Managing Corporate Risk

Managing Corporate Risk 1

Managing Corporate Risk:

Value at Risk

Managing Corporate Risk 2

Managing Corporate Risk:

Value at Risk

Corporate risk, or impaired enterprise value, represents a legitimate concern for many corporations. Unfortunately, it is a measure that is largely ignored by most private corporations. Properly managing risk is a multiple step process that requires:

(a) Examination of enterprise value

(b) Value at risk exploration

(c) Corporate governance

This review of corporate risk focuses on these 3 steps.

Examination of Enterprise Value

It is a commonly held belief that a constant stream of revenues, profits, and cash flows equate to increasing shareholder value (Leitner, 2006). However, this is not always true. Only by measuring enterprise value can one be definite. Enterprise value provides a measure of a corporations value in terms of the total funds used to finance it. More precisely, enterprise value is often reported as a ratio to earnings before interest, tax, depreciation, and amortization. The enterprise value to earnings before interest, tax, depreciation, and amortization ratio is used as an alternative to the price/earnings ratio because it provides a measure of the economic return rather than the accounting return that the firm is generating on the total value of capital. (“Enterprise Worth”, 2000).

Managing Corporate Risk 3

Value at Risk

Once a corporation embarks upon a path of making enterprise value a regular part of its planning and operating decisions, it can then start measuring value at risk. Similar to securities traders, corporations can use value at risk to forecast losses in specific circumstances. Typical scenarios would be interest rate hikes, geographical events, loss of key personnel, drastic shifts in raw material prices, and bankruptcy of a key supplier or competitor. Value at risk, implies measuring a firm’s enterprise value, and then using probabilistic scenarios to estimate how much value would be lost (Leitner, 2006). Armed with the knowledge obtained during the value at risk analysis, hedges against the studied scenarios can then be identified, priced and acquired.

Corporate Governance

Enterprise value management is rising because many firms