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Choice of corporate risk management tools under moral hazard

Bena, Jan (2006) Choice of corporate risk management tools under moral hazard. Discussion paper, 566. Financial Markets Group, London School of Economics and Political Science, London, UK.

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Abstract

This paper examines the choice of tools for managing a firm’s operational risks: cash reserves, insurance contracts, and financial assets under an optimal financing contract that solves moral hazard between insiders and outside investors. Risk management is valuable as it reduces the costs of raising external financing, increases debt capacity, lessens underinvestment, and improves welfare. I show that insurance is superior as it facilitates the outside financing relationship but leads to inefficient excessive continuation if used without coverage limits. When insurance against an operational risk is not available, the firm uses financial assets instead or resorts to holding cash reserves.

Item Type: Monograph (Discussion Paper)
Official URL: http://fmg.lse.ac.uk
Additional Information: © 2006 The Author
Library of Congress subject classification: H Social Sciences > HB Economic Theory
Journal of Economic Literature Classification System: G - Financial Economics > G3 - Corporate Finance and Governance > G31 - Capital Budgeting; Fixed Investment and Inventory Studies
D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D82 - Asymmetric and Private Information
G - Financial Economics > G2 - Financial Institutions and Services > G22 - Insurance; Insurance Companies
Sets: Research centres and groups > Financial Markets Group (FMG)
Collections > Economists Online
Collections > LSE Financial Markets Group (FMG) Working Papers
Rights: http://www.lse.ac.uk/library/usingTheLibrary/academicSupport/OA/depositYourResearch.aspx
Identification Number: 566
Date Deposited: 19 Jul 2009 19:31
URL: http://eprints.lse.ac.uk/24518/

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