Corporate Risk Tolerance Research Articles

Managerial myopia and audit fees: Evidence from China

Following the upper echelons and time orientation theoretical frameworks, this study meticulously examines the effects of managerial myopia on audit fees utilizing data of Chinese A-share listed companies spanning from 2007 to 2022. Employing textual analysis and machine learning techniques on MD&A, we find that managerial myopia can significantly increase audit fees by intensifying financial constraints, diminishing accounting information comparability, and compromising internal control quality. However, this relationship is accentuated by analyst coverage but attenuated by digital transformation. Cross-sectionally, we document a particularly pronounced positive association between managerial myopia and audit fees within firms exhibiting higher corporate risk tolerance, diminished industrial competition and a lower degree of marketization. Collectively, this study further enriches corporate governance and audit fees literature, advancing valuable insights for regulators, accountants and auditors.

Board's informal hierarchy: influences on enterprise innovation quality

PurposeUtilizing the expectation states theory in sociology, this study probes into the influence of the board's informal hierarchy on the quality of enterprise innovation, originating from the perspective of internal directorial interactions, while analyzing the boundary effects exhibited by the nature of property rights and the intensity of geo-culture.Design/methodology/approachThe study selects China's A-share listed companies from 2008 to 2021 as the research sample, employing the Tobit regression analysis method to scrutinize the hypotheses presented in the text.FindingsThe regression results demonstrate a positive correlation between the board's informal hierarchy and the enterprise innovation quality (EIQ). Upon introducing variables specific to property rights and geographical culture, the authors found that in comparison to non-state-owned enterprises (non-SOEs), the influence of the board's informal hierarchy on the quality of corporate innovation is diminished in SOEs. Conversely, the intensity of geo-culture across Chinese provinces enhances their mutual positive influence. In the additional analysis, the authors also found that the elevation of corporate risk tolerance is a significant pathway for the positive effect of the board's informal hierarchy on EIQ. Moreover, this positive influence is more profound in high-tech enterprises, businesses implementing equity incentive plans and companies that have subscribed to director and officer liability insurance.Originality/valueThe findings not only deepen the understanding of how the board's internal status characteristics influence corporate decision-making but also enrich the application scope of expectation states theory. Furthermore, this study offers valuable guidance for optimizing innovation decision-making by adjusting the personnel structures of corporate boards.

Firm Risk and Tax Avoidance in Vietnam: Do Good Board Characteristics Interfere Effectively?

This paper investigates the role of board characteristics in the relationship between tax avoidance behavior and corporate risk tolerance to elucidate the importance of corporate governance mechanisms. The applied methodology is System-GMM for 334 listed corporations in Vietnam from 2008 to 2020 to avoid endogenous problems in our models. The main findings are that higher (lower) corporate risk-taking is related to higher (lower) corporate tax avoidance if the size of the board of directors and the supervisory board are larger (lower) than six and three members, respectively. Furthermore, if the board independence ratio is lower than 48.63%, an increase in corporate risk-taking leads to increased tax avoidance. Our results support the argument that the influence of corporate risk-taking on tax avoidance behavior is governed by governance structure. Therefore, the practical implications will be towards building the optimal governance mechanism for enterprises in Vietnam.

Corporate Risk Tolerance and Acceptability towards Sustainable Energy Transition

The omnipresence of risk prevails in almost every aspect of human life. Individuals and societal factors are pivotal in the decision-making process to judge acceptability and tolerability of risk. Tolerability of risk (ToR) is characterized by dynamism pinned in the process of decision making that helps to gauge the society and individual’s risk. The energy transition implies switching the energy system from fossil fuels or any traditional mechanism to modern renewable sources that are sustainable. The energy transition is paramount important in the current global energy system to attain sustainable goals for organizations. This study used the positivism research paradigm to address the research questions. The quantitative approach helps to examine the cause-and-effect relationship. It also helps to collect systematic information to meet the objectives of the research. A total sample of 300 was selected for the data collection from renewable energy companies. The study used positivism research philosophy applied deductive approach. The data is analyzed through PLS-SEM. It is summarized that the scale of risk acceptability and tolerability in Pakistan is moderate which encourages companies to work progressively and increases sociocultural activities to make society a partner of this new shift in energy transition that will ultimately increase the level of risk acceptability. Nevertheless, as a society, people are neither high-risk takers nor risk avoiders due to income constraints, macroeconomic uncertainty, and political instability.

