Managerial Personal Traits and Corporate Risk Management Practices

Businesses take risks in their value creation processes. Taking these risks result in upward potentials (rewards) and downward dangers (losses) that have to be monitored and mitigated. Risks essential for the firm to remain in business are inherent and inseparable in their operations. Oversight responsibility to ensure that firms to do not engage in excessive risk taking is maintained by the board of directors through good corporate governance practices. Risk management is therefore considered very important in safeguarding cash flow volatility.

Firms manage their downside risks if such risks have the potential to spiral into financial distress. Financial distress on its own threaten the existence of businesses. Considering the implicit benefit of risk management practices to firms, it is not out of place to assume that firms across industries and market capitalization would be incentivised to implement risk management policies.

Several theories have evolved since Modigliani and Miller’s perfect market model to explain the reasons or motivations that drive firm hedging or in a broader context risk management practices. Separation of ownership and control which creates the age old agency problem has been widely cited as a determinant of corporate risk management. Shareholders seeking to maximise their wealth become sceptical about self-serving managers who may maximise their utility using corporate resources at the expense of these shareholders. Similarly, shareholder-bondholder conflict equally drives risk management in firms.

Financial distress cost and reduced tax liabilities are also other known determinants of corporate risk management. Firms ensure they minimise volatility in cash flow to allow for investment in positive net present value projects with their internally generated capital than contract costly external funding. The use of risk management for such purposes and also to cut down tax liabilities is well supported in financial literature. Firm size also correlates positively with risk management. It is observed that larger firms engage more in risk management compared to the marginalized smaller firms. Extant theories of risk management (e.g. information asymmetry) predict that smaller firms should engage more in risk management, however, the opposite is true. Theory contrast reality.

Have some important explanatory variables been ignored? Probably so. Thankfully, the body of knowledge in financial risk management is growing rapidly due to increased accounting disclosure. New data emerging and models suggest the human factor may in part explain the reason behind firm risk management. Interestingly, this is a factor that has been overlooked and or ignored in previous theories. Firm net worth and managerial personal characteristics (traits) are such variables modelled as determinants of firm risk management. Whilst the former is a relatively new variable, the latter has roots in earlier research but has not received much attention in the literature. In his notable studies published in 1996, Tufano found evidence to support managerial risk aversion as a determinant of risk management in North American gold mines. Not surprising, managers with equity stake in their firms found reason to manage their risk and in so doing their own wealth too. Considering that there has been a surge in share based (restricted and performance) incentives following the financial crisis, perhaps the relationship between personal managerial risk traits and firm risk appetite can be examined further down this corridor.