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Every company executes specific activities which are associated with certain risks. In the course of such actions, one must identify possible adverse situations that may hinder organization’s operation or become a substantial threat. Furthermore, it is crucial to assess the level of these threats and select the most safe, acceptable, and feasible options that would facilitate the process. The combination of all these actions comprises a complicated field of risk management, a sufficient and effective implementation of which is indispensable in any company wanting to become prosperous and viable. Its major objective lies within mitigating the adverse effects of possible and existing threats on the outcomes of commercial activities. Risk management policy consitutes a set of measures aimed at reducing the likelihood of making a mistake at the time of making a decision, as well as reducing the possible negative consequences of this decision. Lajili (2009) underlines that risk recognition and management are vital in all business strategy designs and implementation (p. 94 ). Overall, in the conditions of existence and development of modern businesses, one should emphasize that avoiding probable adverse situations is just as unsafe as risking too much; therefore, it is of utmost importance not to avoid dangerous situations, but to learn to manage them in an efficient manner as well as foster effective risk management practices.
Risk disclosure is a crucial concept associated with risk management. As a matter of fact, risk disclosure and management are progressively becoming the key function of modern businesses in numerous sectors and industries throughout the world. It is argued that the need for the disclosure of information by companies to the market is among the explanations justifying corporate risk management. At the same time, it is also outlined that risk management practices can be regarded as a tool for companies’ disclosure policy. Risk analysis plays a crucial role in disclosing information.
In addition, a vital role in disclosing information is played by risk assessment. By risk assessment we understand the totality of regular procedures, identifying their sources of occurrence, determining the possible magnitude of the consequences of the manifestation of risk factors, and procedures for minimizing or compensating for identified risks. Risk assessment is based on theoretical and practical research. Fundamentally, it includes identifying sources of risk, the financial activities of the company and its interaction with the external environment are studied; determining external and internal risk factors; analysing hypothetical chains of events under the influence of internal and external risk factors; determining risk assessment indicators; as well as establishing mechanisms and forming models of relationships and risk factors. The results of risk assessment can be used in two main directions. The first direction is directly related to the preliminary ordering by the criterion of the level of risk of various options for the development of the company and the selection on this foundation of the "base" option. The second area uses these basic assessments to manage risks when developing measures to reduce their negative consequences in the course of the financial and economic activities of the company. In modern conditions, a company should disclose information that allows users of financial statements to assess the nature and extent of risks
This paper is dedicated to analysing two articles that concern corporate risk disclosures as well as risk management and governance. The first article is by Lajili titled ‘Corporate risk disclosure and corporate governance’, while the second one was written by Mohd Ali and Taylor under the title ‘Content analysis of corporate risk disclosure in Malaysia’. Furthermore, the paper will also pay closer attention to examining the concepts of risk disclosure and corporate governance in order to be able to evaluate the corresponding articles better. The analysis of the two articles is to provide distinct understanding of risk management strategies, the connection between risk management and risk disclosure with corporate variables, as well as clear categorization of risk disclosure information.
The Concept of Risk Disclosure
In the modern setting, the foundation of risk disclosure is relied upon International Financial Reporting Standards (IFRS), as well as an adequate methodology for disclosing information in international accounting standards (International Accounting Standard - IAS). IFRS 7 Financial Instruments: Disclosures necessitates disclosure of the importance of financial instruments for an entity, as well as the nature and extent of the risks associated with such instruments, both in qualitative and quantitative terms; specific disclosures are need with regard to transferred financial assets and numerous other aspects (IASPlus 2020). On the whole, disclosure involves the revelation of pertinent qualitative and quantitative data in the yearly financial statements, to which the provisional financial statements and other applicable information are attached. All economic decisions made by interested parties are ensured through the full disclosure and reliable presentation of useful information. Therefore, the financial activities of the company in all its forms are fraught with numerous risks, the degree of influence of which on the results of these activities and the level of financial security is substantially increasing at present times. Disclosure of qualitative information in the context of the disclosure of quantitative information allows individuals to combine the relevant disclosures and, thus, form a general idea of the nature of the amount of risks arising in connection with financial instruments. The interaction between quantitative and qualitative disclosure of information contributes to such disclosure of information that will allow people to assess the risks of the company in a much more effective manner.
The Critique of the First Article
Published in the Journal of Risk and Financial Management, the article by Lajili (2009) examines the likely connections between corporate governance and corporate risk disclosure concentration. It does so through the employment of a sample of Canadian publicly-traded companies (TSX 230). Accordingly, the following outcomes were obtained which indicate that larger Canadian public companies with more independent members on the boards of directors are more prone to reveal risk management data beyond the compulsory risk disclosures. Thus, firm size and industry nature substantially influence the probability of greater risk disclosure by sample firms. Besides, it is emphasized that ownership structures governing minority voting seem to have a negative impact on risk disclosure.
