Get 20M+ Full-Text Papers For Less Than $1.50/day. Start a 14-Day Trial for You or Your Team.

Learn More →

Corporate Risk Management and the Incentive Effects of Debt

Corporate Risk Management and the Incentive Effects of Debt ABSTRACT This paper demonstrates how the incentive of manager‐equityholders to substitute toward riskier assets, commonly referred to as the “asset substitution problem,” is related to the level of observable risk in the firm. When observable and unobservable risks are sufficiently positively correlated, increases (decreases) in observable risk generate the incentive for manager‐equityholders to increase (decrease) unobservable risk. Thus, credible commitments to hedge observable risk can benefit the firm's manager‐equityholders by reducing the incentive to shift risk and the associated agency cost of debt. This provides a positive rationale for hedging diversifiable risk at the firm level. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png The Journal of Finance Wiley

Corporate Risk Management and the Incentive Effects of Debt

Loading next page...
 
/lp/wiley/corporate-risk-management-and-the-incentive-effects-of-debt-6F8PYqJFgb

References (15)

Publisher
Wiley
Copyright
1990 The American Finance Association
ISSN
0022-1082
eISSN
1540-6261
DOI
10.1111/j.1540-6261.1990.tb03736.x
Publisher site
See Article on Publisher Site

Abstract

ABSTRACT This paper demonstrates how the incentive of manager‐equityholders to substitute toward riskier assets, commonly referred to as the “asset substitution problem,” is related to the level of observable risk in the firm. When observable and unobservable risks are sufficiently positively correlated, increases (decreases) in observable risk generate the incentive for manager‐equityholders to increase (decrease) unobservable risk. Thus, credible commitments to hedge observable risk can benefit the firm's manager‐equityholders by reducing the incentive to shift risk and the associated agency cost of debt. This provides a positive rationale for hedging diversifiable risk at the firm level.

Journal

The Journal of FinanceWiley

Published: Dec 1, 1990

There are no references for this article.