Risk assessment and management instruments are difficult to use and monitor. Understanding them requires extensive knowledge of finance, mathematics, and statistics. Thus, audit committee members who lack specialized training may not be able to correctly monitor the hedging and especially the speculation issues presented to them, often quickly and very broadly. For example, at the Enron audit committee meeting on February 12, 2001, nine important points were on the agenda, including two related to risk assessment and management. Yet the meeting lasted only 95 minutes! Although this committee was made up of experts in management and university educators (the points discussed and committee members are listed in Healy and Palepu, 2003), it is unlikely that all these subjects were covered in depth, particularly those related to transactions that may appear questionable or cause conflicts of interest.

Researchers have shown that conflicts of interest may arise between senior managers and shareholders regarding risk management, notably when executives are paid by stock options (Smith and Stulz, 1985).

Consider the example of risk management in gold mines, which has been long studied in detail (Tufano, 1996; Dionne and Triki, 2013). The main random variable linked to firms’ financial risks is the sale price of an ounce of gold. The three main questions that mining company executives constantly ask are:

  1. Should we hedge the sale price from future fluctuations?
  2. If so, in which proportions?
  3. With which instruments?

Aside from the main objective of maximizing firm value, risk management can also maximize executive welfare. However, this second objective may clash with the first and thus create governance problems, especially when executive compensation is heavily weighted in stock options. Tufano (1996) showed that executives in the North American gold production industry whose pay includes stock options invest much less in risk management than do other executives (also see Dionne and Triki (2013) who obtained similar results with updated data and different econometric specifications, and Rodgers (2002), who reached the same conclusion with a different database).

This result is explained by the fact that the value of executives’ options increases with stock or firm value volatility. Even if managers are risk averse concerning their personal wealth, they have convex preferences (that is, high risk tolerance) based on firm value when they hold stock options from the firm they run. They may consequently undertake fewer risk management activities because more risk management would reduce the volatility of firm value and hence the value of their options and the probability of exercising them, particularly when they are out of

the money.

A theoretical counterargument was presented by Carpenter (2000). The author argues that holding options creates two consequences regarding senior managers’ wealth. The first, described above, is that officer wealth increases with the volatility of the options held, particularly when options are out-of-the-money.

The second consequence is related to the fact that the value of the option portfolio may decrease proportionately with the total portfolio value or when the evaluation date is far away. We therefore have a theoretical arbitrage relationship, but the empirical results mentioned above seem to confirm the dominance of the convexity of manager preferences and the source of conflict of interest between executives and shareholders, especially when options are not in-the-money.

Further, these results reveal another potential conflict of interest involving board members and committees, which raises questions about the makeup of the risk committee. Several directors may also hold options on the stock of the company on whose boards they sit. This is why the board of director’s risk committee should also be made up of independent directors only, and especially directors who do not hold stock options for these companies. Simple regulation for the makeup of an audit committee is surely insufficient to limit potential conflicts linked to risk evaluation and management, particularly for companies that have committees dedicated to these tasks.

This question is important because the general risk management policy must be approved and monitored by the board of directors. Some studies have shown that firms with a larger number of external directors engage in more risk hedging (Borokhorich et al., 2001; Dionne and Triki, 2013).


  • Dionne, Georges, 2019, Corporate Risk Management: theories and applications, Wiley, ISBN 9781119583172 (Epdf)
  • Dionne, G., and Triki, T., 2013. “On Risk Management Determinants:What ReallyMatters?’ European Journal of Finance 19, 145–164.

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