Firm type variation in the cost of risk management

• Published in: Journal of corporate finance (Amsterdam, Netherlands) Netherlands), 2020-10, Vol.64, p.101691, Article 101691
• Main Author: Howell, Sabrina T.
• Format: Article
• Language: English
• Subjects: Family firms; Insurance; Private firms; Procurement; Risk management
• ISSN: 0929-1199; 1872-6313
• DOI: 10.1016/j.jcorpfin.2020.101691

This paper explores how the cost of risk management varies with firm characteristics, offering the first comparison between private, public, and family-owned firms. It exploits a natural experiment in highway procurement, which features diverse firms with common exposure to commodity risk. The Kansas government began to insure highway paving firms against oil price risk in 2006. The analysis compares Kansas to Iowa, which has an otherwise similar highway procurement system but never introduced such a policy. Using data from 1998 to 2012, I show that the policy reduced average bid sensitivity to oil price volatility. Private firms with high credit risk and low industry diversification exhibit the most risk pass-through, while public firms exhibit no pass-through. Family-owned firms do not have a higher than average cost of risk. Financial constraints and distress costs appear to best explain the cost of risk management, rather than risk aversion, information, or agency problems. •How does the cost of risk management vary with firm characteristics?•Private firms with high credit risk and low diversification face the highest cost of bearing oil price risk.•Financial constraints and distress costs explain the cost of risk management, rather than risk aversion, information, or agency problems.