The Value Ambiguity of ERM: the Case Study of Pike River Coal Mine Xia
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The value ambiguity of ERM: The case study of Pike River Coal Mine Xia Meng Post-graduate Student Business School Eastern Institute of Technology Napier, New Zealand [email protected] Noel Yahanpath Senior Lecturer Business School Eastern Institute of Technology Napier, New Zealand [email protected] Corresponding author: Noel Yahanpath, Private Bag 1201, Taradale, Napier, Ph +64 6 974 8000, Fx +64 6 974 8910, Email [email protected] The value ambiguity of ERM: The case study of Pike River Coal Mine Abstract Enterprise risk management (ERM) has drawn increasing interests in academia and practice. At a theory level, many frameworks and standards have been developed. However, in practice, relatively few organizations have successfully implemented ERM and met expectations (Locklear, 2012). Two common explanations for ERM failures are: firstly, firms fail to implement ERM appropriately and secondly, the ERM framework has limitations in itself. This paper provides further evidence supporting the second explanation. There are many vague terms in current ERM frameworks, for example, risk appetite (Bromiley, McShane, Nair, & Rustambekov, 2014; Power, 2009), but the critical term is “value”. While ERM is generally accepted as a value-adding approach, there is no universal interpretation on the term “value”. This paper argues that the lack of ERM success arises from “value ambiguity” and, in particular, whose value should be enhanced? Therefore, more specific questions are: Managing risks for whose value? Is it for shareholders or other stakeholders? If for shareholders, is it for major shareholders or minor shareholders? To evaluate these issues, this paper first reviews literature on ERM and then examines the role of “value ambiguity” in the case study of Pike River Coal Mine. This paper offers insights for ERM researchers and practitioners to reconsider current ERM frameworks and the dangers of “value ambiguity” in implementing ERM programmes. Keywords: Pike River Mine, enterprise risk management II The value ambiguity of ERM: The case study of Pike River Coal Mine 1 Introduction Risk management has been practised for thousands of years; however, there is no universally accepted risk management framework. Generally, risks can be managed in two fundamentally different ways: one risk at a time or all risks together (Nocco & Stulz, 2006). The latter approach is often referred to as Enterprise Risk Management (ERM) and is viewed as the best practice (Locklear, 2012). Although ERM is conceptually straightforward, its implementation is far more complex. At a theory level, many frameworks and standards have been developed. However, in practice, relatively few organizations have successfully implemented ERM and met expectations (Beasley, Branson, & Hancock, 2010; Locklear, 2012). Why is achieving effective ERM so hard? One popular answer is to blame organisations and managements for failing to implement the framework properly. For example, Fadun (2013) concluded that risk management failures can be classified as operational failure and operators’ failure. Operational failure comes from execution of ERM systems while operators’ failure refers to a firm’s managers’ misconduct. However, these reasons are too broad. Basically, they can be used to explain any business failures. On the contrary, another explanation is that there is something wrong with current ERM frameworks. Power (2009) argued that ERM is fundamentally “flawed” at the level of design. Also, even the most widely accepted framework, which is developed by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is perceived to be too theoretical and contains overly vague guidance (Beasley et al., 2010). Vague terms like “risk culture” and “risk appetite” are often used in regulations and recommended procedures, but they are not explicitly explained (Bromiley, McShane, Nair, & Rustambekov, 2014). However, those terms are not the only ones that are not well defined. In fact, current ERM framework fails to clarify its objectives. Risk management is well accepted as an approach to add value, but whose value should be enhanced? This leads to a 1 fundamental flaw in ERM frameworks; we have used the term “ value ambiguity” to explain this shortcoming. One common approach is shareholder value maximisation (SVM). SVM is often presented as the primary goal of risk management (Quon, Zeghal, & Maingot, 2012). However, shareholders do not share equal rights and usually the majority shareholders tend to have more influence, leading to inequitable situations even among shareholders. The other issue is stakeholder value maximisation. For example, the COSO ERM framework is based on the premise that every entity