Enterprise Risk Management In The Airline Industry - Risk Management .

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Enterprise Risk Management in the Airline Industry - Risk Management Structures and Practices A thesis submitted in partial fulfilment of the requirements of Brunel University for the degree of Doctor of Philosophy By Anna Misiura Brunel Business School Brunel University London May 2015

i Abstract This thesis expands on the literature in the under-researched field of airline risk management by exploring organisational structures and practices of airline risk management systems and their technical and institutional drivers. In particular, it focuses on the phenomenon of Enterprise Risk Management (ERM) and its alignment to the requirements of airline business contexts. The theoretical framework informing this study combines structural contingency theory with two strands of institutional theory, namely old institutional economics and new institutional sociology. In this thesis, the phenomenon of risk management is investigated in situ as an organisational practice through a two-stage empirical study. Firstly, an exploratory field study was undertaken in a panel of ten international airlines. Secondly, the field study was complemented with findings from two explanatory case studies. This study explains how in developing risk management systems airlines balance the sometimes conflicting technical and institutional demands of their respective task and institutional environments. The adoption and implementation of ERM in airlines are found to be driven primarily by coercive and normative pressures, and expectations of improved organisational effectiveness and efficiency. This study additionally improves general understanding of the nature of ERM and its coupling and fluidity in the organisational settings of airlines. It lends evidence for systematic variations in roles, uses, and organisational design choices of ERM systems. It shows the interdependent nature of airlines’ ERM systems and other management systems. The study also demonstrates that the adoption of ERM in airlines drives development of new institutions, rules, and routines for comprehensive management of risks. Consistent with the tenets of contingency theory, this study conveys lack of a universally appropriate design of an airline ERM system. The main contribution of this thesis is to assess airline risk management systems, identify core drivers of effective risk management practice, and provide a framework with the aim of guiding airlines in the development of enterprise-wide risk management approaches aligned with the requirements of their institutional and technical contexts. Furthermore, this research overcomes the limitations of previous, mostly quantitative studies of ERM coupling and dynamics in organisations, as it explores and explains the structures, practices, and rationales of airline risk management systems within wider organisational contexts through the use of qualitative methodologies.

ii Dedication To my parents, Teresa and Leon, for their everlasting love and endless support.

iii Acknowledgements First and foremost I would like to thank Dr Abraham Althonayan and Dr Mirna Jabbour for their support and encouragement throughout the duration of this research. I would also like to express appreciation to academic and administrative staff at Brunel Business School. My heartfelt gratitude especially to Fernando, Julita, and Kamil, for their love. Last but not least, my special appreciation to all my friends who sustained me with their encouraging words and wishes over the years of study.

iv Declaration I, Anna Misiura, hereby declare that the contents included in this PhD thesis are entirely my own work, have been developed specifically for this research, and have not been previously submitted for any other qualification.

v Table of Contents Chapter 1: Introduction . 1 1.1 Background . 1 1.2 ERM concept . 4 1.3 Risks and challenges in the airline industry . 6 1.4 Research problem . 9 1.5 Aims and objectives of the study . 12 1.6 Significance of the study . 14 1.7 Outline of the thesis. 16 Chapter 2: Literature Review . 17 2.1 Introduction . 17 2.2 Evolution of the risk management discipline . 18 2.3 Risk management in the airline industry . 20 2.3.1 Airline business environment and risk management practice . 21 Key areas of airline risk management practice . 23 Operational risk management in airlines . 27 2.3.2 Trends and new directions in research and practice of airline risk management. 32 2.4 Adoption and implementation of ERM and their driving forces . 39 2.4.1 Drivers of ERM adoption and implementation . 39 2.4.2 ERM implementation . 41 2.5 Overview of landmark ERM frameworks and risk management standards. 44 2.5.1 Australian and New Zealand Standard for Risk Management AS/NZS 4360 . 48 2.5.2 COSO Enterprise Risk Management – Integrated Framework . 49 2.5.3 ISO 31000 Standard . 52 2.5.4 Alignment of ERM frameworks and risk management standards to organisational contexts . 55 2.6 Limitations of literature. 58 2.7 Conclusions . 59 Chapter 3: Theoretical Framework . 61 3.1 Introduction . 61

