Financial risk management: is it a value-adding activity?

Author: Fairchild Richard  

Publisher: Emerald Group Publishing Ltd

ISSN: 0965-7967

Source: Balance Sheet, Vol.10, Iss.4, 2002-10, pp. : 22-25

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Abstract

Considers whether financial risk management is value-adding. Although risk management can reduce total risk, this may not affect the cost of capital or firm value. Well-diversified investors have already eliminated all of the specific risk, and risk-management may be seen as a zero NPV activity at best, and at worst, a value-reducing activity. However, there is a role for risk management. Reduction of total risk may reduce the expected costs of financial distress, hence increasing expected cashflows. This increases firm value. Presents a method of investment appraisal that takes account of total risk through expected financial distress costs. Such a method can result in three possible decisions relating to a new project; reject the project invest in the project; and risk-manage; or invest in the project but do not risk-manage. Finally, presents worked examples.