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Strategic Corporate Finance: Applications in Valuation and Capital Structure by Justin Pettit

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CHAPTER 10

Strategic Risk Management: Where ERM Meets Optimal Capital Structure

Alarge energy company sells future oil production today, locking in price and interest rates, with proceeds used for share repurchases. A well-known technology hardware company increases the size of its bank line and foreign exchange (FX) hedging program to feel more comfortable with its decision to reduce the size of its large and growing cash balance. An international retailer de-risks the investment portfolio of its pension plan to accommodate increased financial leverage. The lines between enterprise risk management (ERM) and optimal capital structure have been blurred.

Many companies have undertaken broad risk management initiatives not necessarily to reduce risk, but to more actively manage it, and analysts have taken note:

Increasing numbers of companies are undertaking enterprise-level approaches to risk, a more encompassing and systematic review of potential risks and ways to mitigate them. These assessments typically are rolled up to a corporate level, sometimes with direct input from the Board or Audit Committee. These assessments have often been relatively broad, focusing on reputation, litigation, product development, and health and safety risks, rather than focusing solely on financial risks. Where we have seen these assessments implemented we have commented favorably, particularly when the Board or Audit Committee is actively involved.1

ERM has grown to occupy a significant portion of ...

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