Title: The ART of Risk Management: Alternative Risk Transfer, Capital Structure, and the Convergence of Insurance and Capital Markets
Abstract: The ART of Risk Management: Alternative Risk Transfer, Capital Structure, and The Convergence of Insurance and Capital Markets, by Christopher Gulp, 2002, New York: John Wiley and Sons Christopher Culp's The ART of Risk Management explains that ART (Alternative Risk Transfer) programs represent the attempts of the insurance industry to provide synthetic debt capital or equity capital to their commercial clients. His target audience is corporate financial officers, and with this audience in mind, Culp does not set out to extend the knowledge frontier. Rather he brings together in one volume, what others have said on the subject of risk financing. Culp collects his material from diverse sources. He references books authored by academics and practitioners, scholarly journal articles, monographs published by the insurance industry, expert testimony by ART practitioners, and of course he draws from his own post-Ph.D. management consulting career. The strength of the for the academic reader, however, is in the detailed (but easy to follow) description of many of the synthetic capital transactions that are shaping the ART landscape. And public details for some of these transactions are only available in this book. The first eight of the book's twenty-six chapters review the nature and role of capital in financing the operations of a firm. There is an extensive analysis of the conditions that lead to capital structure irrelevancy, a discussion of optimal capital structure theories, and examples of how to price different forms of capital. A summary of empirical evidence for and against these theories rounds up the discussion. The notation, however, wantonly proliferates. For example, the cost of debt capital is [rho], the cost of equity capital is e, the combined weighted average cost of them is [lambda], the number of shares outstanding is [eta] and [beta] depending on which chapter the reader encounters it either the number of bonds outstanding or the systematic risk of equity. This overuse of notation makes for slow reading at times, but skipping the equations so notated does not materially handicap the reader. The discussion on optimal capital structure revolves around the familiar themes of the versus the hypotheses. As you may recall, the trade-off hypothesis posits that a firm's capital structure is the result of balancing the tax advantages of debt against the costs of financial distress. The pecking-order hypothesis posits that a firm's capital structure is a function of its profitability relative to its investment needs, where managers use up internally generated funds first followed by debt and then by issues of equity. The text book material on capital structure, according to a survey of finance practitioners by Graham and Harvey (Journal of Financial Economics, 2001), cannot solve the capital structure problem of corporate financial officers, the target audience for Culp. It is puzzling, therefore, why Culp takes up so much space to restate this material, but ignores emerging explanations of capital structure. For example, Hayne Leland in a series of articles starting in the 1994 Journal of Finance develops a theory of firm capital structure that explicitly links capital structure decisions to firm risk. The central theme of chapters 9,10, and 11 is whether risk management can increase the firm's expected cash flows and whether an ART program can reduce a firm's cost of capital. A risk management program can increase the firm's expected cash flow because it mitigates the management's unwillingness or inability to make optimal capital investment decisions and lowers the firm's tax bill. As Culp very nicely explains, however, manager initiated risk programs may have little to do with enhancing stakeholder value and a lot to do with managers' own interests. …
Publication Year: 2004
Publication Date: 2004-06-01
Language: en
Type: article
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Cited By Count: 4
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