Write-down bonds, credit risk and imperfect information

A structural model of pricing Write-Down (hereafter WD) bonds under imperfect information has been developed to investigate the effect of WD bonds issuance on credit risk. Information is not only delayed but also asymmetrically distributed between managers and outside investors. We derive analytical solutions for corporate securities prices and find the issuance of WD bonds could significantly improve firm value via reducing bankruptcy cost. Our numerical results further demonstrate that the WD bonds issuance increases corporate risk tolerance and reduces the risk of bankruptcy and credit spreads under imperfect information.

Handling Risk and Uncertainty in Portfolio Production Forecasting

Summary Stochastic modeling provides a mechanism for incorporating risk and uncertainty considerations into portfolio production forecasts. Through this process, insight is gained into the likelihood of production targets being missed, met, or exceeded. This insight enables organizations to better manage operational, positioning, and strategic planning activities around stakeholders’ production expectations. Inherent in all capital programs are numerous uncontrollable, but definable, factors that affect overall corporate production performance. These factors can be categorized into four groups: (1) timing uncertainties, (2) performance uncertainties, (3) sequencing uncertainties, and (4) risk. Timing uncertainty considers spud scheduling, spud-to-first-production cycle timing, and production-ramp-up cycle timing. Performance uncertainty considers the historical or modeled distribution of period-specific production rates within the constituent plays (e.g., What is the unavoidable range of variability within a play as depicted in a peak-normalized composite-production plot of wells within the analog population?). Sequencing uncertainty considers performance-percentile clustering or sequencing within the program (e.g., the number of top-quartile wells that are, by chance, drilled early in the year vs. later in the year). Finally, risk addresses commercial failure within a program attributed to either geology or execution, or both. By integrating historical operational data with a standardized set of play-assessment deliverables, the building blocks of a stochastic capital-program forecast and analysis are readily available. Ultimately, the use of stochastic modeling in portfolio production forecasting provides an organization's decision makers with the information necessary to examine investment and strategic decisions in the context of corporate-risk tolerance.

Optimal Capital Allocation Principles

AbstractThis article develops a unifying framework for allocating the aggregate capital of a financial firm to its business units. The approach relies on an optimization argument, requiring that the weighted sum of measures for the deviations of the business unit's losses from their respective allocated capitals be minimized. The approach is fair insofar as it requires capital to be close to the risk that necessitates holding it. The approach is additionally very flexible in the sense that different forms of the objective function can reflect alternative definitions of corporate risk tolerance. Owing to this flexibility, the general framework reproduces several capital allocation methods that appear in the literature and allows for alternative interpretations and possible extensions.

Some Determinants of Corporate Risk Aversion

In this paper we roughly quantify the degree of risk aversion induced by three rationales for corporate risk management: the cost of financial distress, costly external finance, and the principal-agent relationship between shareholders and management. In so doing, we provide a foundation for the use of corporate utility functions. However, we are unable to fully support the degree of risk aversion reported in the decision analysis literature. Specifically, financial distress and costly external finance appear to induce relatively little risk aversion, while principal-agent concerns lend only partial support to published corporate risk tolerance guidelines.

Measuring and Utilizing Corporate Risk Tolerance to Improve Investment Decision Making

Strategic investment decisions are generally characterized by financial risk as well as an irrevocable commitment of significant amounts of capital. The firm's willingness to undertake financial risks plays an important role in the investment decision making process. A comprehensive economic decision analysis to evaluate strategic investment decisions requires a measure of the firm's tolerance for financial risk. This article describes a decision analysis–based technique for assessing managerial risk tolerance as well as managers' ability to be consistent in terms of their financial risk taking. These assessments are then utilized to assist the firm in establishing a corporate risk policy that can guide strategic decisions under uncertainty. The study firm is a business unit within a U.S.-based major oil company with an annual capital budget of approximately $400 million. Our findings suggest that managers are generally risk averse but struggle in terms of being consistent in their financial risk-taking decisions. This work enabled the firm to implement a financial risk tolerance that could be utilized in the economic decision analysis of investment decisions.

