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

Rationales for Risk Management in Banks 63
matter how the “pie” 51 is sliced among the various claimholders of the firm,
because the size of the “pie” does not change through these decisions in this
neoclassical world. However, that reinforces the ultimate objective of the
firm: As soon as the value of the firm is maximized (due to good capitalbudgeting
decisions), each of the owners will be better off than in the case
when the firm tries to choose non-value-maximizing investments by trying
to match the individual preferences of the owners. 52 Again, Equation (2.1),
and hence the traditional (shareholder) value framework, 53 can be applied:
The firm value equals the net cash flows of the firm discounted at the appropriate
rates, which only reflect the systematic risk of these cash flows.
Under the above assumptions, risk-management activities are purely
financial transactions 54 that do not affect the value of a company’s operating
assets. Consequently, financial hedging strategies have no impact on firm
value, because they affect neither the firm’s relevant marginal costs nor its
marginal revenues. Analogously to the M&M propositions, there is no reason
to worry about risk management—it is as irrelevant as capital-structure
or dividend-policy decisions for value creation on the firm level. Therefore,
a firm’s decision to use financial instruments to manage its risk exposure
and its pricing and production decisions are also separable. 55
This is true because in such a neoclassical world of efficient capital
markets and under the M&M assumptions, financing, and hence riskmanagement
decisions by a firm in a specific risk class can always be undone
by investors. 56 Even though derivatives can make individual investors
better off because they could achieve payoffs they could otherwise not
achieve, 57 firms cannot increase value through the use of derivatives. 58 Buying
and selling, for example, option contracts, cannot change the company’s value,
because individual investors in the company’s stock can always buy and sell
such contracts themselves at the same terms if they care to adjust their
exposure to a specific risk factor. 59 Likewise, market players can construct
portfolios that offset any position taken by a bank, and hence intermediation
cannot create value. 60 Also, there is no need to manage risk at the
51 See Brealey and Myers (1991), p. 401, who use this term for the overall value of
the firm.
52 See Schmidt and Terberger (1997), p. 59.
53 As, for example, described by Copeland et al. (1994).
54 This definition excludes changes in operations.
55 See Smith (1995), p. 23.
56 See Fenn et al. (1997), p. 16.
57 For example, a static portfolio investment strategy can achieve only inferior payoffs
to a strategy using derivatives.
58 See Stulz (2000), pp. 2-48 and 2-51.
59 See Froot et al. (1993), p. 1630.
60 See Allen and Santomero (1996), p. 2.