exists to provide value for its stakeholders (COSO, 2004). Similarly, the Casualty Actuarial Society (CAS) defines the purpose of ERM is to increase the organization's short and long term value to its stakeholders (CAS, 2003). Notably, shareholders are also stakeholders. Therefore, the question remains whether ERM is for shareholders or for all stakeholders. “Value ambiguity” adds more challenges in implementing ERM, as all the actions and decisions made via ERM are supposed to align with an entity’s value. Different interpretations may lead to a totally different focus in ERM implementations. Clearly, in reality, conflicts between shareholders and even conflicts within shareholders are inevitable. Thus, this paper aims to outline the limitations in current ERM frameworks by arguing that the large portion of ERM failures arises from difficulties in clarifying ERM objectives, which is defined as “value ambiguity”. To illustrate the role of “value ambiguity” in ERM failures, a case study of Pike River Coal Mine is used. The remainder of this paper is organised as follows. The methodology is presented in Section 2. A literature review of the current state of ERM is given in section 3 and section 4 examines the role of “value ambiguity” in the case of Pike Rive Coal Mine. Section 5 contains the summary and conclusion. 2 Methodology The basic methodology used in this paper is a combination of historical case-study approach and documentary research method. The documentary research method is used to categorise, investigate and interpret the research interest from the most commonly written documents, in both the private and public domains (Payne & Payne, 2004). This method is useful but sometimes even more cost effective than other 2 methods (Gaborone, 2006). According to Bailey (1994), the documentary method refers to the analysis of documents that contain information about the phenomenon that researchers wish to study (Ahmed, 2010). For this research, data have been collected from various published sources, including Tragedy at Pike River Mine: How and why 29 men died, a number of financial reports, NZ Government Ministries, and some newspaper articles and magazines and so on. 3 The current state of ERM To understand the ambiguity surrounding ERM’s objectives and implementations, it is necessary to have a broad understanding of how ERM emerged, why firms implement ERM and current ERM framework’s limitations. 3.1 Emergence of ERM Although risk management has been practised for thousands of years, enterprise risk management is a relatively new concept (D’Arcy & Brogan, 2001). The term “enterprise risk management” was first used by James Lam in the mid-1990s (Locklear, 2012). In fact, risk management was originally developed by a group of innovative insurance professors in 1950s (D’Arcy & Brogan, 2001). In 1963, Robert I. Mehr and Bob Hedges published the first risk management text named “Risk management and the Business Enterprise” (Head, 1982). In this text, the objective of risk management was defined as “to maximise the productive efficiency of the enterprise”. At that time this goal was mainly achieved by transferring risks to insurance companies (Dickinson, 2001). This risk-transferring tactic was sufficient until corporations were exposed to various financial risks, such as volatility in exchange rates, commodity prices, interest rates and stock prices, which cannot be transferred to insurance institutions. Since 1970s, financial risk management began as a formal system practised by firms (Razali & Tahir, 2011). At the same time, tools of financial risk management were developed by investment banks to allow their corporate customers to hedge financial risks (Dickinson, 2001). These financial products are forwards, futures, swaps and options (D’Arcy & Brogan, 2001). They allowed financial institutions and other corporations used them to manage risks in a similar approach as insurance risk management had previously (Dickinson, 2001). 3 Since mid-1990s, corporations realised the possibility to manage various risks at the same time. Then, risk management shifted from traditional “piecemeal” risk management to ERM, a systematic and integrated approach to manage total risks at organisational level (Dickinson, 2001). This dramatic change emerges mainly from the revolution in two fields, namely, corporate finance and governance. In the field of corporate finance, the rise of shareholder value models facilitated the emergence of ERM frameworks. More specifically, Dickinson (2001) highlighted that shareholder value concepts inspired organisations to pay more attention to risk, which has always played a central role in finance theory. Accordingly, financial organisations and institutions began to emphasise on developing and practising risk measurement tools, such