Agenda for Tuesday's class (November 20, 2012) - Business Risk ...

Next Tuesday (November 20, 2012), we will start class with a quiz based upon the following two readings:

1. Why is Risk Costly to Firms? (Doherty, Chapter 7)
2. How Insurance Solves the Underinvestment Problem, by James R. Garven

I also have assigned an optional reading (authored by yours truly) entitled ?The Modigliani-Miller Theorems and Corporate Risk Management Theory?.? Although I won?t quiz on this, this brief (4 page) reading is important because it helps to set the logical framework underlying our discussion of corporate risk management theory and policy, which is the final topic for Finance 4335.

There are subtle yet important distinctions to be made between individual risk management and corporate risk management.? In the case of individual risk management, we saw?that risk management ?matters? because individuals are risk averse.? Furthermore, since informational asymmetries between principals and agents?are commonplace in real world market settings, we also saw that risk management decisions impact the extent?to which moral hazard and adverse selection problems can be mitigated.? Our focus changes somewhat as we consider corporate decision-making instead of individual decision-making.? Our objective is no longer to maximize expected utility.? Rather, the corporate objective is to?maximize the value of the firm?s equity.? As I show in ?The Modigliani-Miller Theorems and Corporate Risk Management Theory?,?by maximizing firm value,?the firm?s?managers indirectly enable?its shareholders to maximize their own expected utilities. Given this change in focus, we explore?how corporate risk affects firm value, and we?find that?corporate risk management ?matters? for a number of reasons, including?taxes,?agency problems,?bankruptcy costs, liquidity and financial flexibility.

Class on Tuesday will begin where we left off last Thursday; i.e., examining credit risk within Black-Scholes-Merton options framework.? Once we finish that topic, we will begin the corporate risk management topic; specifically by examining?how corporate income?taxation distorts corporate risk-taking incentives.? We will continue our discussion of corporate risk management during the final week of class.

One final note ??as a further incentive to ?show up? on the last class prior to the Thanksgiving holiday, I have decided to offer an extra credit opportunity.? Specifically, you?may earn extra credit for Finance 4335 by writing a succinct (1-2 page) ?executive summary? in which you summarize what you learn from next Tuesday?s class meeting. Email your report (in either Microsoft Word or Adobe Acrobat format) to risk@garven.com by no later than the Monday, November?26 at 5 p.m. I will use your grade on this assignment to replace your lowest quiz grade in Finance 4335 (assuming that your grade on the extra credit is higher than your lowest quiz grade). If you have any questions about this extra credit opportunity, please let me know by emailing me at James_Garven@baylor.edu or calling me at 254-307-1317.

Source: http://risk.garven.com/2012/11/17/agenda-for-tuesdays-class-november-20-2012/

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