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The Value of Corporate Risk Management - Essay
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The Value of Corporate Risk Management

The Value of Corporate Risk Management

Business organizations deal with both pure and speculative risks. Pure risk is associated with hazards having only a negative consequence, while speculative risks may have positive or negative consequences. From a finance perspective, the distinction between pure and speculative risk blurs because the rate of return, shareholders require depends on its non-diversifiable risk {systematic risk) or core risk. The core risk can include pure and speculative risk components. Investors do not accept a lower rate of return for the stock of a firm that does, through a risk management program, what the shareholders can do for themselves at lower cost through portfolio diversification. In fact, the opposite may be true. Viewing the firm as a combination of assets-in place and future growth opportunities, as the total risk of the firm declines, the systematic risk of growth opportunities increases his relative importance but the proportion of the total shareholder value attributable to growth declines. Thus, the equity’s systematic risk, its beta, may decline, increase or remain unchanged.

Regardless of the effects risk management may have on systematic risk, if diversified equity holders value their firm’s risk management program it is because it mitigates the side- effects of volatile cash flow. These side-effects include foregoing profitable future investments, the erosion of the firm’s debt capacity, and ubiquity as to the true profitability of the firm. But a firm, rather than mitigating these side- effects by reducing the volatility of its cash flow, can instead achieve the same result by reducing its operating leverage, by altering its financing policies and by modifying the compensation structure of managers. But, manager- initiated risk programs may have little to do with shareholder value and a lot to do with managers’ own interests. Managers may have an incentive to reduce the firm’s total risk because they are risk averse.

Personal Risk Management is looking around the home and life of customers, recognizing risk, and planning what to do about it. Corporations recognize that in business, Just about the only sure thing is that there will be a risk. In the corporate world, risk management referrers to a company’s evaluation of its exposure to risk identification. A company may be able to identify risk easily, because it comes in the form of a decision. At other times, a company may faces risks and not even be aware of them. The majority of corporations has developed risk management programs and invests time and money into implementing changes and insuring exposures.

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