Managerial hedging and equity ownership

Acharya, V and Bisin, A (2002) Managerial hedging and equity ownership. Working Paper. London Business School IFA Working Paper.

Abstract

Riskaverse managers can hedge the aggregate component of their exposure to firm's cash flow risk by trading in ficial markets, but cannot hedge their firmspecific exposure. This gives them incentives to pass up firmspecific projects in favor of standard projects that contain greater aggregate risk. Such risk substitution gives rise to excessive aggregate risk in stock markets and excessive correlation of returns across firms and sectors, thereby reducing the risksharing among stock market investors. Managerial ownership of the firm can be designed to mitigate theis externality. We characterize the resulting endogenous relationship between the managerial ownership and the extent of aggregate risk in the firm's cash flows, and discuss its implications for existing empirical research.