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74 RISK MANAGEMENT AND VALUE CREATION IN FINANCIAL INSTITUTIONS
would be useful and is the goal of risk management), the immediate hypothesis
would be that all firms would want to manage (all of) their risks. However,
there is a wide variation in the use of risk management (instruments) across
firms, even within the same industry 100 and even when they have similar
exposures. 101 Therefore, there must be other reasons that can help to explain
these differences in actual behavior.
Moreover, as is reflected in the recognition of value at risk 102 as an industry
standard by choice or by regulation, for banks (and many other market
players), the current constitution of their portfolio counts and influences
their decisions. Likewise, for many market players not only systematic,
but rather total risk (including specific risk, even if they are welldiversified)
matters.
Explaining and diminishing these discrepancies between theory and
practice was identified as one of the motivations for writing this book.
It seems that only market imperfections can help to explain what happens
in reality. The neoclassical theory is—at best—only a partial solution,
because it is too perfect to describe reality. We, therefore, turn now to the
neoinstitutional theory, which is—as we will see below—also only a partial
solution. 103
RISK MANAGEMENT AND VALUE CREATION IN
THE NEOINSTITUTIONAL FINANCE THEORY
The risk management irrelevance proposition only holds in the perfect and
complete markets of the neoclassical world, because only then is the price
for bearing risks the same within and outside the firm. As soon as we introduce
market imperfections, this does not necessarily need to be the case.
There might be situations where risk management by the firm cannot be
replicated by individual investors at the same terms, which in turn can increase
the firm’s value.
100 See Tufano (1996) for an extensive analysis of the differences in North American
gold-mining companies. Likewise, there is anecdotal evidence for differences in the
risk-management policies of banks.
101 See Smith (1995), p. 20.
102 The value-at-risk measure will be described in detail in Chapter 5. It summarizes
risks at an aggregated level, taking into account diversification effects, and can be
translated into an amount of equity capital needed to absorb unexpected losses with
a prespecified degree of certainty.
103 See Schmidt and Terberger (1997), p. 53.