Title: Does Risk Management Add Value? A Survey of the Evidence
Abstract: Journal of Applied Corporate FinanceVolume 17, Issue 3 p. 8-17 Does Risk Management Add Value? A Survey of the Evidence Charles Smithson, Charles Smithson Founder and principal owner of Rutter Associates, a risk management consulting firm that specializes in measuring and managing credit and market risks for financial institutionsSearch for more papers by this authorBetty J. Simkins, Betty J. Simkins Associate Professor of Finance at Oklahoma State UniversitySearch for more papers by this author Charles Smithson, Charles Smithson Founder and principal owner of Rutter Associates, a risk management consulting firm that specializes in measuring and managing credit and market risks for financial institutionsSearch for more papers by this authorBetty J. Simkins, Betty J. Simkins Associate Professor of Finance at Oklahoma State UniversitySearch for more papers by this author First published: 26 October 2005 https://doi.org/10.1111/j.1745-6622.2005.00042.xCitations: 90AboutPDF ToolsRequest permissionExport citationAdd to favoritesTrack citation ShareShare Give accessShare full text accessShare full-text accessPlease review our Terms and Conditions of Use and check box below to share full-text version of article.I have read and accept the Wiley Online Library Terms and Conditions of UseShareable LinkUse the link below to share a full-text version of this article with your friends and colleagues. Learn more.Copy URL Share a linkShare onEmailFacebookTwitterLinkedInRedditWechat Abstract The fact that 92% of the world's 500 largest companies recently reported using derivatives suggests that corporate managers believe financial risk management can increase shareholder value. Surveys of finance academics indicate that they too believe that corporate risk management is, on the whole, a valueadding activity. This article provides an overview of almost 30 years of broadbased, stock-market-oriented academic studies that address one or more of the following questions: • Are interest rate, exchange rate, and commodity price risks reflected in stock price movements? • Is volatility in corporate earnings and cash flows related in a systematic way to corporate market values? • Is the corporate use of derivatives associated with reduced risk and higher market values? The answer to the first question, at least in the case of financial institutions and interest rate risk, is a definite yes; all studies with this focus find that the stock returns of financial firms are clearly sensitive to interest rate changes. The stock returns of industrial companies exhibit no pronounced interest rate exposure (at least as a group), but industrial firms with significant cross-border revenues and costs show considerable sensitivity to exchange rates (although such sensitivity actually appears to be reduced by the size and geographical diversity of the largest multinationals). What's more, the corporate use of derivatives to hedge interest rate and currency exposures appears to be associated with lower sensitivity of stock returns to interest rate and FX changes. But does the resulting reduction in price sensitivity affect value—and, if so, how? Consistent with a widely cited theory that risk management increases value by limiting the corporate “underinvestment problem,” a number of studies show a correlation between lower cash flow volatility and higher corporate investment and market values. The article also cites a small but growing group of studies that show a strong positive association between derivatives use and stock price performance (typically measured using price-to-book ratios). But perhaps the nearest the research comes to establishing causality are two studies—one of companies that hedge FX exposures and another of airlines' hedging of fuel costs—that show that, in industries where hedging with derivatives is common, companies that hedge outperform companies that don't. References: Adam, T. and C. Fernando, 2005, “Hedging, Speculation, and Shareholder Value,”Journal of Financial Economics (forthcoming). Google Scholar Ahmed, A., A. Beatty, and C. Takeda, 1997, “ Evidence on Interest Rate Risk Management and Derivatives Usage by Commercial Banks,”Unpublished working paper. Google Scholar Allayannis, G. and J. 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Publication Year: 2005
Publication Date: 2005-06-01
Language: en
Type: article
Indexed In: ['crossref']
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