Question

Why don’t shareholders always share the views of firm managers with respect to foreign exchange risk management? What are the implications of such disagreement and what would you recommend in order to alleviate it?

Answer 1

The foreign exchange risk arises when the company has operation in more than one country or its revenue is occurring in different currency than the currency of the home country. The major reason why there is a discrepancy between the manager s and the shareholders for issues related to foreign exchange risk is that most manager choose to hedge the foreign exchange risk which reduce the uncertainty in income but it also removes the upside potential profitability and in reality when the actual risk is less than the risk estimated by the manager shareholders blames on the inefficiency of the manager but this is not the case. The major implication is that sometimes manager do not hedge their position in order to avoid criticism from the shareholders as well as from his superiors but then this is more of a risky scenario, if the exchange rate movement is unfavorable then it can significantly affect the profit negatively. One way to reduce the differences is to communicate that reason why hedging of currency exchange risk is done is not to increase profit but to reduce the volatility of income. Shareholders look at hedging from the perspective of increasing profit potential but the hedging is done to reduce risk.