CAN RISK MANAGEMENT ADD VALUE?

Abstract

Proper risk management reduces risk, but does it necessarily add value for corporate shareholders? Modigliani and Miller argued in 1958 that the answer is 'no' in a perfect market setting. How risk management adds value in an imperfect markets setting is shown. In particular, the corporate risk management decision is linked to the leverage decision to measure the impact of risk reduction on shareholder value. A quantitative model is developed and is applied to five public commodity companies to calculate the value increase due to optimal risk management and leverage. Finally, the practical aspects of implementing a joint risk management and capital structure program are discussed.