vi 3.2 Theoretical approach: Duality of technical and institutional environment . 62 3.2.1 Contingency theory perspective . 64 3.2.2 Institutional theory perspective . 66 3.3 Theoretical model . 70 3.3.1 Components of the theoretical framework: analysis under the contingency approach . 72 3.3.2 Components of the theoretical framework: analysis under the institutional approach . 78 3.4 Conclusions . 81 Chapter 4: Research Design. 83 4.1 Introduction . 83 4.2 Research paradigm . 83 4.3 Research methodology . 86 4.3.1 Field study . 87 4.3.2 Case study. 89 4.4 Definition of units of study . 91 4.4.1 Field study sampling . 91 4.4.2 Case study sampling . 96 4.5 Research methods . 97 4.5.1 Data collection methods . 98 4.5.2 Data analysis methods . 104 4.6 Ethical considerations . 107 4.7 Limitations of the field study and case study research, and reliability and validity considerations . 108 4.8 Conclusions . 112 Chapter 5: Field Study: Airline Risk Management Structures, Practices, and their Determinants . 114 5.1 Introduction . 114 5.2 Determinants of airline risk management approaches . 115 5.2.1 Institutional pressures . 115 5.2.2 Contingency factors . 121 5.3 Review of airline risk management systems . 125 5.3.1 Characteristics of airline risk management systems. 126 5.3.2 Maturity and advancement of airline risk management approaches . 133

vii 5.4 Conclusions . 138 Chapter 6: Case Study: ERM System in Alpha Airlines . 142 6.1 Introduction . 142 6.2 Outline of the case study . 143 6.3 ERM model . 144 6.3.1 ERM governance structures . 145 6.3.2 ERM technologies . 150 6.3.3 Pillars of the ERM model . 157 6.3.4 ERM internal environment . 166 6.4 Conclusions and lessons learnt . 168 Chapter 7: Case Study: Risk Management System in Beta Airline . 172 7.1 Introduction . 172 7.2 Outline of the case study . 174 7.3 Risk management model . 175 7.3.1 Risk management governance structures . 179 7.3.2 Risk management technologies . 181 7.3.3 Functionality of Beta s risk management system. 193 7.4 Conclusions and lessons learnt . 196 Chapter 8: Discussion . 199 8.1 Introduction . 199 8.2 ERM framework in the airline industry . 200 8.2.1 Risk governance structures . 203 8.2.2 Management of enterprise-wide risks: ERM process and airline risk profile . 207 8.2.3 ERM architecture . 210 8.2.4 ERM internal environment . 212 8.2.5 Context-specific design of an ERM system . 215 8.3 Determinants of airline risk management and ERM systems . 217 8.3.1 Institutional determinants of airline risk management systems . 217 8.3.2 Technical determinants of airline risk management systems . 224 8.4 Maturity, roles and uses of airline risk management and ERM systems . 231 8.5 Conclusions . 235

viii Chapter 9: Conclusions . 239 9.1 Introduction . 239 9.2 Research questions revisited . 240 9.2.1 Determinants of adoption and implementation of risk management systems in airlines . 240 9.2.2 Organisational structures and practices within airline risk management systems . 242 9.2.3 Assessment of airline risk management systems . 244 9.2.4 Recommendations for improvement of airline risk management systems. 246 9.3 Contribution of the study. 247 9.3.1 Contributions to theory. 248 9.3.2 Contributions to methodology applications . 249 9.3.3 Contributions to knowledge and practice . 250 9.4 Research limitations . 254 9.5 Recommendations for further research . 257 9.6 Final remarks . 258 References . 259 Appendix A: Theoretical Framework . 288 Appendix B: Coding Scheme . 297 Appendix C: Analysis of Field Study Findings . 299 Appendix D: Extension of Findings from Alpha Case Study . 326 Appendix E: Interview Agenda Designed for the Field Study. 335 Appendix F: Interview Agenda designed for the Case Studies . 341

ix List of Tables Table 2-1: ICAO’s Safety Management System Framework . 31 Table 4-1: Airlines participating in the empirical research . 95 Table 4-2: Field study and case study interviewees . 103 Table 4-3: Organisation and analysis of empirical data . 106 Table 4-4: Triangulation. 109 Table 5-1: Institutional pressures influencing airline risk management systems. 117 Table 5-2: Contingency factors influencing airline risk management systems . 123 Table 5-3: Perceived status of risk management development . 127 Table 5-4: Characteristics of airline risk management systems . 129 Table 5-5: Maturity and advancement of airline risk management systems . 134 Table 8-1: Drivers of effective risk management in airlines . 203 Table 8-2: Review of key findings . 237 List of Figures Figure 2-1: Airline risk management matrix . 23 Figure 2-2: Evolution of safety risk management . 28 Figure 2-3: Research trends in airline risk management . 33 Figure 2-4: Evolution of airline risk management approaches . 35 Figure 2-5: Implementation of ERM . 42 Figure 2-6: Risk management process - AS/NZS 4360 . 48 Figure 2-7: COSO s Enterprise Risk Management Integrated Framework. . 51 Figure 2-8: Relation between the components of the ISO 31000 standard . 53 Figure 3-1: Schematic representation of the theoretical model. 71 Figure 8-1: ERM framework in the airline industry . 201