Important Issues Highlighted
When to take specific aspects illuminated in the paper into account, one of the most significant concepts this study examines is the one concerning risk management. As a matter of fact, Lajili brings it to readers’ attention that the mindfulness of the risk profile, the level of risk exposure and risk management are rudiments in producing well-informed portfolio investment decisions. Indeed, it is underlined that risk management across the company is an essential component of corporate governance. There are particular frameworks governing risk management practices within enterprises. Among the most renowned ones is the report by COSO (i.e., Committee of Sponsoring Organizations of the Treadway Commission) (2004) that recommends an international framework for enterprise risk management to simplify information distribution and communication between executives and other employees. Furthermore, diversifying risk in an enterprise is paid attention to. Indeed, Lajili refers to the study by Tufano (1996) that emphasizes the prominence of managerial risk aversion and executive risk diversification strategies rooted in their incentive contracts. Essentially, due to corporate risk management progressively advancing throughout the world in order to attend to specific matters within business operations, corporate governance and corporate risk management have become more entwined. In this regard, one accentuates the prominence of interdependencies and mutual effects of corporate governance selection on general risk management strategies and disclosures.
The paper stresses the significance of regarding few dimensions of corporate governance at the same time in order to assess the efficiency of corporate governance structures as well as scrutinize in a wide-ranging way accounting disclosures associated with governance and risk disclosure matters. Hence, corporate governance is reached from two dimensions: the features of the board of directors linked to effective governance mechanisms following previous research and topical regulations as well as an agency theory-based approach in view of the agency costs engaged in governance structures. The empirical analysis supports the existence and importance of these connections, with the results providing overall support to some of the recent guidelines (e.g., SOX, CICA) and to agency theory forecasts as well. Overall, the study shows that, having analysed a decent amount of largely qualitative data regarding risk disclosure and risk management as revealed by firms engaged in this research, corporate risk disclosure intensity is closely connected to particular corporate governance variables. For example, it is indicated that Canadian public companies are prone to disclosing risk information when having more independent members on their boards of directors.
Moving on, Lajili stresses the importance of business entities disclosing relevant information regarging their exposure to risks due to specific regulations worldwide. Indeed, as mentioned above and is affirmed in the study by Lajili now, Financial accounting and reporting standards as well as security exchange commissions demand that business entities reveal such information to financial statement users. Besides, it is underlined that the most controlled categories of risk, which can also be seen in Lajili and Zeghal, are financial and market risk exposés, namely currency, interest rate and credit risks. Specifically, the Canadian Institute of Chartered Accountants (or CICA) Handbook (Section 3860) obliges firms to reveal any information that may assist users of financial statements in evaluating the level of risk associated financial tools use, e.g. the level and essence of the financial tools comprising the terms and conditions. What is more, according to the CICA Handbook, one encourages institutions to disclose a discussion of the range to which financial tools are used, as well as their risks and the business objectives served. All in all, it may be concluded that compulsory risk disclosures principally have to do with financial tools use being commonly described in the notes to the financial statements. Nevertheless, discussions of the risks comprising qualitative or quantitative data concerning the use of financial tools and management’s policies to regulate risks are mainly voluntary.
The Significance of the Article to the Practices of Risk Management
The article by Lajili contributes to the practices of risk management to a great extent. First and foremost, it accentuates the necessity to cultivate effective enterprisewide risk management, which is regarded as a vital aspect within corporate governance. In addition, it gives prominence to the significance of examining mutual influences of corporate governance choice on risk management strategies and risk disclosures in view of corporate governance and corporate risk management having become tightly connected. In this regard, Lajili argues that, due to being purposefully designed process and a performance control instrument, enterprise risk management is essentially entwined with corporate governance tools; in such a way, it should be executed through the adherence to an integrated approach that covers all probable aspects of firm’s functioning as well as administrative and governance-oriented features.
Essentially, the article provides crucial information regarding the importance of various aspects, which facilitate risk management procedures. In particular, it underlines the significance of well-informed and coherent risk assessment. Thorough risk analysis by companies indicates their exposure to various risks. For instance, having conducted meticulous risk assessment, firms involved in this study report that they are greatly exposed to numerous operational risks such as technical failures and low employee retention. Overall, Lajili draws attention to the further industry analysis which underlines the highest exposure to the operational risks in such industries as the services sector, the financial services sector, as well as the mining and transportation sectors. Additionally, it is shown that even though the observed probability of risky events or risk features appears to be greater for particular non-financial risk forms like operational risk, or government regulation risk, the effect of such risk factors seems to be not that austere compared to financial risks.
