2008 RethinkingRiskManagement

(Stulz, 2008) ⇒ René M. Stulz. (2008). “Rethinking Risk Management.” In: Corporate risk management. doi:10.7312/chew14362-005

Subject Headings: For-Profit Risk Management, High Financial Exposure.

Notes

Real-World vs. Theoretical Risk Management: Examines why firms’ actual hedging strategies deviate from the “full hedge” recommendations often found in academic research. Many times, real-world constraints—such as transaction costs, agency issues, or incomplete information—cause firms to adopt selective or partial hedging. Additionally, market views of managers often guide hedging decisions more than purely theoretical risk-reduction prescriptions.
Gains from Hedging: Reviews how hedging can reduce bankruptcy, tax, agency, and financing costs—but also clarifies where hedging may be less effective or even counterproductive. In practice, firms need to weigh the cost of hedging against the size of these potential savings. Moreover, the ability to raise cheap equity or handle moderate losses can make fully comprehensive hedging unnecessary.
Capital Structure Relevance: Explains how leverage determines whether firms benefit greatly from hedging or whether they might pursue riskier strategies. Highly leveraged firms risk distress from cash-flow shortfalls, so robust hedging reduces that vulnerability. Conversely, those with strong balance sheets can afford to take selective bets if they foresee profitable market opportunities.
Comparative Advantage in Risk-Taking: Argues that firms with special information or operational expertise can profitably bear certain risks that would be too costly for outsiders. This advantage may arise from deep industry knowledge, size, or unique data access. By hedging exposures they cannot profitably handle, these firms free capital to exploit the segments where they possess genuine insight.
Managerial Incentives and Agency: Shows how managerial compensation and equity ownership often shape risk-taking behaviors. When managers own large equity stakes, they are likelier to hedge aggressively to protect personal wealth. In contrast, option-heavy pay packages or bonus structures based on large successes can encourage speculative strategies and bigger “bets.”
VaR Critique and Alternative Risk Measures: Evaluates why VaR is popular for summarizing potential losses yet can obscure true downside and path-dependent risks. Fat-tailed return distributions, serially correlated cash flows, or abrupt market moves may lead to larger losses than VaR suggests. Thus, corporations worried about distress should consider additional metrics that better capture tail events and shifting exposures.
Risk Management Organization and Internal Controls: Emphasizes the need for strong oversight when firms allow trading desks or treasury units to take market positions. Clear policy guidelines, regular audits, and performance metrics aligned with risk-adjusted returns ensure that these positions benefit shareholders rather than just individual traders. Ultimately, a thoughtful governance framework balances beneficial speculation with firm-wide stability.

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Quotes

Abstract

Empirical evidence shows that the practice of risk management is limited and does not correspond to the prescriptions of the academic literature. In particular, the practice focuses on hedging transactions exposures and a firm’s hedge ratios depend on the views of the managers of that firm. In this paper, we provide a new approach to risk management that is consistent both with the main results of the academic literature but takes into account the fact that firms can have a comparative advantage in bearing some kinds of risks. We examine the implications of this new approach for the management of risk management and for risk measures such as Var.

References

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	Author	volume	Date Value	title	type	journal	titleUrl	doi	note	year
2008 RethinkingRiskManagement	René M. Stulz			Rethinking Risk Management				10.7312/chew14362-005		2008