Corporate Risk Management as a Tool to Create Shareholder Value

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Date Submitted: 11/09/2010 03:07 AM

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Module:Monetary Economics and International Finance - Ec4418

Essay Title: Corporate Risk Management as a tool to create Shareholder Value

Name & ID:Niall Maloney (0652032)

Corporate Risk Management as a tool to create Shareholder Value

The recent Global downturn and continuing economic crisis has forced businesses to become acutely competitive when managing corporate strategy. Now more than ever risk management and corporate hedging are being used as a means to generate much needed liquidity and to increase shareholder value. Corporations are faced with a wide variety of risks such as supply-demand coordination risks, exchange rate risks, political risks and disruption risks. Corporate risk management programs aim to systematically manage such risk exposures so as to increase firm value (Toktay 2004). Hedging, one of the principal tools of risk management has therefore come to the fore in many firms endeavors to manage their risk. Nance, Smith and Smithson (1993) refer to corporate hedging as the use of off-balance sheet instruments- forwards, futures, swaps and options- to reduce volatility of firm value. In the current volatile environment it is the firms that execute effective risk management strategies that will gain a competitive advantage and survive when so many others are dying. In this paper I hope to explore the relationship between corporate risk management and increasing shareholder value by anlaysing existing evidence and opinion adduced by established and respected academics.

The basis for many modern risk management and capital structure theories emanates from the Miller and Modigliani capital structure irrelevance principle (1958). Fundamentally the theorem stated that the value of a firm is not correlated to how the firm is financed. The work of Miller and Modigliani combined with modern portfolio theories imply that active risk management reduces shareholder value on the basis that all shareholders are diversified and do...