Author: kenney.154

How Management Risk Affects Corporate Debt

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Abstract: Management risk, which reflects uncertainty about the management’s value added, is an important yet unexplored determinant of a firm’s default risk and debt pricing. CDS spreads, loan spreads and bond yield spreads all increase at the time of management turnover, when management risk is highest, and decline over the first three years of CEO and CFO tenure, regardless of the reason for the turnover. These effects all vary with the ex ante uncertainty about the new management. Understanding the effects of management risk on corporate liabilities has a number of implications for the pricing of liabilities and corporate financial management.

Author: Yihui Pan, Tracy Yue Wang, Michael S. Weisbach

Date: May 15, 2016

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How Do Hurricanes Affect Life Insurance Premiums? The Effects of Financial Constraints on Pricing

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Abstract: I identify effects of financial constraints on firms’ product pricing decisions, using a sample of insurance groups (conglomerates) that contain both life and P&C (property & casualty) subsidiaries. P&C subsidiaries’ losses can tighten financial constraints for the life subsidiaries through internal capital markets. I present a model that predicts following P&C losses, premiums should fall for life policies that initially increase insurers’ statutory capital, and rise for policies that initially decrease capital. Empirically, I find that P&C losses cause changes in life insurance premiums as my model predicts. The effects are concentrated in more financially constrained groups. Evidence also indicates that life subsidiaries increase capital transfers to P&C subsidiaries following larger P&C losses. These results hold when instrumenting for P&C losses using data on weather damages, implying that P&C losses do cause changes in life insurance premiums and internal capital transfers. My findings suggest that when financial constraints tighten, firms change product prices to relax the constraints, and how prices change depends on the initial impact of selling the products on firms’ financial resources.

Author: Shan Ge

Date: November 8, 2017

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How Companies Can Use Hedging to Create Shareholder Value

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Abstract: The key to companies successfully using hedging to create shareholder value is communication. It sounds simple, but the inability to communicate the structure and success of this risk management strategy could destroy – rather than preserve a firm’s value. Risk management managers have to clearly articulate to top management and board members why the hedge is needed and the source of the potential benefit. Managers also must make investors aware that some losses may occur.

Author: René Stulz

Date: Fall 2013

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How Much for a Haircut? Illiquidity, Secondary Markets and the Value of Private Equity

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Abstract: Limited partners (LPs) of private equity funds commit to invest with extreme levels of illiquidity and significant uncertainty regarding the timing of capital flows. Secondary markets have emerged which alleviate some of the associated cost. This paper develops a subjective valuation model incorporating these institutional features. Model-implied breakeven returns are close to empirically observed average fund returns for moderately risk tolerant LPs with private equity allocations up to 40%. Likewise, optimal portfolio allocations for these LPs are similar to those observed in practice. More risk averse LPs optimally place little, but not zero, weight on private equity.

Author: Berk A. Sensoy, Nicholas P. B. Bollen

Date: March 2, 2016

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The Use of Multiple Risk Management Strategies: Evidence from the Natural Gas Industry

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Abstract: Starting in 1978 and continuing throughout the 1980s, natural gas pipelines faced a series of regulatory changes, including price deregulation, which changed their exposures to price and quantity risk. We exploit this unique environment and examine cross-sectional and time-series patterns in the use of multiple risk management strategies by pipeline companies. Natural gas pipelines use a combination of such strategies, including gas storage, cash holdings, line-of-business and geographic diversification, and commodity derivatives to hedge their increasing risks. Gas storage shows a complementary relation to holding cash and using derivatives to mitigate these risks. However, differences in the financial characteristics of derivatives hedgers and storage hedgers suggest that firms use derivatives to manage price risk and store gas to manage volume risk. Derivatives hedgers are similar to firms that diversify. In addition, firms that engage in hedging activities have smaller and less variable sensitivities to price changes than firms that do not, especially post-deregulation.

