Corporate risk management and investment decisions

Abstract

PurposeCorporate risk management is one of the critical concerns of managers when they make investment allocation decisions among multiple projects. The purpose of this paper is to address corporate investment issues illustrated by target‐beating in capital budgeting, and further discuss their applications in financial management, especially in venture capital finance.Design/methodology/approachValue‐at‐risk, a typical down‐side risk measure which is considered more appropriate for economic agents, is applied to the analysis. Probability theory and optimal control methodologies are used to derive analytical solutions.FindingsBy maximizing the probability of beating a pre‐determined target, an analytical optimal corporate investment allocation strategy is presented, and the corresponding probability and expected earliest time of success derived.Research limitations/implicationsVarious types of utility functions of economic agents and other dynamic downside risk measures can be considered in future research along this line.Practical implicationsThis paper paves the road for applications of continuous‐time downside risk in making corporate investment decisions, especially in the field of new venture finance.Originality/valueAs one of the early studies investigating optimal investment decisions in continuous‐time downside risk‐based capital budgeting system, this project sheds light on corporate risk management, and provides risk‐averse decision makers with an effective tool.