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Could Risk Management Be Harmful to Firms?

Author

Listed:
  • Rui Li

    () (College of Management, University of Massachusetts)

Abstract

Based on a theoretical model, this paper shows that risk management policies shielding firms from marketwide risk exposures could be harmful to the firms. Specifically, if a firm's operation is delegated to a manager and subject to moral hazard problems, risk exposures could align the manager's interests with the firm owner's so that they alleviate the moral hazard problems and raise the firm's value. As a result, the risk management policies could reduce the firm's value to the owner.

Suggested Citation

  • Rui Li, 2018. "Could Risk Management Be Harmful to Firms?," Annals of Economics and Finance, Society for AEF, vol. 19(1), pages 247-263, May.
  • Handle: RePEc:cuf:journl:y:2018:v:19:i:1:li
    as

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    File URL: http://down.aefweb.net/AefArticles/aef190110Li.pdf
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    References listed on IDEAS

    as
    1. Obstfeld, Maurice, 1994. "Risk-Taking, Global Diversification, and Growth," American Economic Review, American Economic Association, vol. 84(5), pages 1310-1329, December.
    2. John Y. Zhu, 2013. "Optimal Contracts with Shirking," Review of Economic Studies, Oxford University Press, vol. 80(2), pages 812-839.
    3. Yuliy Sannikov, 2008. "A Continuous-Time Version of the Principal-Agent Problem," Review of Economic Studies, Oxford University Press, vol. 75(3), pages 957-984.
    4. Noah Williams, 2011. "Persistent Private Information," Econometrica, Econometric Society, vol. 79(4), pages 1233-1275, July.
    5. Peter M. Demarzo & Michael J. Fishman & Zhiguo He & Neng Wang, 2012. "Dynamic Agency and the q Theory of Investment," Journal of Finance, American Finance Association, vol. 67(6), pages 2295-2340, December.
    6. Hayne E. Leland, 1968. "Saving and Uncertainty: The Precautionary Demand for Saving," The Quarterly Journal of Economics, Oxford University Press, vol. 82(3), pages 465-473.
    7. PETER M. DeMARZO & YULIY SANNIKOV, 2006. "Optimal Security Design and Dynamic Capital Structure in a Continuous‐Time Agency Model," Journal of Finance, American Finance Association, vol. 61(6), pages 2681-2724, December.
    8. Hui Ou-Yang, 2003. "Optimal Contracts in a Continuous-Time Delegated Portfolio Management Problem," Review of Financial Studies, Society for Financial Studies, vol. 16(1), pages 173-208.
    9. Qiang Gong & Shen Jia & Justin Yifu Lin, 2009. "Firm Liquidation and Economic Crisis under Unexpected Exchange Rate Shock," Annals of Economics and Finance, Society for AEF, vol. 10(1), pages 1-14, May.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    risk management; dynamic contracts; moral hazard;

    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

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