Cephalon, Inc. Taking Risk Management Theory Seriously

60 Pages Posted: 17 Jul 2000 Last revised: 2 Nov 2012

See all articles by George Chacko

George Chacko

Santa Clara University - Finance Department

Geoffrey Verter

Harvard Business School

Peter Tufano

University of Oxford - Said Business School; National Bureau of Economic Research (NBER); University of Oxford - Said Business School

Multiple version iconThere are 2 versions of this paper

Date Written: June 2000

Abstract

We study a firm that justifies its novel use of equity derivatives as a cash-flow hedging strategy. Our purpose is to understand the challenge of translating risk management theory into managerial action. Cephalon Inc., a biotech firm, bought a large block of call options on its own stock. If the FDA approved the firm's new drug, the firm would have large cash needs, which the options were designed to meet. We analyze this stated rationale for the firm's choice, applying the cash flow hedging concepts articulated by Froot, Scharfstein and Stein (1993). In applying the theory to practice, there are lessons for both managers and theorists. Managers consider deadweight costs of financing and of risk management, whereas theory tends to ignore the latter costs. While theory is driven by costs of external financing, managers must measure these costs to arrive at decisions and this measurement problem is severe. Cephalon's risk management decisions seem motivated as much by fluctuations in the availability and cost of external financing and by accounting considerations as by fluctuations in operating cash flows or desired investment. Finally, even a field-based examination of this strategy cannot reject the conclusion that the transaction was motivated by goals other than risk management.

Suggested Citation

Chacko, George and Verter, Geoffrey and Tufano, Peter, Cephalon, Inc. Taking Risk Management Theory Seriously (June 2000). NBER Working Paper No. w7748. Available at SSRN: https://ssrn.com/abstract=235706

George Chacko

Santa Clara University - Finance Department ( email )

Santa Clara, CA 95053
United States

Geoffrey Verter

Harvard Business School ( email )

Soldiers Field Road
Morgan 270C
Boston, MA 02163
United States

Peter Tufano (Contact Author)

University of Oxford - Said Business School ( email )

Park End Street
Oxford, OX1 1HP
Great Britain
+44 (0) 1865 288551 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

University of Oxford - Said Business School ( email )

Park End Street
Oxford, OX1 1HP
Great Britain
+44 (0) 1865 288551 (Phone)

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