Corporate decision making for publicly traded insurers
Miller, Steven Michael
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In my dissertation, I study corporate decision making for publicly traded insurers, by examining the relation between line specialization and corporate governance stringency and the adoption of Enterprise Risk Management (ERM). I examine the incremental impact of corporate governance mechanisms in mitigating managerial discretion costs after controlling for the incentive alignment of managerial ownership. I achieve this through extending the managerial discretion hypothesis to predict that, for firms with the same set of governance tools, those firms that utilize these tools more stringently to control agency costs will command greater contracting cost advantages, leading them to specialize in conducting business that requires higher levels of managerial discretion. Consistent with my hypotheses, I find a significant positive relationship between the stringency of governance controls and the level of managerial discretion for a sample of 72 publicly-traded property-casualty insurers from 1994 to 2006. I also test the hypothesis that practicing Enterprise Risk Management (ERM) reduces firms’ marginal cost of risk reduction. Adoption of ERM represents a radical paradigm shift from the traditional method of managing risks individually to managing risks collectively, in a portfolio. This formation and management of a portfolio of risks allows ERM-adopting firms to better recognize natural hedges, prioritize hedging activities towards the risks that contribute most to the total risk of the firm, and optimize the evaluation and selection of available hedging instruments. I hypothesize that these advantages allow ERM-adopting firms to produce greater risk reduction per dollar spent. The resulting lower marginal cost of risk reduction provides economic incentive for profit-maximizing firms to reduce risk until the marginal cost of risk reduction equals the marginal benefits. Therefore, my hypothesis predicts that, after implementing ERM, firms experience profit maximizing incentives to lower risk. Consistent with this hypothesis, I find that firms adopting ERM experience a reduction in stock return volatility. Due to the costs and complexity of ERM implementation, I also find that the reduction in return volatility for ERM-adopting firms becomes stronger over time. Further, I find that operating profits per unit of risk (ROA/return volatility) increase post ERM adoption.