Shifting Risk: The Divorce of Risk from Reward in American Capitalism

By Prasch, Robert E. | Journal of Economic Issues, June 2004 | Go to article overview

Shifting Risk: The Divorce of Risk from Reward in American Capitalism


Prasch, Robert E., Journal of Economic Issues


After incurring losses of $1.22 billion in 2001 and $1.27 billion in 2002, the senior executives of Delta Airlines quietly funded a special account to ensure that their own pensions would be completely protected in the event of that airline's then widely anticipated bankruptcy. As to the pensions of all other employees, their level of underfunding rose from $2.4 billion to $4.9 billion during 2002. In the event of bankruptcy, the funding of their pensions would be left to the vagaries of the legal process ("Delta Air Moves to Secure Pensions of Struggling Carrier's Executives," Wall Street Journal, March 26, 2003, C7). This story suggests the theme of this paper. Just who, in out deregulated form of hyper-capitalism, are the risk takers? Additionally, are the actual risk takers of our age being compensated for the risks they routinely undertake with additional rewards?

As the Delta Airlines example suggests, the shifting of risk does not necessarily take place through "voluntary" or "compensated" transactions, as the finance textbooks would lead us to believe. Yes, it is true that risks are often traded by firms and individuals in complex commodities, bond, asset, and derivative markets. Yet it is also evident that in the event of unequal bargaining power, legalized protections, and asymmetric information we also experience a tendency for a separation of reward from risk. To be specific, we have seen, and can expect to continue to see, the systematic shifting of risks toward those who cannot afford them, cannot control them, and do not want them.

Admittedly, the size and scope of this shift is difficult if not impossible to quantify. The reason is that these shifts are infrequently the result of explicit negotiations or market transactions. But a lack of easy quantification should not, as it too often is in economics, be taken as evidence that the phenomenon in question is not occurring. Indeed, the continuing divorce of risk from reward represents an important contributor to the sense of insecurity that is increasingly evident among so many middle and working class Americans.

Deregulation in general, and financial deregulation in particular, is valued by its beneficiaries in part for its ability to separate risk from reward. Modern financial markets enable management, major shareholders, and other of the firm's "insiders" to shift risks away from themselves. While professional insurers, speculators, and hedgers may accept these risks for a fee, it is clear that some of these risks can also be shifted toward smaller and less informed stockholders, bondholders, employees, customers, and other stakeholders, including the general public. These latter groups, if they understand these risks at all, are generally less willing and frequently less able to bear the risks they are being forced to shoulder. Sadly, it is often the case that they are not even aware that they are being subjected to them. (1)

The Economics of Shifting Risk

Consider, in light of the above, the following statement from a conventional finance textbook:

   These considerations of risk and expected return lead to a general
   principle of great importance. Investors will make a risky
   investment only if they believe that the expected return justifies
   the risk. That is the key idea of the risk/return (or more exactly,
   the risk/expected return) trade-off. It is simply a fact of life
   that high expected return and high risk normally go together. (Kolb
   and Rodriquez 1992, 10, italics added)

This now-conventional understanding of the relation between risk and reward depends upon a crucial premise: that the risks in question be entirely and voluntarily borne by either (1) the party whose activities and decisions are creating the risks in question or (2) by another party who has contracted with the first party, either directly or through one or more intermediaries, to accept the risk in question for an explicit fee.

The rest of this article is only available to active members of Questia

Sign up now for a free, 1-day trial and receive full access to:

  • Questia's entire collection
  • Automatic bibliography creation
  • More helpful research tools like notes, citations, and highlights
  • Ad-free environment

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Project items

Items saved from this article

This article has been saved
Highlights (0)
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

Citations (0)
Some of your citations are legacy items.

Any citation created before July 30, 2012 will labeled as a “Cited page.” New citations will be saved as cited passages, pages or articles.

We also added the ability to view new citations from your projects or the book or article where you created them.

Notes (0)
Bookmarks (0)

You have no saved items from this article

Project items include:
  • Saved book/article
  • Highlights
  • Quotes/citations
  • Notes
  • Bookmarks
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited article

Shifting Risk: The Divorce of Risk from Reward in American Capitalism
Settings

Settings

Typeface
Text size Smaller Larger
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Full screen

matching results for page

Cited passage

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited passage

Welcome to the new Questia Reader

The Questia Reader has been updated to provide you with an even better online reading experience.  It is now 100% Responsive, which means you can read our books and articles on any sized device you wish.  All of your favorite tools like notes, highlights, and citations are still here, but the way you select text has been updated to be easier to use, especially on touchscreen devices.  Here's how:

1. Click or tap the first word you want to select.
2. Click or tap the last word you want to select.

OK, got it!

Thanks for trying Questia!

Please continue trying out our research tools, but please note, full functionality is available only to our active members.

Your work will be lost once you leave this Web page.

For full access in an ad-free environment, sign up now for a FREE, 1-day trial.

Already a member? Log in now.