A FRAMEWORK FOR RISK MANAGEMENT

In recent years, managers have become aware of how their companies can be buffeted by risks beyond their control. Fluctuations in economic a nd financial variables such as exchange rates, interest rates, and com modity prices have often had destabilizing effects on corporate strate gies and performance. To insulate themselves from such risks, many com panies are turning to the derivatives markets, taking advantage of ins truments like forwards, futures, options, and swaps. Although heavily involved in risk management, most companies do not have clear goals un derlying their hedging programs. Without such goals, using derivatives can be dangerous. Kenneth Froot, David Scharfstein, and Jeremy Stein present a framework to guide top-level managers in developing a cohere nt risk-management strategy. That strategy cannot be delegated to the corporate treasurer - let alone to a hotshot financial engineer. Ultim ately, a company's risk-management strategy needs to be integrated wit h its overall corporate strategy. The authors' risk-management paradig m rests on three premises: (1) the key to creating corporate value is making good investments; (2) the key to making good investments is gen erating enough cash internally to fund them; (3) cash flow can often b e disrupted by movements in external factors, potentially compromising a company's ability to invest. Therefore, a risk-management program s hould have one overarching goal: to ensure that a company has the cash available to make value-enhancing investments.