Author: Christopher C. Géczy, Benadette A. Minton, Catherine Schrand

Date: May 11, 2006

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Financial Expertise of the Board, Risk Taking, and Performance: Evidence from Bank Holding Companies

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Abstract: Financial expertise among independent directors of U.S. banks is positively associated with balance-sheet and market-based measures of risk in the run-up to the 2007-2008 financial crisis. While financial expertise is weakly associated with better performance before the crisis, it is strongly related to lower performance during the crisis. Overall, the results are consistent with independent directors with financial expertise supporting increased risk-taking prior to the crisis. Despite being consistent with shareholder value maximization ex ante, these actions became detrimental during the crisis. These results are not driven by powerful CEOs who select independent experts to rubber stamp strategies that satisfy their risk appetite.

Author: Bernadette A. Minton, Jérôme Taillard, Rohan Williamson

Date: July 2012

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A Theory of Risk Capital

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Abstract: We present a theory of risk capital and of how tax and other costs of risk capital should be allocated in a financial firm. Risk capital is equity investment that backs obligations to creditors and other liability holders and maintains the firm’s credit quality. Credit quality is measured by the ratio of the value of the firm’s option to default to the default-free value of its liabilities. Marginal default values provide a full and unique allocation of risk capital. Efficient capital allocations maintain credit quality and preclude risk shifting. Our theory leads to an adjusted present value (APV) criterion for making investment and contracting decisions. We set out implications for risk management and corporate finance.

Author: Isil Erel, Stewart C. Myers, James Read

Date: April 21, 2014

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Why Did Holdings of Highly Rated Securitization Tranches Differ So Much Across Banks?

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Abstract: We provide estimates of holdings of highly rated securitization tranches of U.S. bank holding companies before the credit crisis and evaluate hypotheses that have been advanced to explain them. Whereas holdings exceeded Tier 1 capital for some large banks, they were economically trivial for the typical bank. Banks with high holdings were not riskier before the crisis using conventional measures, but they performed poorly during the crisis. We find that holdings of highly rated tranches were correlated with a bank’s securitization activity. Theories unrelated to the securitization activity, such as “bad incentives” or “bad risk management,” are not supported in the data.

Author: Isil Erel, Taylor Nadauld, René M. Stulz

Date: February 4, 2015

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From Risk to Resilience: Find (& Overcome) Your Company’s Weakest Link

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Abstract: In today’s tightly connected global economy, traditional management practices that rely on “steady-state” conditions are challenged by chaotic external pressures and turbulent change. Just in the last few years, the world has experienced a string of catastrophic events, including a global economic meltdown, a volcanic eruption in Iceland, an oil spill in the Gulf of Mexico, a disastrous tsunami and power blackout in Japan, and political upheavals in Africa and the Middle East. Managing the risk of an uncertain future is a challenge that requires resilience—the ability to survive, adapt, and grow in the face of turbulent change. This research develops a measurement tool titled the Supply Chain Resilience Assessment and Management (SCRAM™). Data gathered from seven global manufacturing and service firms are used to validate SCRAM™, using qualitative methodology with 1,369 empirical items from focus groups reviewing 14 recent disruptions. Critical linkages are uncovered between the inherent vulnerability factors and controllable capability factors. Through mixed-method triangulation, this research identified 311 specific linkages that can be used to guide a resilience improvement process. Pilot testing suggests a correlation between increased resilience and improved supply chain performance.

Author: Joseph Fiksel, Mikaella Polyviou, Keely L. Croxton, Timothy J. Pettit

Date: March 20, 2013

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Alliance Activity as a Dynamic Capability in the Face of a Discontinuous Technological Change

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Abstract: Using a dynamic capabilities lens, this study examines how technological and complementary capabilities affect firms’ abilities to enter emerging technologies. The empirical evidence from a sample of pharmaceutical firms entering the new biotech fields indicates that both technological and complementary capabilities potentially affect firms’ entry into emerging technologies and entry mode. However, the results also show that capabilities in the traditional technology and the emerging technology have different effects. Firms with capabilities in the emerging technology are more likely to enter new technological fields and more likely to use internal development in doing so. Complementary capabilities also increase the rate of entry into emerging technological fields. However, capabilities in traditional technology are found to be unrelated to the propensity to enter new fields, and to the choice of entry mode. These results are consistent with insights from the literature on dynamic capabilities and evolutionary theory. We examine the implications of these results for literatures on strategic alliances and technological competition.

Author: Jaideep Anand, Raffaele Oriani, Roberto S. Vassolo

Date: February 22, 2010

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