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

CHAPTER 4
Implications of the
Previous Theoretical
Discussion for This Book
I
n the previous chapter(s), we have closely investigated the circumstances
under which risk management at the corporate level can increase the value
of a firm. We can draw the following conclusions from this theoretical discussion.
First, even though the neoclassical theory with its strict assumptions has
laid the foundation for the development of extremely useful theories like the
CAPM and the M&M propositions, we saw that in such a world risk
management at the bank level is irrelevant, unnecessary, and can even be
harmful with respect to the corporate objective of value creation.
Second, we also saw—by relaxing these strict assumptions—that in the
neoinstitutional world various market imperfections can build the rationale
for conducting risk management. Here, managing risk at the corporate level
can create value, because it can reduce the present value of, for example,
agency and transaction costs.
Third, neither of the two theories offers a general framework that can
be used to guide risk-management strategies and that gives detailed instructions
on how to apply these conditions in practice (a normative theory of
risk management). This is due to the fact that the previous analysis has focused
on why risk management at the corporate level is necessary and desirable
from a value creation perspective, rather than on how much or what sort of
risk management is optimal for a particular firm. Therefore, much of the
previous academic work comes to the extreme conclusion that firms should
always fully hedge (when they decide to hedge), completely insulating their
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