CRO Appointments

1. The Information Conveyed in Hiring Announcements of Senior Executives Overseeing Enterprise-Wide Risk Management ProcessesMark Beasley, Don Pagach, Richard Warr

2. CRO Appointments ETRADE FINANCIAL Elects James R. Bidwell Chief Risk Officer Position Created to Integrate Risk Management with All Levels of Business Planning and ProcessesIn his new role, Bidwell will be responsible for coordinating an enterprise-wide system for strategy and organizational planning, internal audit, asset protection, liability management and cost containment while ensuring risk control for the Company. 

3. Enterprise Risk Management COSO defines Enterprise Risk Management as: • A process, ongoing and flowing through an entity - Applied in strategy setting • Applied across the enterprise, at every level and unit, and includes taking an entity level portfolio view of risk • Designed to identify potential events that, if they occur, will affect the entity and to manage risk within its risk appetite • Able to provide reasonable assurance to an entity’s management and board of directors

4. Enterprise Risk Management Actuarial Society defines ERM as: “ERM is a discipline by which an organization in any industry assesses, controls, exploits, finances and monitors risks from all sources for the purpose of increasing the organization’s short- and long-term value to its stakeholders”

5. So why is ERM important? • Growing embrace of ERM RISE OF THE CHIEF RISK OFFICER. Financial Director, May 1, 2002 “With the increasing importance of risk management, more and more corporates are appointing chief risk officers to provide a holistic approach to risk exposure and put in place an early warning system.US financial services institutions led the way in the mid-1990s and today there are 200 companies around the world with a board-level chief risk officer (CRO) - and not only in financial services.“

6. So why is ERM important? • Regulatory Developments • Sarbanes-Oxley • Basel II Capital Accord – Operational risk focus • London Stock Exchange Rules

7. So why is ERM important? • Ratings Agencies - S&P, Fitch • Having a solid enterprise risk management (ERM) strategy is key to remaining competitive, and it will be an increasingly important factor in our credit ratings. In 2007 and 2008, we are likely to raise and lower ratings in part based on companies’ ERM. • S&P Insurance Industry Survey, 12/7/06

8. So why is ERM important? • Growth of financial products that allow hedging: Freight-Rate Swapping Lets Investors Wager on Costs of Shipping By ANN DAVIS - January 4, 2007; Page C1 of WSJ Investors in the increasingly crowded commodities sector are betting not just on the price of raw materials but also on the cost of delivering them. Trading ocean-freight rates -- prices for getting oil, grain and coal to their destinations -- has become a hot new pursuit, with trades totaling an estimated $35 billion to $45 billion annually, up from roughly $20 billion to $30 billion a couple of years ago, participants estimate.

9. So why is ERM important? • Risk is getting more Board of Director’s attention due to public expectations • Appointments of Chief Risk Officer (CROs) becoming more common Main Question: Does all of this attention on ERM create value for shareholders?

10. How valuable? Fitch Ratings Service: Considering the vast number of consultants, software firms and universities touting their expertise in ERM and the multiple seminars focused on this topic, it would appear that ERM is the greatest development in the industry since marine risks were first pooled in Lloyd’s coffee shop over three centuries ago.

11. Need for Research • In general about Enterprise Risk Management • Who is implementing ERM? • How is it being implemented? • Why is it being implemented? • In particular – do shareholders/stakeholders value ERM adoption? • ERM ultimately should preserve and enhance entity value

12. Tension • On one hand • Better management of risk should be perceived favorably by shareholders • On the other hand • Portfolio theory suggests that shareholders manage their own risks through diversification Thus – not sure if ERM adoption is favorably perceived by shareholders

13. Background Stulz (1996, 2003) lays out these arguments • Primary goal of ERM – “By managing risk, a firm can reduce the probability of large adverse cash flow shortfalls.” • Benefits of RM may not be same across all entities – hedging a FC receivable is cheaper than hedging exchange rate risk related to future sales • An increase in total risk is costly because it is more likely that a firm would have a cash shortfall that would force it to give up valuable projects • Value creation comes about when ERM reduces “costly lower tail outcomes”

14. General Expectation Shareholders will perceive benefits to ERM when companies are in situations in which the likelihood of “costly lower tail outcomes” increases

15. Hypotheses # 1 HypothesisRelation to CAR Growth Options + Companies with a greater growth options require more consistent capital investment –– when hedging is cheap a small cost insures the company will be able to implement all of its projects. Companies with growth options will benefit from implementing ERM.

16. Hypotheses # 2 HypothesisRelation to CAR Intangible Assets + In times of financial distress intangible assets are likely to be undervalued, in addition, there may not be financial hedges for many intangibles. Companies with large amounts of intangibles will benefit from implementing ERM.

17. Hypotheses # 3 HypothesisRelation to CAR Slack on Balance Sheet - (cash ratio) If a company has a large amount of liquid assets it is able to “self-insure” against the probability of large adverse cash flows, these companies will not benefit from implementing ERM.

18. Hypotheses # 4 HypothesisRelation to CAR Earnings Volatility + Earnings volatility leads to costs such as missing earnings targets, violating debt covenants, poor relationships with stakeholders – ERM that reduces volatility should increase firm value.

19. Hypotheses #5 HypothesisRelation to CAR Leverage + Greater leverage increases financial risk which increases the cost of capital and borrowing costs. ERM that reduces operational volatility may lead to lower financing costs and should be viewed positively by shareholders.

20. Hypotheses #6 HypothesisRelation to CAR Firm Size + Past research (Culp and Miller, 1995) has shown that large firms use hedging to a greater degree this might suggest that these companies have more operational risks. Companies with large amounts of operational risks will benefit from implementing ERM.

21. Sample Approach • Use CRO announcements as proxy for ERM implementation • CRO suggests top-down, enterprise view TIME PERIOD 1992-2003: # of unique announcements 348 -private firms <100> -foreign firms <36> -unavailable price data <52> -unavailable F/S data <40> Final sample 120

22. Sample by industry/year

23. Descriptive statistics

24. Univariate CAR • Average CAR = -.001 (not significant) • Suggests no broad consensus as to the benefit/cost of the initiation of an ERM program. • However, the benefits/costs may be firm specific.

25. Regression Results- full sample

26. Multivariate Results

27. Results • Significant positive relationship for size and earnings volatility • Significant negative relationship cash ratio • No results for growth, intangibles • Leverage – opposite our expectations

28. What are we missing Managerial Wealth and Compensation • While shareholders can diversify away firm-specific risks, this is not true of managers. • Manager’s human capital is undiversified • If substantial equity based compensation then managers wealth is (purposefully) undiversified • The decision to adopt ERM could be motivated by managers own interests and not those of shareholders

29. Contributions • No evidence that ERM has broad value • Shareholder perceived value of ERM depends on firm-specific characteristics • Perceived benefit for non-financial institutions that • Have volatile earnings • Have less cash for “self-insurance” • Have little leverage

30. Thank you!