x List of Abbreviations ATM - Air Traffic Management AS/NZS 4360 - Australian and New Zealand Standard for Risk Management CAPEX - Capital Expenditure COSO - Committee of Sponsoring Organisations of the Treadway Commission EASA - European Aviation Safety Agency EMS - Environmental Management System ERM - Enterprise Risk Management EPS - Earnings Per Share Value ESARR - Eurocontrol Safety Regulatory Requirements FMS – Flight Management System IATA - International Airlines Transport Association ICAO - International Civil Aviation Organization IS – Information System ISO - International Organisation for Standardisation IT – Information Technology MCS – Management Control System NIS - New Institutional Sociology theory NYSE - New York Stock Exchange OHSMS - Occupational Health and Safety Management System OIE - Old Institutional Economics theory SeMS - Security Management System SUMS - Supplier Management System S&P - Standard and Poor's SOX - Sarbanes Oxley Act SMS - Safety Management Systems SOAM - Systemic Occurrence Analysis Methodology SWOT – Analysis of Strengths, Weaknesses, Opportunities and Threats QMS - Quality Management System

1 Chapter 1 Introduction 1.1 Background This thesis explores organisational structures and practices of airline risk management systems and their technical and institutional drivers. Airline risk management systems are investigated within task (or technical) and institutional environments which, as conveyed respectively by contingency and institutional theories, exert technical and institutional demands on organisations. Under these theoretical perspectives technical pressures are concerned with enhancing efficiency and effectiveness of organisational performance (Scott, 2002; Gupta, 1994), and institutional pressures are concerned with gaining social legitimacy (Meyer and Rowan, 1977; DiMaggio and Powell, 1983). The theoretical perspectives informing this study are discussed in more detail in Chapter 3. In this theoretical context, this study particularly focuses on the phenomenon of Enterprise Risk Management (ERM) in airlines, explained as follows in section 1.3 of this chapter, and its alignment to the requirements of airline business contexts. For the purpose of this study the researcher defines ERM as a continuous process of identifying, analysing, and managing exposures across different organisational units and functional areas in airlines, aimed at assuring the achievement of organisational objectives and therefore preserving and creating value through effective management of risks. Interest in corporate governance, particularly within the domain of risk management has continued to grow in recent years (Hoyt and Liebenberg, 2011; Gephart et al., 2009; Power, 2007). Risk management moved up the agendas of cross-industry regulators, rating agencies, practitioners, and scholars (Lam, 2006; Paape and Spakle 2012; Woods, 2009). Although risk has always formed an integral part of business reality, the widespreading concern for risk management has been recently stimulated by the growing complexity and volatility of the global environment, making organisations susceptible to an increasing number of risks affecting their operations (Wharton and Skinner, 2007). Over time, a paradigm shift occurred in the perception of risk management (Gordon et al., 2009). The traditional, silo-based approach to managing risks evolved towards a more holistic perspective, denominated Enterprise Risk Management (ERM), which links risk management with organisational objectives (Power, 2009), and which is now

2 advocated by regulatory and normative bodies as a recommended mode of corporate governance (Spira and Page, 2003; Power, 2004). Multiple principles, frameworks, and standards emerged to assist organisations in developing enterprise-wide risk management approaches, that conceptualised ERM in both regulatory and normative terms and have become widely followed across industries (Soin and Collier, 2013). Yet, scholars argued there may be a considerable value in adapting the “universal” and “hierarchical” risk management guidelines (Arena et al., 2010, p. 661) to match particular circumstances of organisations (e.g. Kaplan and Mikes, 2014; Woods, 2009, 2011; Power, 2007; Paape and Spakle, 2012; Barton et al., 2002). Despite the “near theological belief in enterprise risk management” (Power, 2009, p. 849) widespread among risk management professionals, critical arguments have been voiced in academia arguing that regulatory and normative frameworks should be a starting point for risk management, which needs to remain sensitive to organisational contexts (Woods, 2011). Managing risk is considered a fundamental concern in the complex, hazardous, and dynamic environment of the airline industry (Adler and Gellman, 2012). Airline operations are encapsulated within a labyrinth of actors and norms, which exempt airlines from freedom to operate in the same way as other global businesses, making them additionally susceptible to a myriad of risks related to other parties they are strongly dependent on (Otero, 2006; IATA, 2011). Apart from internally driven risks, a substantial part of airlines’ challenges is embedded in the social, political, and macroeconomic context with interdependent contextual variables (Tjorhom, 2010); in this complex system interlinking a network of human operators, technological systems, and policies and procedures, risks are interconnected (Netjasov and Janic, 2008). The operational complexities inherent in the airline business, and the highly volatile competitive environment of the industry, expose airlines to a number of significant risks; nowadays the challenges related to poor industry structure, misguided regulations, and inconsistent strategy choices of airlines are considered the major determinants of poor airline profitability (IATA, 2013). Although airlines create great value for other businesses along the air transport value chain, persistently poor profitability has been created for investors in airlines; over the last 40 years the airline industry, in comparison

