THE EFFECT OF MARKET RISK MANAGEMENT ON COMPANY VALUE AMONG THE FIRMS LISTED AT THE NAIROBI SECURITIES EXCHANGE By JOSEPHINE ACHIENG ABIERO A RESEARCH PROJECT SUBMITTED IN PARTIAL FULIFILMENT OF THE REQUIREMENTS FOR THE AWARD OF MASTER OF BUSINESS ADMINISTRATION DEGREE, SCHOOL OF BUSINESS, UNIVERSITY OF NAIROBI NOVEMBER, 2012 I DECLARATION I declare that the work presented here is my original work and has not been presented for a degree or any other examination in any University except where acknowledged. \V-v\' . Signed: Date:-------------------------- Josephine Achieng Abiero D61/61067/2011 This project has been submitted for examination with my approval as a university supervisor. Signed: Date:................................... Mr. Otieno Luther Odhiambo Lecturer, Department of Finance and Accounting University of Nairobi 11 DEDICATION I dedicate this project to my family for their support and encouragement throughout the period. Their love, care and encouragement inspired me to achieve this. u ACKNOWLEDGEMENTS First and foremost I thank the almighty God for giving the grace for sound health to complete my studies. I appreciate and thank my husband Alfred for being there for me, encouraging and pushing me to exploit my potential whereas meeting my financial needs for the MBA program. 1 must appreciate my children Tina, Lydia, Emily, Marvin, Eddie and Mich for their sacrifice and patience in the whole period I was undertaking this course. Finally I wish to thank my supervisor Luther Otieno who has been the ideal supervisor. His astute advice, insightful criticisms, and patient encouragement aided the writing of this thesis in innumerable ways. While I may not be able to mention and recognize the effort of others who contributed in a way or the other I take this opportunity to thank you all. May the Lord bless you in abundance. IV ABSTRACT This paper investigates the effect of market risk management on firm value with specific reference to those listed at the NSE. Management of market risk is of essence at the NSE as investors have put huge sums of their capital to get value in return. Some of the components of market risk are foreign exchange risk, commodity risk and exchange rate risk. Theories based on market imperfection imply that hedging should increase the firm’s market value. To test this, views have been sought from CEOS who are charged with the responsibility of initiating risk management in their respective companies. The study sought to know from the CEOs of the listed companies their view of the effect of market risk management on firm value with use of questionnaires as a research instrument. Questionnaires were designed to test on usage and effectiveness of the various market risk instruments used to hedge. The objective of the study was to determine the effect of market risk management on the value of the firm among companies listed at the NSE. The findings revealed the CEOs used commodity risk, foreign exchange and interest rate instruments to hedge risk and reported their effectiveness to an extent but the value added to firms on their usage could not be determined except for foreign exchange instruments usage. The researcher recommends that CEOs and the board should infuse a risk culture in the organization and this integrated in performance goals and compensation decisions to achieve value from risk management activities. vi TABLE OF CONTENTS DECLARATION..............................................................................................................ii DEDICATION.................................................................................................................. ii ACKNOWLEDGEMENTS.............................................................................................iv ABSTRACT......................................................................................................................vi TABLE OF CONTENTS...............................................................................................vii LIST OF TABLES............................................................................................................x LIST OF FIGURES..........................................................................................................xi CHAPTER O N E............................................................................................................. 2 INTRODUCTION...........................................................................................................2 1.1 Background to the Study............................................................................................2 1.1.1 Market Risk Management and Company Value...............................................3 1.1.2 Risk Management...............................................................................................4 1.1.3 Corporate Managers Challenge..........................................................................5 1.1.4 Nairobi Securities Exchange..............................................................................6 1.2 Research problem........................................................................................................7 1.3 Objective of the Study................................................................................................ 8 1.4 Value of the Study...................................................................................................... 9 CHAPTER T W O .......................................................................................................... 10 LITERATURE REVIEW ............................................................................................ 10 2.1 Introduction................................................................................................................10 2.2 Corporate financial risk management.......................................................................10 2.2.1 CEO and Risk Management............................................................................ 11 2.2.2 Risk Irrelevance Proposition............................................................................12 2.2.3 Risk Relevance Proposition............................................................................. 13 2.3 Market risk types and Management Approaches.................................................... 15 2.3.1 Equity price risk............................................................................................... 15 2.3.2 Interest rate risk.................................................................................................16 2.3.3 Commodity price risk.......................................................................................16 vii 2.3.4 Foreign exchange risk....................................................................................18 2.4 Conceptual Model.................................................................................................... 20 2.5 Summary................................................................................................................... 21 CHAPTER THREE..................................................................................................... 22 RESEARCH METHODOLOGY...............................................................................22 3.1 Introduction............................................................................................................... 22 3.2 Research design.........................................................................................................22 3.3 Population................................................................................................................. 22 3.4 Data collection Method.............................................................................................22 3.5 Data Analysis............................................................................................................23 CHAPTER FOUR.........................................................................................................24 DATA ANALYSIS AND INTERPRETATION OF RESULTS...........................24 4.1 Introduction............................................................................................................... 24 4.2 Commodity Risk Instruments Usage....................................................................... 25 4.3 Effectiveness in hedging price risks........................................................................ 27 4.4 Foreign exchange risk instruments usage................................................................28 4.5 Effectiveness in hedging foreign exchange risks.................................................... 29 4.6 Interest rate risk instruments usage in your firm..................................................... 31 4.7 Effectiveness in hedging interest rate risks..............................................................32 4.8 Conclusions............................................................................................................... 33 CHAPTER FIVE...........................................................................................................35 SUMMARY, CONCLUSIONS AND RECOMMENDATIONS........................... 35 5.1 Introduction............................................................................................................... 35 5.2 Summary....................................................................................................................35 5.2 Conclusions..............................................................................................................