Corporate Decision-Making with Macroeconomic Uncertainty: Performance and Risk Management

by Lars Oxelheim, Clas Wihlborg

Overview

Macroeconomic turbulence and volatility in financial markets can fatally affect firm's performance. Very few firms make serious attempts to inform market participants and other outsider stakeholders about the impact of macroeconomic fluctuations--manifested as changes in exchange rates, interest rates, inflation rates and stock market returns-- on performance. These stakeholders, as well as financial analysts, must make their own assessments but they generally lack both the required tools and the information to do so. Worse, top management in most firms do not themselves possess the tools to identify whether a change in performance represents a change in the firm's intrinsic competitiveness or a reflection of macroeconomic conditions outside their influence. Corporate Decision-Making with Macroeconomic Uncertainty: Performance and Risk Management develops and presents in an easily comprehensible way the essential elements of a corporate strategy for managing uncertainty in the macroeconomic environment. This Macroeconomic Uncertainty Strategy, or MUST, enhances firm value by allowing management and external stakeholders to become better informed about the development of corporate competitiveness in a turbulent macroeconomic environment. The MUST also provides guidelines for how to develop a successful risk management program. This research based book includes methods to identify the impact of macroeconomic fluctuations on cash flows and value, to develop strategies for macroeconomic risk management, to provide informative reports to external stakeholders, to evaluate the relative performance of subsidiaries and business units in multinational companies, and to evaluate performance for purposes of setting executive compensation and of fulfilling the due diligence requirements in an M & A context. The authors' use of value-based management, various performance measurements, the concept of real options, and risk management from the perspective of shareholder wealth maximization, makes the book rich and compelling. They address researchers and students in the field of international business, finance and corporate governance. On the business side, executives with strategic responsibilities, chief financial officers, and bankers who analyze corporate performance and give advice on risk management will benefit from reading this book.

Product Details

ISBN-13:	9780190450571
Publisher:	Oxford University Press
Publication date:	09/26/2008
Sold by:	Barnes & Noble
Format:	eBook
File size:	5 MB

Table of Contents

1 Macroeconomic Uncertainty in a Corporate Perspective 3

1.1 Introduction 3

1.2 The macroeconomic environment of the firm 6

1.3 What level of concern? 11

1.4 Macroeconomic Uncertainty Strategy (MUST) 12

1.5 The contents of this book 13

2 Concepts of Macroeconomic Risk Management 16

2.1 Introduction 16

2.2 Corporate risk: A brief review of the concept 17

2.3 Corporate risk: Who cares? 20

2.4 Macroeconomic risk 25

2.5 What could be gained from a risk management program? 28

2.6 Risk management and the creation of options 30

2.7 Concluding remarks: The case for risk management 31

3 Traditional Approaches to Measuring Macroeconomic Exposure 34

3.1 Introduction 34

3.2 From transaction exposure to economic exposure 35

3.3 Translation exposure 42

3.4 From translation exposure to economic exposure 43

3.5 Does the translation method matter? 45

3.6 A comparison of exchange rate exposure measures 46

3.7 Interest rate exposure measures 49

3.8 Concluding remarks on traditional exposure measures 55

Appendix 3.1 Measuring translation exposure under the monetary/non-monetary and the all-current methods 56

Appendix 3.2 Purchasing Power Parity and real exchange rates 60

Appendix 3.3 International Fisher Parity 65

4 Measuring Macroeconomic Impact on the Firm: A Comprehensive Approach 70

4.1 Introduction 70

4.2 Determinants of cash flow exposure 71

4.3 Estimating cash flow exposure 76

4.4 Decomposing cash flow exposure 84

4.5 Exposure coefficients and sizes of shocks 85

4.6 The share price and macroeconomic fluctuations 85

4.7 Concluding remarks on the comprehensive approach 86

5 Measuring Macroeconomic Exposure: The Caseof Volvo Cars 88

5.1 Introduction 88

5.2 Exposure coefficients 89

5.3 The choice of dependent variable 90

5.4 The choice of independent variables and time horizon 93

5.5 Volvo Cars 94

5.6 Results, interpretations, and the use of coefficients 101

5.7 Using the exposure coefficients for future periods 107

5.8 Concluding remarks on the case of Volvo Cars 110

6 Hedging Macroeconomic Exposure 113

6.1 Introduction 113

6.2 Derivative contracts and transaction exposure: An overview 114

6.3 Practices in managing translation exposure 120

6.4 Hedging interest rate and inflation risks 125

6.5 Hedging macroeconomic exposure to market price variables 129

6.6 Hedging with uncertain exposure using derivatives 135

6.7 Taxes and hedge contracts 138

6.8 Concluding remarks on approaches to hedge macroeconomic uncertainty 140

7 Evaluating Cash Flow at Risk 143

7.1 Introduction 143

7.2 From exposures to Cash Flow at Risk (CFaR) 144

7.3 Information requirements for CFaR analysis 147

7.4 Norsk Hydro and its exposures 148

7.5 Estimating CFaR 151

7.6 Hedging exposure to reduce CFaR 152

7.7 Concluding remarks on Cash Flow at Risk 153

8 Strategies for Risk and Exposure Management 155

8.1 Introduction 155

8.2 Choice of target variable and time horizon 156

8.3 Management's risk attitude 159

8.4 Price adjustment in goods and financial markets 160

8.5 Choice of exposure management strategies 161

8.6 Information requirements 164

8.7 Adjustability of commercial operations: Real options 167

8.8 Concluding remarks on the choice of strategy 169

9 Recognizing Macroeconomic Fluctuations in Value-Based Management 170

9.1 Introduction 170

9.2 VBM and macroeconomic fluctuations 171

9.3 Cash flow decomposition and valuation: The case of Electrolux 173

9.4 Decomposition in performance assessment 176

9.5 Taking flexibility into account 177

9.6 Concluding remarks about MUST analysis in performance assessment 180

10 Evaluation, Feedback, and Organization 183

10.1 Introduction 183

10.2 Managers' incentives and the firm's objectives 184

10.3 Realized versus non-realized and anticipated versus unanticipated gains and losses 187

10.4 Nominal versus real magnitudes 190

10.5 Evaluation of risk management strategies 190

10.6 Centralization versus decentralization of risk management 192

10.7 Concluding remarks on evaluation, feedback, and organization 195

11 What Shareholders Ought to Know 197

11.1 Introduction 197

11.2 Efforts to create standards 200

11.3 A comprehensive approach to assessing the impact of macroeconomic fluctuations on the firm 204

11.4 Contemporary practice relative to IAS 1 on reporting of macroeconomic influences 205

11.5 Illustration of an information release that satisfies the demands of the outside shareholder 212

11.6 Concluding remarks on the reporting of the impact of macroeconomic fluctuations on corporate performance 215

12 Macroeconomic Uncertainty Strategy (MUST) Analysis: A Summary 218

12.1 Introduction 218

12.2 Shortcomings of traditional methods 219

12.3 Measures of corporate performance and exposure assessment 220

12.4 Elements of MUST analysis 222

References 226

Index 235