How internal control is correlated with a company’s market value as represented by its share price? What is the impact of an organization’s risk management mechanism over the financial performance and health of a company, eventually exhibited via the securities traded in the secondary market.

To examine the associations between these variables, in the first hand, the gravity of internal control and risk management over the company’s value should be, in prior, minutely scrutinized. What are the areas or issues governed by the internal control mechanism of an organization? Basically, from a layman’s perspective, internal control mechanism is all about setting an organizational operational framework, so that every resources and activities of organizations are stringently monitored and controlled, eventually optimizing the organizational performance. Generally, the scope of internal control is voluminous, be it to minimize the wastage of organizational resources in terms of human resources, capital, assets, et cetera, curbing the possibilities of organizational failures, or to enhance the organizational performance, consequently assuring the organizational profitability, growth and long-run sustainability.

As internal control mechanism is all about the attempt to optimize organizational performance by effectively mobilizing organizational resources, on the contrary, risk management regime ought to always aspire to dilute overall unsystematic risk that the enterprises are faced with. For instance, in Nepal, Banks and Financial Institutions (BFIs) have to mandatorily adopt Basel II framework as the risk management tool or guidelines. As Basel II is a risk management framework, covering credit risk, operational risk and market risks, facilitating to streamline the overall organizational risks, it has been providing a solid ground for BFIs to mitigate their overall business risk.

Now, how the effectiveness or prudent execution of internal control and risk management mechanisms is reflected by the company’s share, which is traded in the market? The first thing to be noted is the impact of these control mechanism over the overall organizational performance, as reflected by the organizational profitability.

For instance, if the internal control mechanism of a commercial bank, obviously listed in the secondary market is extremely effective, the overall credit risk management or asset management of the said bank would be at a standard level, i.e., above industry par. Once the credit risk management or assessment mechanism has been made strong, the chances of asset or lending portfolio to degrade and turn into default is always at a minimal level, as the lending decisions are strictly controlled and regulated by strong Credit Policy Guidelines (CPG), manuals, credit policies, products, which eventually generates a sound credit lending decision. Now, how would the picture of the bank’s Non-performing loans (NPL) look like once the lending mechanism have been strictly bounded by the strong and standard credit control mechanism? Obviously, in this scenario, the weight or proportion of NPL would be at a lower end compared to the size of industry weighted NPL. This is how the effective internal control mechanism enhances the organizational value. To be more specific, once the NPL of the given bank is found to be at a strong position relative to the industry standard, the market reputation and standings of the institution would definitely outshine others or relative industry counterparts, consequently supporting the organizational value as represented by the optimistic stock prices.

Similar to internal control regime, risk management, as an important component of Corporate Governance (CG), has also been evolving as a significant tool to mitigate the overall organizational risks and operate organization at a tolerable risk levels. For instance, if the companies are not properly governed and risk management mechanism is practiced at a lower level, the risk tolerance capacity of the institution would head towards the south, inviting catastrophic results in the adverse business operating scenarios, whether the events are internal or external. Again evaluating BFIs risk management mechanism, it is evident to all that the Capital Adequacy Ratio (CAR) of any BFIs adopting effective risk management mechanism is always at a desired level, as required by the regulators. Under such scenario, if the CAR level of the given BFI is at an attractive level, let’s say 14 percent (for commercial banks in Nepalese financial industry, as required by Nepal Rastra Bank, the central bank of Nepal), obviously the figure is ultimately reflected in the share price of that individual bank being traded in the secondary market, i.e., Nepal Stock Exchange in Nepal’s case.

This is how the impact of effective internal control and risk management regimes could be observed and realized on the company’s increasing value, as reflected by the Market Share Price (MSP) of a particular company and vice versa.