Risk Management and Value Creation in ... - Arabictrader.com

Rationales for Risk Management in Banks 83
and do care about the specific risks of that firm and who have a preference
for the management of these risks (the risk preference problem).
Under these circumstances, risk management by the firm’s stakeholders
is not an adequate substitute for risk management by the firm. When firms
try to hedge these firm-specific risks, stakeholders will not require a higher
compensation for bearing these risks, which they otherwise would. Since
these higher (risk) premiums would lower the value of the firm’s equity (agency
costs of equity), avoiding their payment would increase the firm’s value.
Therefore, the stakeholders’ risk aversion can provide an important incentive
148 for the firm to engage in risk-management activities, 149 even if there
is no default risk for the firm through debt.
The Risk Preference Problem of Managers Managers can have a risk preference
problem for two reasons. On the one hand, they would like the firm to
conduct risk management on their behalf because they are risk averse and
not well diversified (as described previously). On the other hand, they would
like (the firm) to hedge to be able to signal their true management capabilities
to the labor market. We will discuss both arguments in more detail in
this section.
Managerial risk aversion: The managerial risk preference problem is due
to a shareholder-manager (principal-agent) conflict 150 and determined
by the agency relations of a firm with its managers. 151 Risk management
may be used by poorly diversified managers who might have
private interests in managing risk to maximize their own utility. The
proposition here is that corporate risk-management choices might be
the product of:
■
■
The managers’ risk aversion
Their exposure to the success of the firm, as offered by their compensation
contracts and their investments in the firm 152
Let us first address managerial risk aversion. 153 Stulz 154 first suggested
the economic reasons for why firm managers are concerned with
148 See Mayers and Smith (1987).
149 See Smith (1993), p. 16.
150 And, as mentioned, a moral-hazard-type problem.
151 Managers are often more risk averse than their shareholders when it comes to
taking projects, because (the probability of) bankruptcy might have more serious
consequences for them.
152 See Tufano (1998).
153 See Stulz (1984), Smith and Stulz (1985), and, for example, Mason (1995), p. 30.
154 See Stulz (1984).