On Corporate Risk Management and Insurance
AbstractInsurance contracts provide the corporation with an instrument to manage risk and create value. Insurance is designed to manage pure risk; a pure risk only yields a loss unlike speculative risks that may yield a gain or loss. Received theory does not provide the necessary distinction between pure and speculative risks that would allow the role of insurance to be investigated. Pure and speculative risks are modeled here as independent random variables. The role that insurance plays in determining an optimal capital structure and otherwise managing risk is investigated. This analysis is a generalization of a classic financial market model and it shows that earlier results such as the use of insurance to control the risk-shifting problem continue to hold. This role, however, can be duplicated by a variety of other instruments including convertible bonds and futures. In an attempt to provide a distinction the analysis is extended. It provides a tax result in which the corporation creates value by substituting a safe tax shelter for a risky tax shelter; this is accomplished by issuing debt to purchase insurance so that the random deduction due to the pure loss is replaced by a known deduction due to the debt. Hence, the analysis reveals a role that insurance can play in developing an optimal capital structure. The analysis also provides the basis for comparing the use of financial futures with that of insurance in managing risk. The analysis shows the conditions under which the corporation may create value for its shareholders by using both insurance and futures contracts to hedge the pure and speculative risks.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.
Bibliographic InfoArticle provided by De Gruyter in its journal Asia-Pacific Journal of Risk and Insurance.
Volume (Year): 1 (2005)
Issue (Month): 1 (June)
Contact details of provider:
Web page: http://www.degruyter.com
You can help add them by filling out this form.
reading list or among the top items on IDEAS.Access and download statisticsgeneral information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Peter Golla).
If references are entirely missing, you can add them using this form.