Question:

In regard Enterprise Risk Management (Brian Nocco & Rene Stulz), are the following statements true or false?

(i) Companies should seek to offload business and strategic risks.
(ii) Companies should try to minimize the probability of financial distress.
(iii) Company VaR is a multiple of the volatility of its asset value.
(iv) Management’s goal should be to minimize earnings volatility.

Answer:

All are false.

(i) False. No, Nocco/Stulz argue that a business exists precisely to take sensible business and strategic risks. That is, a business is competent in its domain. This competence likely includes information advantages, and shareholders want the business to take risks that are core and strategic.
(ii) False, strictly speaking. To minimize the probability of financial distress would be to eliminate it; this would make the business riskfree and, from a risk/reward perspective, equivalent to a US Treasury bond. Shareholders do not want to invest in a riskless vehicle.
(iii) False, strictly speaking. Volatility will only be useful if the distribution of firm values is normal (which includes symmetrical). Note: delta normal VaR that computes VaR by multiplying volatility by a factor of confidence is a usable parametric VaR, but it assumes the normal distribution implied by volatility is correct in the first place!
(iv). False. The authors argue that to minimize earnings volatility may be to sub-optimize firm value (i.e., the present value of future cash flows).