Rationales for Corporate Risk Management - A Critical Literature Review

Abstract

This paper describes theoretical motivations for corporate risk management activities and empirical evidence provided by different scholars on such rationales. These theoretical considerations can be extended also to the new risk management practices such as enterprise risk management. Based on modern financial theory’s assumption that markets are perfectly efficient, organizations should not implement risk management practices since they cannot contribute to add firm value. However, in the presence of market imperfections, risk management, stabilizing firm’s earnings, can benefit companies in the following manners: reducing transaction costs especially the expected costs of bankruptcy, lowering corporate taxes, aligning financing and investment policies and reducing costs associated with agency problems and asymmetric information.

Keywords: Risk Management, hedging, market imperfections, agency problem, underinvestment problem, cost of financial distress, transaction costs

JEL Classification: G32