Choice of corporate risk management tools under moral hazard

Jan Bena

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

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.

Keywords: Risk management; Corporate insurance; Moral hazard; Optimal contracting (search for similar items in EconPapers)
JEL-codes: D82 G22 G31 (search for similar items in EconPapers)
Pages: 41 pages
Date: 2006-06-01
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http://eprints.lse.ac.uk/24518/ Open access version. (application/pdf)

Related works:
Working Paper: Choice of Corporate Risk Management Tools under Moral Hazard (2006)
Working Paper: Choice of Corporate Risk Management Tools under Moral Hazard (2006)
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Persistent link: https://EconPapers.repec.org/RePEc:ehl:lserod:24518

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