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FRM Part I · FRM Exam Part I · How Do Firms Manage Financial Risk?

Which of the following is a recognized reason why managers may hedge even when it does not increase shareholder value?

Managers may hedge because their human capital and equity holdings are concentrated in the firm, making them risk averse to firm-specific risk. This agency motive can lead to hedging that benefits managers rather than diversified shareholders.

  1. AManagers hold undiversified human capital and equity in the firm, so they are risk averse to firm-specific riskCorrect
  2. BManagers are always compensated with fixed salaries only
  3. CHedging always increases the firm's expected earnings
  4. DRegulators require all firms to hedge all exposures

Explanation

Managers' wealth and careers are concentrated in the firm, so they may hedge to reduce personal risk, which is a potential agency motive. Options B, C and D are false statements: pay often has equity components, hedging need not raise expected earnings, and no universal hedging mandate exists.

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