Utility transversality: a value‐based approach

AbstractWe examine multiattribute decision problems where a value function is specified over the attributes of a decision problem, as is typically done in the deterministic phase of a decision analysis. When uncertainty is present, a utility function is assigned over the value function to represent the decision maker's risk attitude towards value, which we refer to as a value‐based approach. A fundamental result of using the value‐based approach is a closed form expression that relates the risk aversion functions of the individual attributes to the trade‐off functions between them. We call this relation utility transversality. The utility transversality relation asserts that once the value function is specified there is only one dimension of risk attitude in multiattribute decision problems. The construction of multiattribute utility functions using the value‐based approach provides the flexibility to model more general functional forms that do not require assumptions of utility independence. For example, we derive a new family of multiattribute utility functions that describes richer preference structures than the usual multilinear family. We also show that many classical results of utility theory, such as risk sharing and the notion of a corporate risk tolerance, can be derived simply from the utility transversality relations by appropriate choice of the value function. Copyright © 2007 John Wiley & Sons, Ltd.

Production from Multiple Horizons: Budget Constraints and Minimum Involvement

For a given oilfield in which a company can invest to drill untapped horizons for profit, the influences of value, cost, success probability and corporate risk tolerance provide an optimal working interest that should be taken in the opportunity in order to maximize the risk adjusted value. When several horizons are available, but when the total budget is insufficient to take optimal working interest in each, an analytic procedure is given for optimizing the risk adjusted value of the total portfolio; the relevant working interests are also derived based on a cost exposure constraint. Several numerical illustrations exhibit use of the method under different budget conditions, and with different numbers of available horizons. The result is that the computations of portfolio balancing can be done quickly utilizing the analytical expressions presented here, thereby providing rapid assessments of undrilled horizons and their worth.

Limiting risk in environmental problems: Corporate budget constraints and minimum involvement

For a given opportunity in which a company can invest to perform environmental remediation for profit, the influences of value, cost, success probability, and corporate risk tolerance provide an optimal working interest (OWI) that should be taken to maximize the risk-adjusted value (RAV). When several opportunities are available, but when the total budget is insufficient to take OWI in each, an analytical procedure is undertaken for optimizing the RAV of the total portfolio; the relevant working interests are also derived based on a cost-exposure constraint. Several numerical illustrations will exhibit the use of the method under different budget conditions and with different numbers of available opportunities. The result is that the computations of portfolio balancing can be done quickly using the analytical expressions presented here, thereby providing rapid assessments of environmental opportunities and their worth.

Modifications to Risk Aversion in High Gain Situations

The classical Cozzolino formula for risk aversion, which determines the optimum working interest that should be taken in an exploration opportunity, suffers from the disadvantage that the predicted optimum working interest decreases for opportunities which have increasing high gain potential, independently of the success chance, while the predicted risk adjusted value tends towards a constant limit, which is independent of anticipated costs and depends only on the corporate risk tolerance and the success probability. For low gain opportunities the classical risk formula does an adequate job of assessing optimum working interest. Modifications are given to the method which, for low gain opportunities, reduce to the classical risk adjusted behaviors but which, for high gain opportunities, provides a predicted optimum working interest which increases with increasing gain. A practical procedure is provided for using these modifications in a simple manner to differentiate between high gain (good-risk) opportunities versus low gain (bad-risk) opportunities. Numerical illustrations indicate graphically the changes in risk aversion brought about by the required modifications.

Similarity, Dependence and Correlation Considerations for Risk Adjusted Values in Hydrocarbon Exploration

This paper explores the influences of both stochastic and deterministic correlations on single and multiple hydrocarbon exploration opportunities within the framework of both unlimited and limited corporate risk tolerances. In addition, both similar and dissimilar opportunities are considered, as well as geologic similarities and fiscal dissimilarities to illustrate the influences of different combinations of factors on risk adjusted values for both single and multiple opportunities. Numerical illustrations are provided to illuminate each of the influences and patterns of behaviour that are sketched, so that a pictorial representation is available of the topological structure of each of the individual points being addressed. The numerical examples include both the stochastic and deterministic effects of correlated and similar behaviours of opportunities in relation to variable success probabilities, corporate risk tolerance, and constraints due to a fixed corporate budget.

