The value of risk management

What can you tell us about your field of research?

My field of research involves exploring the best policies a company can implement at a given stage of its lifecycle or in the context of its environment. I study, for example, whether it is the right time for a firm to focus on growing its capital or making it more efficient. I explore how much cash a firm ought to have in reserve to reduce the risk of cutting investments when earnings are low. Can a firm issue new shares to top up its cash balance, for instance? If so, when? Equity issuance appears to be timed to manage the costs of stock-market volatility. I try to identify these costs and, thus, predict the optimal time to borrow.

You are a Research Fellow at the Centre for European Policy Research (CEPR). How does your research feed into your course?

It is impossible to teach a class well without having researched a subject or followed state-of-the-art research into it. For example, my current research on liquidity management tells us how to hedge a firm’s exposure to long-term and short-term earnings risk. Before, we simply didn’t know how exposed firms were to these two things. My research tells us how much cash savings a firm should hold to hedge such risks. Also, in class, students often ask for real-life examples of the topic of the day. It really helps when those examples are in the datasets of my or other studies!

You are an expert in the valuation of illiquidity risk, the dynamics of ownership concentration, and the determinants of bank runs and financial fragility. How do you apply this expertise in the course you teach on Corporate & Treasury Risk Management? 

Silicon Valley Bank (SVB) failed because it had significant short-term exposure to changes in interest rates. SVB ignored this reality and thought, mistakenly, that it had invested in the safest possible bonds. On the contrary, its duration exposure made it vulnerable and put it in a position where it could easily become illiquid with just small changes in interest rates. Duration and other kinds of interest-rate exposure are well-known, core topics in risk management. Such mistakes should not occur. My course discusses similar lessons. I know these lessons well, as I needed to study them for my own research into the illiquidity of shadow banks and controlling stakes in public companies.

What are the main concepts the students will review in this course?

We start by establishing when risk management adds value to a firm and when it does not. We review the different sources of risk exposure of a modern corporation, then learn which financial instruments are best suited to what type of exposure. Not all instruments work well for all exposures. For example, a futures hedge can work well against known short-term exposures, but perform very badly against uncertain long-term exposures. Are options worth their price? We will determine when. And how can a firm hedge without financial instruments and with non-financial policies? Hedging can add most value if it is part of a firm’s long-term strategic plan. Many case studies illustrate this point beautifully.

How does sustainable finance impact risk management?

Recent evidence shows that a firm’s downside risk increases with its carbon intensity. Therefore, a reduction in carbon intensity or, more generally, a reduction in the firm’s negative environmental or social impact, is effectively a risk management policy, because it decreases the firm’s cost of insurance.

Are there books or publications that students should read in preparation for your course?

John Hull’s book, Options, Futures, and other derivatives is an excellent manual on market derivatives. I always have it by my side. Rene Stulz’s textbook, Risk-taking and Risk Management by banks, parts of which we follow closely in the course, views the risk management function as a corporate policy rather than a trading strategy. I recommend reading the first few chapters before the course starts. But it is probably best to read as many financial press articles as possible about risk management. Read about what companies do and whether they fail or succeed at it. Don’t worry if you don’t understand much of them. Very few people do. Instead, make a note, write down some questions, and bring them to class.

Will students work on business cases? 

Yes, we will study four business cases during the term and one as a final assignment. Case studies cover complex, real-life situations and allow us to extract lessons about the best risk management practices. They are also entertaining and combine risk management with other corporate treasury policies.

What do you expect your students to learn and have mastered on completion of your course?

I expect students to understand the fundamental difference between speculation and hedging. Financial history teaches us that even the treasurers, CEOs and board members of large companies confuse them. Students will also learn that risk management, when done well, is a value-increasing policy that has been elevated to the executive suite and must be coordinated with investment and financing policies.

Do you teach any other master’s courses?

I teach the core Corporate Finance course to MSc in International Finance students and Advanced Corporate Finance at Ph.D. level.

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