Another Reason That ERM Will Not Prevent Firms from Failing

Guest post from Neil Bodoff

Firms use ERM techniques to quantify and reduce risk. But the very act of doing so makes firms feel safer and more secure, leading them to take more risk. This phenmomenon is often described as the “Peltzman effect“:

So even though ERM can help firms master risk, the net result will be that firms take more risk, leading us back to the original situation in which the amount of risk that firms take will lead, eventually, to some

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One Comment on “Another Reason That ERM Will Not Prevent Firms from Failing”

  1. Good point, though the sequence of events is often reversed. In particular, a company believes it is safe and secure from the beginning. The ERM program is then rolled out in the expectation that it will “prove” what management already believes. However the result is the same – once the company’s safety is “proven,” it can be justified in taking more risk or decreasing its capital.

    The moral of the story is that the motivation for the ERM program matters a lot, and the strength or weakness of the risk culture will trump ERM model outputs.

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