Moreover, the qualitative risk evaluation and analysis as revealed by the model firms of this study provide valuable comprehensions concerning the inclination of some companies to communicate risk information to their stakeholders openly. Indeed, it is indicated that some firms may withhold some associated information from all stakeholders. Nevertheless, this would be a detrimental practice since effective risk management should involve primarily efficient communication among all stakeholders. As a matter of fact, effective risk management has to involve the stakeholders, which can comprise such individuals as executives, employees, customers, shareholders, and others, during each stage, starting with initial risk assessment. Since all these people embody dissimilar roles and accountabilities within a company, they can provide a holistic picture of all of the characteristics of one’s business as well as every risk that may appear in it. In this regard, they might be key to conducting efficient risk management. Therefore, one should encourage all stakeholders to help enhance the continuous risk process by getting them engaged in it. Lastly, it is of utmost importance to communicate possible and existing risks throughout a business entity, which is another crucial aspect of risk management. In such a way, major risks that are likely to have a substantial organizational impact, are recognized and examined by all departments in a proper manner. Essentially, each person involved in this process should be aware of risks through effective communication techniques within a company.
Recommendations on How to Improve the Paper
This study could benefit from exploring more governance variables that have potential effects on risk management and disclosure. For example, it could investigate such a variable as executive incentive compensation and its influences on general governance as well as risk management and disclosure behavior. In addition, it would be beneficial and apposite to pay attention to risk disclosure quality apart from risk disclosure intensity. In this regard, risk disclosures would be employed to comprehend the quality and efficiency of the risk management approaches and corporate governance on the whole. Finally, one could further investigate the effect of various ownership and decision control arrangements on the value, transparency of risk disclosure as well as corporate governance efficacy in general. In such a way, more elaborate findings could be provided.
Lajili’s study proves to be useful as it contributes to the field of risk management. Specifically, it provides sufficient information regarding the probable relations between corporate governance and corporate risk disclosure intensity. It views enterprise risk management as a tactically designed process and an efficient performance control instrument that is innately connected with corporate governance tools. The author stresses that effective enterprise risk management should be executed following an cohesive approach that includes all thinkable aspects of the operational as well as organizational and governanceoriented features of a company. Essentially, it is accentuated that the framework for enterprise risk management has to be well adapted for delivering a hypothetically sound, wide-ranging and certifiable basis for incorporating all the probable risks to which organizations are exposed. Furthermore, the article underlines the need for effective communication among all stakeholders.
The Critique of the Second Article
Mohd Ali and Taylor’s study titled ‘Content analysis of corporate risk disclosure in Malaysia’ is a conference paper being a part of 4th Annual International Conference on Accounting and Finance (AF2014). Principally, it is aimed at exploring the peculiarities of risk disclosure, particularly its essence, extent and types of risk information through the usage of the context of corporate reporting in Malaysia. It uses hand-collected data from yearly 2009 reports from 200 companies. This study applies content analysis while risk disclosure in yearly reports is coded. It underlines four major risk disclosure types, namely operational risk, financial risk, environmental risk, as well as strategic risk. Most importantly, it finds that the first two risk disclosures constitute the premier types of risk disclosure in yearly reports.
Important Issues Highlighted
The primary attention within this study is paid to exploring the issue of corporate risk reporting. Primarily, corporate risk reporting is recognized as a vital tool and a major vehicle for rendering the value the risk function brings to a company. Particularly, the authors underline that there have been more requirements for corporate reporting with regard to risk management since the global financial crisis. As a matter of fact, the dynamic nature and growing intricacies of the business environment also increases demand for higher disclosure by companies concerning their risks and uncertainties. As a result, company boards are encouraged to produce higher risk disclosure in relation to financial and operational risks. In addition, risk reporting is believed to provide benefits in evaluating the hazards of an organization’s risk profile and enable investors to generate well-informed decisions concerning the distribution of their capital; this standpoint is supported primarily in Healy and Palepu, Solomon et al., and Linsley and Shrives. All in all, it is asserted that demands for risk disclosures are increasing in the modern business environment.
In addition, the article examines the issue of corporate risk classification. It is accentuated that, since a risk is regarded as an uncertainty possibly providing both a gain or a loss, adverse and advantageous outcomes are to be taken into account while exploring risk disclosure. In view of this, one should consider the entire range of uncertainties that may impact future prospects of a business comprising both upside and downside risks, ambiguity risk and instability risk. Besides, it should be mentioned that Crouhy et al. regard risk as the instability of returns that results in unforeseen losses, with greater volatility signifying greater risk. What is more, the paper draws attention to the fact that the modern state of risk disclosure is also guided by the growing germaneness of specific types of risks and uncertainties, predominantly while making investment decision. In such a way, one needs a distinct recognition of the various sources of uncertainty.
