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

Rationales for Risk Management in Banks 61
money by managing risks, 32 they should behave as a risk-neutral agent in
the aggregate. 33
In efficient capital markets, 34 corporate financing decisions only reshuffle
cash flows among investors. 35 Since (financial) risk-management decisions
are a subset of these financing decisions, corporate risk management does
not hurt, 36 but it also cannot create value. 37 Value can—according to M&M—
only be created on the left-hand side of the balance sheet when companies
make good investments that ultimately increase (expected) operating cash
flows. How companies finance those investments on the right-hand side of
the balance sheet—whether through debt, equity, or retained earnings—is
irrelevant in this world. 38 The financial policy decisions can only affect how
the value created by a company’s real investments is divided among its investors.
But, in efficient and well-functioning capital markets, they cannot
affect the overall value of those investments, 39 because the value of (a stream
of) cash flows is determined in the market and is the same for all market
players.
However, this does not mean that financing and risk management is
redundant. It only means that the way in which it is done is irrelevant for
value creation under the above assumptions, because investors can always
undo or replicate any financing decision by adjusting their own portfolios 40
at the same terms as the firm.
Corollaries from the Neoclassical Finance Theory
with Regard to Risk Management
Modern financial theory and its rigid assumptions, as described in the previous
section, have also lead to some other interesting corollaries, especially
with regard to banks and their risk management.
In frictionless, perfect, and complete markets there would be no intermediation
and no role for banks, 41 because everybody would contract directly
with the market 42 at the same terms, as described in the traditional
32 Unless they have a competitive advantage, which banks often claim to have.
33 See Raposo (1999), p. 42.
34 As described by the above assumptions.
35 See Fenn et al. (1997), p. 16.
36 However, if risk management comes at a cost, it destroys value.
37 See Schmidt and Terberger (1997), p. 61, and Stulz (2000), p. 2-4, and below in
more detail.
38 See Economist (1996) and Fenn et al. (1997), p. 15.
39 See Fenn et al. (1997), p. 16.
40 See Fenn et al. (1997), p. 16.
41 See Schmidt and Terberger (1997), p. 63.
42 See Perridon and Steiner (1995), p. 485.