Enterprise risk management : essays on community bank adoption characteristics, performance, and risk shift

Abstract

This dissertation encompasses a body of knowledge on enterprise risk management (ERM) adoption, firm performance, and risk-shift within the United States community banking industry. Community banks (CBs) are depository institutions with less than $10 billion in assets. These institutions represent 97% of U.S. banking institutions by quantity. Adoption of ERM and its effects have never been explored in a CB context. This dissertation includes three novel essays related to CB determinants of ERM adoption, firm performance post-ERM adoption, and firm risk-shift post-ERM adoption, spanning 1997 through 2020. Essay 1 is an exploratory study that identifies determinants of CB ERM adoption. Results showed CB ERM adoption first occurred in 1999 and accelerated after 2007, with 57% of the CB sample adopting ERM by 2018. Empirical findings showed CBs that are larger and those with riskier profiles are significantly more likely to adopt ERM. Essay 2 is a financial performance study that examines CB market and accounting performance post-ERM adoption. Results showed ERM has a significant negative effect on CB market performance and that larger and riskier ERM CBs have lower performance. Economically, ERM represented ~$34.8 million in lost shareholder value two years post-ERM adoption when measured using the capital asset pricing model and ~$37.9 million in lost shareholder value one-year post-ERM adoption when measured using buy-and-hold abnormal returns. Adoption of ERM had no significant effect on CB accounting performance (Tobin’s Q, return on assets, and return on equity). These findings empirically demonstrate ERM has a significant negative effect on CB financial performance. Essay 3 is a risk-shift study that examines movement in common financial risk proxies within CBs pre- and post-ERM adoption. Findings showed risk significantly increases two years after CBs adopt ERM and continues to increase as these programs mature, resulting in higher earnings volatility and standard deviation of returns. Additional analysis on early versus late adopters showed CBs that adopted ERM post-2007 (i.e., late) significantly pursued riskier non-traditional bank activities, resulting in increased risk. These risk-shift results were the opposite of what was expected and were surprise findings. Collectively, these essays contribute new and valuable knowledge to ERM and banking empirical literature and for industry practitioners. Overall results showed (a) larger and riskier CBs are more likely to adopt ERM; (b) post-ERM adoption, CBs experience lost shareholder value and performance degradation; and (c) post-ERM adoption, CBs pursue additional risk within two years, resulting in long-term increased risk-shift.