Corporate Risk Management and the Incentive Effects of Debt

TIM S. CAMPBELL, WILLIAM A. KRACAW

Research output: Contribution to journalArticle

34 Citations (Scopus)

Abstract

This paper demonstrates how the incentive of manager‐equityholders to substitute toward riskier assets, commonly referred to as the “asset substitution problem,” is related to the level of observable risk in the firm. When observable and unobservable risks are sufficiently positively correlated, increases (decreases) in observable risk generate the incentive for manager‐equityholders to increase (decrease) unobservable risk. Thus, credible commitments to hedge observable risk can benefit the firm's manager‐equityholders by reducing the incentive to shift risk and the associated agency cost of debt. This provides a positive rationale for hedging diversifiable risk at the firm level. 1990 The American Finance Association

Original languageEnglish (US)
Pages (from-to)1673-1686
Number of pages14
JournalThe Journal of Finance
Volume45
Issue number5
DOIs
StatePublished - Dec 1990

Fingerprint

Incentive effect
Corporate risk management
Debt
Incentives
Hedging
Hedge
Finance
Rationale
Assets
Asset substitution
Credible commitment
Agency costs of debt
Substitute

All Science Journal Classification (ASJC) codes

  • Accounting
  • Finance
  • Economics and Econometrics

Cite this

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Corporate Risk Management and the Incentive Effects of Debt. / CAMPBELL, TIM S.; KRACAW, WILLIAM A.

In: The Journal of Finance, Vol. 45, No. 5, 12.1990, p. 1673-1686.

Research output: Contribution to journalArticle

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