Portfolio Balancing and Risk Adjusted Values under Constrained Budget Conditions

For a given hydrocarbon exploration opportunity, the influences of value, cost, success probability and corporate risk tolerance provide an optimal working interest that should be taken in the opportunity in order to maximize the risk adjusted value. When several opportunities are available, but when the total budget is insufficient to take optimal working interest in each, an analytic procedure is given for optimizing the risk adjusted value of the total portfolio; the relevant working interests are also derived based on a cost exposure constraint. Several numerical illustrations are provided to exhibit the use of the method under different budget conditions, and with different numbers of available opportunities. When value, cost, success probability, and risk tolerance are uncertain for each and every opportunity, the procedure is generalized to allow determination of probable optimal risk adjusted value for the total portfolio and, at the same time, the range of probable working interest that should be taken in each opportunity is also provided. The result is that the computations of portfolio balancing can be done quickly in either deterministic or probabilistic manners on a small calculator, thereby providing rapid assessments of opportunities and their worth to a corporation.

On the Value of Options in Exploration Economics

Representations are given of the value of optioning a buy-in position to an exploration project based on both the Cozzolino risk adjusted value (RAV) formula as well as on the parabolic RAV formula; numerical illustrations indicate that there is little difference between maximal option values based on either formula. For deterministic values of success probability, ps, gain, G, costs. C, corporate risk tolerance, RT, and working interest, W, illustrations are given of the maximum option value in relation to the RAV. In addition, when probability distributions for Ps, G, C, RT and W are taken to represent ±10% or ±20% variations around fixed mean parameter values, it is shown that the corresponding cumulative probability distributions for maximum option value are remarkably similar when based on either the Cozzolino or parabolic RAV formula. It is also shown that contributions of equal fractional variations of ps, G, C, RT and W to the variance in the maximum option value are extremely unequal in relative importance and, further, increasing the variations from ± 10% to ± 20% not only causes a four-fold increase of the volatility around the mean option value, but also causes a 20% decrease in the mean, as well as re-ordering the relative importance of factors contributing to the variance around the mean option value. For massive variations of ps, G, C, or RT, which occur outside of initial estimated ranges, it is shown that the maximum option value (or the desired working interest) has to be adjusted either to keep total project costs at a fixed level or, if the working interest is fixed, then while the total project costs increase, the RAV decreases faster than the maximum potential value, so that the maximum option value increases. The purpose of these computations has been to illustrate explicitly how one can quantify uncertainty in option decisions at the start of an exploration project, when information is normally inaccurate and imprecise, and also how one can use later unanticipated changes in success probability, costs, gains, or corporate risk tolerance to immediately re-evaluate both the RA V of the project, the maximum worth of the option, and a new working interest to minimize or hold constant total project costs including the option cost.

Corporate Risk Tolerance and Capital Allocation: A Practical Approach to Implementing an Exploration Risk Policy

Petroleum exploration companies are confronted regularly with the issue of allocating scarce capital among a set of available exploration projects, which are generally characterized by a high degree of financial risk and uncertainty. Commonly used methods for evaluating alternative investments consider the amount and timing of the monetary flows associated with a project and ignore the firm`s ability or willingness to assume the business risk of the project. The preference-theory approach combines the traditional means of project valuation, net present value (NPV) analysis, with a decision-science-based approach to risk management. This integrated model provides a means for exploration firms to measure and to manage the financial risks associated with petroleum exploration, consistent with the firm`s desired risk policy.

Decision Analysis: Practice and Promise

Decision analysis stands on a foundation of hundreds of years of philosophical and practical thought about uncertainty and decision-making. The accomplishments and promise of the field are impressive, yet it has not become commonplace even in very important decisions. While human nature may pose an ultimate limitation, maintaining clarity of concept and exploiting progress in the realms of scope, skill, and efficiency should lead to more widespread use. A central conceptual distinction is that between normative and descriptive views of decision-making. We discuss the importance of maintaining this distinction in the face of attempts to compromise. The procedures for formulating, eliciting, evaluating, and appraising the decision problem are all experiencing major improvements. The strategy-generation table helps in finding creative alternatives. Decision quality concepts permit us to assure both effectiveness and efficiency in analyzing decision problems. The influence diagram provides new clarity to the conversation between decision-maker and analyst, allowing representations that are both easily understandable and mathematically consistent. The clarity test makes sure we know what we are talking about regardless of what we are saying about it. Direct and indirect values illuminate preferences. Generic risk attitude considerations indicate how to relate corporate risk tolerance to the financial measures of the corporation. Spreadsheet, decision tree, and influence diagram programs speed evaluation. Intelligent decision systems realized in computers offer promise of providing the benefits of decision analysis on a broader scale than ever before. Decision analysis is now poised for a breakthrough in its usefulness to human beings.