The Impact of Risk Management Decisions on Firm Value: Gordon's Growth Model Approach

Abstract

This article examines the possible impact of risk management decisions of a firm on its value by using Gordon's infinite growth model. Expected earnings and expected losses of the firm are allowed to grow at a constant rate. Cash flows for different risk management tools are measured under the assumptions of an actuarially fair insurance premium and an exponential loss control function. Cost of capital is evaluated after considering fluctuations of cash flows. Firm value is determined by discounting appropriate cash flows at cost of capital in excess of the earnings growth rate.