Risky Investment Policies Research Articles

Board tenure diversity, culture and firm risk: Cross-country evidence

We examine the impact of board tenure diversity on firm risk in 37 countries. Using a difference-in-differences design facilitated by corporate board reforms across the world, we find that board tenure diversity leads to lower stock return volatility. This effect is more pronounced among firms with longer board tenures, which are more likely to result in board entrenchment and weak monitoring. The positive impact of board tenure diversity on reducing firm risk is weakened in more individualistic and higher power distance cultures, due to the balancing act between group independence and cohesiveness. Further tests suggest the lower risk levels are likely due to that tenure-diverse boards tend to adopt less risky investment policies.

On Conditional Lower Partial Moments and Its Applications

SYNOPTIC ABSTRACTLower partial moments (LPM) are predominantly used in portfolio theory and in areas involving financial risk, which addresses the problem of managing risky investment policies with the object of maximizing returns. LPM also plays an important role in the analysis of risks in income (poverty) studies. In this article, we extend the notion of LPM to the conditional set up and study its usefulness in the context of stochastic modeling. The relationship between various measures in reliability studies, income (poverty) studies, and risk analysis are also proved. Finally, a non-parametric estimator for conditional LPM is proposed and has been validated through simulated and real data sets.

Accounting for banks, capital regulation and risk-taking

This paper examines risk-taking incentives in banks under dierent accounting regimes with capital regulation. In the model the bank’s decisions of capital issuance and investment policy are jointly determined. Given exogenous minimum capital requirement, the bank is more likely to issue equity capital in excess of the minimum required level and implement less risky investment policy under either lower-of-cost-ormarket accounting or fair value accounting than under historical cost accounting. But fair value accounting may induce more risk-taking compared to lower-of-cost-or-market accounting due to short term interest in the part of the bank. However, the disciplining role of lower-of-cost-or-market accounting may discourage bank’s incentive to exert project discovery eort

Managerial incentives in the presence of golden handshakes

This paper examines the effect of “golden handshakes” on managerial incentive compensation and risk-taking. Golden handshake, one on hand, increases CEO's pay-for-performance sensitivity by providing a high-powered incentive scheme. On the other hand, it also increases the sensitivity of CEO wealth to stock volatility, and induces CEOs to implement risky investment policy. I show the optimal incentive level increases in the presence of golden handshake. The results help to shed light on the important role of severance contract on the optimal executive compensation.

Verification Theorems for Models of Optimal Consumption and Investment with Annuitization

This paper verifies the uniqueness and existence for the value function of optimal consumption and investment problem with annuitization. The main results in this paper are closed form solutions with verification theorems. I combine the variational inequality approach of Bensoussan and Lions (1982) with an analysis of optimal stopping problem that I can solve in a closed form. Finally, I obtain analytical comparative statics for optimal consumption and risky investment policies.

Auswirkungen der anhaltenden Niedrigzinsen auf das Versicherungswesen

Abstract This paper discusses the effects of the present low interest rate environment on the German life insurance industry. By referring to a recent study of the “International Center for Insurance Regulation”, we assess insolvency probabilities for life insurers with different capital endowments under different interest rate scenarios. Based on that, we discuss measures of insurance regulation that try to cope with the imminent problems of the life insurance industry. Finally, we have a look at product developments and investment strategies of life insurers in the presence of low interest rates. Hereby, life insurance products with lower investment guarantees that are granted for a shorter period of time are regarded as the best remedy to avoid low interest rate problems in the future. Such product development also allows for a more risky investment policy of life insurers that can make life and annuity products more attractive.

