Choice of Corporate Risk Management Tools under Moral Hazard
AbstractThis paper examines the choice of tools for managing a firm’s operational risks: cash reserves, insurance contracts, and financial assets under an optimal financing contract that solves moral hazard between insiders and outside investors. Risk management is valuable as it reduces the costs of raising external financing, increases debt capacity, lessens underinvestment, and improves welfare. I show that insurance is superior as it facilitates the outside financing relationship but leads to inefficient excessive continuation if used without coverage limits. When insurance against an operational risk is not available, the firm uses financial assets instead or resorts to holding cash reserves.
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Bibliographic InfoPaper provided by Financial Markets Group in its series FMG Discussion Papers with number dp566.
Date of creation: Jun 2006
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This paper has been announced in the following NEP Reports:
- NEP-ALL-2006-07-21 (All new papers)
- NEP-BEC-2006-07-21 (Business Economics)
- NEP-CFN-2006-07-21 (Corporate Finance)
- NEP-FIN-2006-07-21 (Finance)
- NEP-FMK-2006-07-21 (Financial Markets)
- NEP-IAS-2006-07-21 (Insurance Economics)
- NEP-RMG-2006-07-21 (Risk Management)
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