Brigham & Ehrhardt, 2014).
Component 3: Event identification. This refers to recognizing a source of risk, as any uncertain outcome that affects a company's previously defined objectives, e.g. increases in input prices, destruction of a factory, and loss of customers to a competitor. This is usually done through definition of risk categories and identifying potential events within these categories (Brigham & Ehrhardt, 2014).
Component 4: Risk assessment. This involves estimating the probability that the risk event will occur and the resulting impact on the company's objectives. For example, to assess this risk of an increase in interest rates, the firm would forecast the probabilities of different interest rates at the time it plans to issue the debt and estimate the cost of issuing debt at the different interest rates (Brigham & Ehrhardt,