Auswirkungen der anhaltenden Niedrigzinsen auf das Versicherungswesen

Abstract Helmut Gründl discusses in his paper the effects of the present low interest rate environment on the German life insurance industry. By referring to a recent study of the “International Center for Insurance Regulation”, he assesses insolvency probabilities for life insurers with different capital endowments under different interest rate scenarios. Based on that, he discusses measures of insurance regulation that try to cope with the imminent problems of the life insurance industry. Finally, he has a look at product developments and investment strategies of life insurers in the presence of low interest rates. Hereby, he argues, that life insurance products with lower investment guarantees that are granted for a shorter period of time are regarded as the best remedy to avoid low interest rate problems in the future. Such product development also allows for a more risky investment policy of life insurers that can make life and annuity products more attractive. Rolf Ketzler und Peter Schwark explicate that the very accommodative monetary policy of the ECB and the related extremely low interest rates are involved with major challenges for the German insurance sector, in particular for life insurers. As long-term investors, insurers are not only affected in their capital investment strategy, but also by different households’ retirement saving patterns in response to the low interest rate environment. Several significant steps have already been taken in order to ensure the long-term viability of life insurance. These include changes in the product portfolio as well as new approaches in the investment strategy. In addition, new regulatory requirements have been established to strengthen the risk bearing capacity of life insurers. Given the substantial risks of low interest rates, from an economic point of view the question concerning an appropriate exit from the low interest rate environment needs more attention in the public debate. They argue that in this context, further progress regarding the economic reform policies in the euro zone is still necessary as a condition for the ECB to normalize its monetary policy as soon as possible. Focusing the perspective of German life insurance industry, the article of Heinrich Schradin starts with a brief description and discussion of the financial impact of the persistently low interest rate environment. Based on an empirical data set of German life insurers, the author illustrates actual limitations to generate sufficient investment income for to meet the given specific financial guarantees. Moreover, the core problem, caused by the use of volatile timing-related interest rates for to evaluate long-term cash flows, becomes obvious. The currently observed regulatory interventions are trying to overcome the existential consequences of the so-called fair value measurement. In consequence, the author derives four central theses: 1. Life insurance in Germany suffers from insufficient capital adequacy. 2. Persistent low interest rates threaten the fulfillment of financial guaranty commitments of German life insurers. 3. The generally accepted principals of economic evaluation do not satisfy to the traditional business model of German life insurers. 4. Under a business perspective, the development of new life insurance products is inevitable.

CEO age and the riskiness of corporate policies

Prior theoretical work generates conflicting predictions with respect to how CEO age impacts risk-taking behavior. Consistent with the prediction that risk-taking behavior decreases as CEOs become older, I document a negative relation between CEO age and stock return volatility. Further analyses reveal that older CEOs reduce firm risk through less risky investment policies. Specifically, older CEOs invest less in research and development, make more diversifying acquisitions, manage firms with more diversified operations, and maintain lower operating leverage. Further, firm risk and the riskiness of corporate policies are lowest when both the CEO and the next most influential executive are older and highest when both of these managers are younger. Although older CEOs prefer less risky investment policies, I document results suggesting that CEO and firm risk preferences tend to be aligned. Lastly, I find that a trading strategy that goes long in a portfolio of stocks consisting of firms managed by younger CEOs and short in a portfolio of stocks comprised of firms led by older CEOs would generate positive risk-adjusted returns. Overall, my results imply that CEO age can have a significant impact on risk-taking behavior and firm performance.

CEO Age, Firm Risk, and Corporate Policies

Prior theoretical work generates conflicting predictions with respect to how CEO age impacts risk-taking behavior. Consistent with the prediction that risk-taking behavior decreases as CEOs become older, I document a negative relation between CEO age and stock return volatility. Further analyses reveal that older CEOs reduce firm risk through less risky investment policies. Specifically, older CEOs invest less in research and development, make more diversifying acquisitions, manage firms with more diversified operations, and maintain lower operating leverage. Further, firm risk and the riskiness of corporate policies are lowest when both the CEO and the next most influential executive are older and highest when both of these managers are younger. Although older CEOs prefer less risky investment policies, I document results suggesting that CEO and firm risk preferences tend to be aligned. Lastly, I find that a trading strategy that goes long in a portfolio of stocks consisting of firms managed by younger CEOs and short in a portfolio of stocks comprised of firms led by older CEOs would generate positive risk-adjusted returns. Overall, my results imply that CEO age can have a significant impact on risk-taking behavior and firm performance.

