Managers who avoid risk tend to seek out firms that engage in risk management, according to a first-of-its-kind study that examined the “human element” in corporate risk management. What’s more, hedging happens even more when managers are compensated by equity in their companies.
“This study took the idea of corporate risk management one step further, looking at the people who are making the decisions,” said Erasmo Giambona, associate professor of finance at Syracuse University’s Martin J. Whitman School of Management, one of the study’s co-authors.
The study, co-authored by Gordon Bodnar (Johns Hopkins University), as well as John Graham and Campbell Harvey (Duke University), found that CFOs who have more of their personal wealth tied to the firm tended to hedge more. This finding was stronger among executives with MBA degrees.
According to Professor Giambona, over the past 25 years, research has focused on the characteristics of companies that hedge. This research challenges this approach.
“While company characteristics are undoubtedly important, we show that the ‘human element’ – executive risk aversion – plays a key role in both the active management of risk and the measurement of the firm’s risk exposure,” he said. “Our study shows that you really need to examine the people. You can’t separate human nature from business.”
He added that risk averse managers might act on the fear that if they are not successful, they could lose their jobs and at that level, losing a job can have lifelong consequences for them.
“Risk averse managers, according to our research, are more likely to rely on more conservative distributions to estimate risk exposure, again a product of their own risk aversion characteristics,” said Professor Giambona.
The study, “A View of Corporate Risk Management,” is forthcoming in Management Science.
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