Skip to main content

Please enter a keyword and click the arrow to search the site

Managerial hedging, equity ownership, and firm value

Subject

Finance

Publishing details

Authors / Editors

Acharya V;Bisin A

Publication Year

2005

Abstract

Risk-averse managers can hedge the aggregate component of their exposure to a firm's cash flow risk by trading in financial markets, but cannot hedge their firm-specific exposure. This gives them incentives to load their firm's cash flows on aggregate risk, that is, to pass up firm-specific projects in favor of standard projects that contain greater aggregate risk. Such risk substitution is a form of moral hazard and it gives rise to excessive aggregate risk in stock markets and excessive correlation of returns across firms and sectors, thereby reducing the risk-sharing among stock market investors. A contract specifiying managerial equity ownership of the firm can be desgined to mitigate this moral hazard. We show that the optimal contract might require "negative incentive compensation," whereby managerial ownership is smaller than in absence of this moral hazard. We characterize the resulting endogenous relationship between managerial ownership and (i) the extent of aggregate risk in the firm's cash flows, as well as (ii) firm value. We show that these endogenous relationships help explain the shape of the empirically documented relationship between ownership and firm performance.

Publication Notes

This Working Paper replaces IFA 361.

Publication Research Centre

Institute of Finance and Accounting

Series Number

FIN 446

Series

IFA Working Paper

Available on ECCH

No


Select up to 4 programmes to compare

Select one more to compare
×
subscribe_image_desktop 5949B9BFE33243D782D1C7A17E3345D0

Sign up to receive our latest news and business thinking direct to your inbox

×

Sign up to receive our latest course information and business thinking

Leave your details above if you would like to receive emails containing the latest thought leadership, invitations to events and news about courses that could enhance your career. If you would prefer not to receive our emails, you can still access the case study by clicking the button below. You can opt-out of receiving our emails at any time by visiting: https://london.edu/my-profile-preferences or by unsubscribing through the link provided in our emails. View our Privacy Policy for more information on your rights.