Risk Management Critical to Corporate Strategy
Dedham, MA – January 7, 2009 –
With the consequences of the current financial crisis spreading to the real
economy, lawmakers are exploring new regulations to govern the financial
markets. The concern among market participants is that policy-makers do not
fully understand how risk management does and should work, and how
derivatives can be beneficial.
In the “MIT Roundtable on Corporate Risk Management” that appears in the
Fall 2008 issue of Morgan Stanley’s
Journal of Applied Corporate Finance, a distinguished group of academics
and practitioners assess how risk management affects corporate growth and
value.
For many companies, effective corporate risk management begins with an
equity cushion in the capital structure. This helps to avoid raising
prohibitively expensive capital following an adverse event. Excessive
leverage contributed to the problems of many banks, leading to the current
industry-wide de-leveraging.
Andrew Lo, Professor of Finance at the MIT Sloan School of Management and
director of MIT’s Laboratory for Financial Engineering, contends that too
often what passes for risk management at many financial companies is really
risk measurement. This offers little prescriptive advice on how to actually
manage the risks, as opposed to corporate governance structures for actively
and effectively managing risks. In addition, some of the current problems
can be attributed to the failure of risk managers and their models to
account for highly improbable events.
A paradox of risk-reducing financial innovation is that it tends to
encourage market participants to increase risk-taking in other ways. Robert
Merton of Harvard Business School and Nobel laureate in economics points out
that the challenge from a regulatory standpoint is to find the right balance
between these two offsetting forces.
“Moving forward, we need more financial engineers, not fewer – risk and
innovation, including derivatives, are not going away, and we need senior
managements, boards, and regulators of financial institutions who understand
them,” Merton notes.
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This study is published in the Journal of Applied Corporate Finance.
Media wishing to receive a PDF of this article may contact
journalnews@bos.blackwellpublishing.net.
To view the abstract for this article, please
click here.
Don Chew, Editor of the Journal of
Applied Corporate Finance, can be reached for questions at
don.chew@morganstanley.com.
Published since 1988 and reaching a broad audience of senior corporate
policy makers, this highly regarded quarterly brings together academic
thinkers and financial practitioners to address topics driving corporate
value. The Journal covers a range of topics, including risk management,
corporate strategy, corporate governance and capital structure. The Journal
also features its popular roundtable discussions among corporate executives
and academics, on topics such as integrity in financial reporting.
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