3 with a wide array of other industries, registered some of the lowest returns on invested capital (IATA, 2013; Wojahn, 2012). The specificity of airline business promulgates the need to embrace enterprise-wide approaches to managing risks from different dimensions of airline operating contexts (Belobaba, 2009). However, airline risk management approaches have traditionally been rooted in compliance with multiple industry regulations, or else segregated into various functional silos, often focusing on management of a limited scope of risks. It should be noted, however, that neither the regulations-based compliance approach nor the silo-based functional approach have allowed airlines to generate returns for investors that are even close to being comparable to those of other service industries (IATA, 2013), while airlines rarely achieved sustained profitability over the last decade. Research centred in the phenomenon of risk management requires previous establishment of understanding of the term “risk”. A variety of definitions exist for this term, while the most commonly found interpretations in popular and academic discourses are possibility of loss or injury, potential for having a negative impact, and likelihood of an undesirable event (Hampton, 2009). Although the risk concept has been frequently associated with negative connotations, some organisations shifted towards a more positive view recognising the two-fold nature of risk, considering both the downside and upside factors associated with risk. Reflection of the upside of risk is an essential part of a strategic risk mind-set (Slywotzky, 2008); hence, risk management practice should not be aimed solely at eliminating risks and, as a result, the reward opportunities associated with them, but rather at balancing risk portfolios for optimal risk and reward ratios (Frigo, 2008). The two-fold view of risk is adopted by the issuers of the landmark guidelines for ERM. Standards Australia and Standards New Zealand (2004) define risk as “a possibility of something happening that impacts on the objectives; it is the chance to either make a gain or a loss”; ISO 31000 (2009) regards risk as the “effect of uncertainty on objectives”; similarly, COSO (2004) proclaims managing both events with possible negative and positive impacts, where events with negative impact represent risks potentially preventing value creation or eroding the existing value, and events with positive impact represent opportunities positively affecting the achievement of objectives and supporting the creation of value or its preservation. Following this logic, this research considers risk in terms of events which

4 may affect accomplishment of organisational strategies either in a positive or a negative way; similarly, the rationale for risk management lies in enhancing the likelihood of positive consequences and reducing the likelihood of negative consequences of events, both determined in relation to the objectives of organisational strategies. 1.2 ERM concept Numerous ERM guidelines have been developed to date; an overview of the most prominent and frequently applied in practice frameworks, COSO's ERM Integrated Framework (2004), the Australia/New Zealand 4360-2004 Standard (2004) or AS/NZS ISO 31000-2009 (2009), and ISO 31000 (2009), is provided in the following chapter (Chapter 2, section 2.4). COSO’s (2004) definition of ERM is one of the most commonly cited in literature: “Enterprise risk management is a process, effected by an entity’s board of directors, management and other personnel, applied in strategy setting and across the enterprise, designed to identify potential events that may affect the entity, and manage risk to be within its risk appetite, to provide reasonable assurance regarding the achievement of entity objectives”. COSO’s definition of ERM suggests a continuous nature of risk management, which should be regarded as a process rather than a one-time management initiative in organisations. Organisational risk portfolios are affected by dynamically fluctuating market cycles, and so risk management should be performed continuously, as an ongoing process designed to be aligned concurrently with changing market conditions and organisational strategies (Althonayan et al., 2011). Ad hoc risk management initiatives may create temporary advantages by punctually smoothing income streams; yet, markets may take sceptical views of such departures from the pattern, which may trigger uncertainty and consequently adverse reactions in the market (Chatterjee et al.,

2.3 Risk management in the airline industry . 20 2.3.1 Airline business environment and risk management practice . 21 Key areas of airline risk management practice . 23 Operational risk management in airlines . 27 2.3.2 Trends and new directions in research and practice of airline risk .

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