Essentially, since risks tend to emerge from different internal and external factors and businesses in various industries are encountering dissimilar risks, outlining a clear set of risk types that is usually faced by corporations is rather an intricate issue. Nevertheless, establishing clear classification of risks is indispensable because ill-defined risk can hinder company’s operations. In this regard, being able to comprehend various categories of risk information helps enhance the knowledge of investors when it comes to describing assets of a business entity as well as its financial stand and risks. In such a way, the study by Mohd Ali and Taylor takes into regard risk categories obtained from previous literature and outline a new classification of categories striving to reveal purely local shareholders’ call for risk information disclosure. Accordingly, one classifies these categories as follows, namely operational risk, financial risk, environmental risk, and strategic risk.
Specifically, operational risk consitutes a risk of opportunity cost or a probable damage because of insufficient techniques and policies like an internal control system glitch. In addition, it comprises a risk of losses, rise in operating costs, human error, decrease in productivity, security issue, management problem, and others. Moving on, the financial risk encompasses financial risk management goals and strategies, interest rate risk, credit risk, and other associated risks. At the same time, environmental risk appears because of the macroeconomic events and factors, which are basically out of the company’s control. It includes disclosures concerning economic risk, for example overall economic situation and global financial crisis, legal and regulation risk, suppliers and clients, and others. Finally, strategic risk is largely a risk triggered by events that are external to the business entity, but the ones that substantially influence its strategic choices or actions. In such a way, strategic risk is frequently a risk that a company might have to take for expansion as well as for the long-standing stability and sustainability that have an impact on the general direction of an organization.
The Significance of the Article to the Practices of Risk Management
The primary contribution of this article to the practices of risk management lies within it providing clear classification of risk disclosures types. More importantly, it proves to be utterly significant since it concludes that risk disclosures tend to heed predominantly financial risk and operational risk. Indeed, the article’s findings indicate that these two types of risk disclosures lead in comparison with strategic risk and environmental risk. As a result, the paper underlines that there is not comprehensive environmental and strategic risk-associated information revealed by companies, with such types of risk information being limited or poorly provided. Therefore, one may conclude that these types of risk information could be disregarded. Nevertheless, Mohd Ali and Taylor argue that in view of environmental and strategic usually being beyond the control of management, they are particularly germane to investors. As a matter of fact, it is argued that the repercussions of the lack of the comprehensiveness of corporate risk disclosure entail that management’s perspectives on external environmental and strategic risk likelihoods would be significant to investors in their evalution of the value of the company, as collected from disclosures in yearly reports.
Fundamentally, regardless of all categories of risk disclosures being potentially pertinent to investors and all stakeholders, the article concluded that corporations do not tend to assemble their risk disclosure consistently with any wide-ranging framework. For that reason, such texts that define comparatively incomplete or ambiguous information in particular risk categories without letting annual report users to gather the possible effect of those risks can conceal imperative decision-modelling information for stakeholders in a substantial manner. Henceforth, the conclusion regarding the insufficient degree of disclosure of information on environmental and strategic risks is that companies, which considerably increase their voluntary disclosure in this area are most likely to be perceived more positively in the stock market.
Recommendations on How to Improve the Paper
First of all, to obtain more comprehensive results within this study, I would recommend to regard more than one year observation expand the circle of risk categories used by the companies in order to render risk information. In addition, employing a meta-analysis method in exploring risk disclosure could be useful as well since it will allow one to reassess risk-associated data which was utilized in previous local as well multi-country studies. As a result, this approach is anticipated to find out whether contradictions in findings tend to emerge because of the research method or because of the context of the study. Nevertheless, even though these recommendations could be used to improve the paper, this study already proves to be of utmost value constituting a solid foundation for future researches in this niche.
The study by Mohd Ali and Taylor is of great use to the field of risk management and risk disclosure since it aims to provide a clear classification of the categories of risk disclosures, which, in turn, allowed one to identify the need for organizations to have more comprehensive risk disclosure. All the four major risk disclosure information types were identified and examined, namely operational risk, financial risk, environmental, and strategic risk. All in all, this study is highly beneficial since it develops a typology and related definitions that can diminish the vagueness and maximize the impartiality of assessing the essence and levels of corporate risk disclosure since the existing literature concerining the methods for designing a typology for corporate risk is rather unstable. Finally, the article’s findings indicate the necessity for companies to stucture their risk disclosure in accordance with a comprehensive framework as well as to heed environmental and strategic risks as they pose to be valuable for investors.