The rise of risk management

Cummins, J. David; Phillips, Richard D.; Smith, Stephen D.

Journal Article

The rise of risk management

Abstract: Risk management is nothing new, despite the increased attention given to the subject over the past decade or two. For well over one hundred years farmers have engaged in risk management, hedging their risks against price fluctuations in commodity markets. Unlike a family farmer, however, a corporation is owned by shareholders, who can, if they so wish, greatly reduce or eliminate the risk of low prices simply by holding a diversified portfolio. ; Why, then, are managers doing for shareholders what shareholders apparently can do for themselves? This article provides a review of the rationales concerning why corporations might engage in risk-management practices. The authors also cite some empirical evidence consistent with the idea that managers use derivative securities, a particular form of risk management, to reduce the volatility of their own income stream. However, a growing body of literature suggests that at least a portion of total derivatives contracting is related to activities known to increase firms' value - for example, avoiding costly external finance and lowering expected tax bills.

Keywords: Derivative securities; Risk;