Managerial Entrenchment and Corporate Risk Management

56 Pages Posted: 30 Aug 2010 Last revised: 7 Jan 2011

See all articles by Praveen Kumar

Praveen Kumar

University of Houston - Department of Finance

Ramon Rabinovitch

University of Houston - Department of Finance

Date Written: December 13, 2010

Abstract

We theoretically and empirically analyze the effects of managerial agency on corporate hedging and risk management. Our theoretical analysis indicates that even risk neutral entrenched managers of unlevered firms will optimally establish costly hedging positions. Moreover, our model presents novel prediction on the relationship between the extent of risk management and the level of managerial entrenchment and available cash flows. Using a unique and hand-collected dataset with detailed quarterly information on derivative positions by non-integrated exploration and production firms in the oil and gas industry during 1996-2008, we test these predictions and find strong support for them, even after controlling for factors used in the earlier literature. We thus provide a theoretical and empirical explanation for why corporations hedge even when it does not increase firm value.

Keywords: Risk management; Managerial entrenchment; Free cash flows; Corporate governance; Oil and gas industry

JEL Classification: G34, G40

Suggested Citation

Kumar, Praveen and Rabinovitch, Ramon, Managerial Entrenchment and Corporate Risk Management (December 13, 2010). Available at SSRN: https://ssrn.com/abstract=1667095 or http://dx.doi.org/10.2139/ssrn.1667095

Praveen Kumar (Contact Author)

University of Houston - Department of Finance ( email )

Houston, TX 77204
United States
713-743-4770 (Phone)
713-743-4789 (Fax)

Ramon Rabinovitch

University of Houston - Department of Finance ( email )

Houston, TX 77204
United States
713-743-4782 (Phone)

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