Do Nonfinancial Stakeholders Affect the Pricing of Risky Debt? Evidence from Unionized Workers

The authors study the impact of a powerful nonfinancial stakeholder—unionized workers—on the pricing of corporate debt. Firms in more unionized industries have lower bond yields. This relation is stronger in firms with weaker financial conditions and cannot be explained by the correlation of unionization with industry characteristics, governance mechanisms, or financial leverage. Firms in unionized industries implement less risky investment policies and are less likely targets of acquisitions. Unionization reduces yields by more when firms’ takeover barriers are lower. Hence, unions are viewed favorably in the bond market because, through their influence on corporate affairs, they protect bondholders’ wealth.

Accounting for Banks, Capital Regulation, and Risk-Taking

This paper examines risk-taking incentives in banks under different accounting regimes with capital regulation. In the model the bank's decisions of capital issuance and investment policy are jointly determined. Given some exogenous minimum capital requirement, the bank is more likely to issue equity capital in excess of the minimum required level and implement less risky investment policy under either lower-of-cost-or-market accounting or fair value accounting than under historical cost accounting. But fair value accounting may induce more risk-taking compared to lower-of-cost-or- market accounting due to short-term interest on the part of the bank. However, the disciplining role of lower-of-cost-or-market accounting may discourage bank from exerting project discovery effort ex-ante. From the regulator's perspective, the optimal accounting choice will be governed by a tradeoff between the social cost of capital regulation and the efficiency of the bank's project discovery efforts. When the former effect dominates, the regulator prefers lower-of-cost-or-market accounting; when the latter effect dominates, the regulator may prefer other regimes.

Do Non-Financial Stakeholders Affect the Pricing of Risky Debt? Evidence from Unionized Workers

We study the impact of a powerful non-financial stakeholder – unionized workers – on the pricing of corporate debt. Firms in more unionized industries have lower bond yields. This relation is stronger in firms with weaker financial conditions and cannot be explained by the correlation of unionization with industry characteristics, governance mechanisms, or financial leverage. Firms in unionized industries implement less risky investment policies, and are less likely targets of acquisitions. Unionization reduces yields by more when firms’ takeover barriers are lower. Hence, unions are viewed favorably in the bond market because, through their influence on corporate affairs, they protect bondholders’ wealth.

Loading members with investment choice

This paper discusses why South African retirement funds might not respond to requests for member investment choice in defined contribution schemes. A significant minority of retirement fund members might want a less risky investment policy than the average. However, no really secure investments are available in South Africa. Equities, though, have given significantly greater returns than other classes, and with less risk when measured over longer periods. The major question facing retirement fund investors, therefore, is the continued existence of this equity premium. In the light of uncertainty as to its future, it is suggested that investment choice is unlikely to be of much value to members as it overloads them with worry and expense.

OPTIMAL INVESTMENT STRATEGIES FOR CONTROLLING DRAWDOWNS

We analyze the optimal risky investment policy for an investor who, at each point in time, wants to lose no more than a fixed percentage of the maximum value his wealth has achieved up to that time. In particular, if Mt is the maximum level of wealth W attained on or before time t, then the constraint imposed on his portfolio choice is that WtαMt, where α is an exogenous number betweenα O and 1. We show that, for constant relative risk aversion utility functions, the optimal policy involves an investment in risky assets at time t in proportion to the “surplus”Wt ‐ αMt. the optimal policy may appear similar to the constant‐proportion portfolio insurance policy analyzed in Black and Perold (1987) and Grossman and Vila (1989). However, in those papers, the investor keeps his wealth above a nonstochastic floor F instead of a stochastic floor αMt. the stochastic character of the floor studied here has interesting effects on the investment policy in states of nature when wealth is at an all‐time high; i.e., when Wt =Mt. It can be shown that at Wt=Mt, αMt is expected to grow at a faster rate than Wt, and therefore the investment in the risky asset can be expected to fall. We also show that the investment in the risky asset can be expected to rise when Wt is close to αMt. We conjecture that in an equilibrium model the stochastic character of the floor creates “resistance” levels as the market approaches an all‐time high (because of the reluctance of investors to take more risk when Wt=Mt).