Magazine article Financial Management (UK)

Thinking: Toronto Rotman School of Management on the Bright Side of Diversification Risk

Magazine article Financial Management (UK)

Thinking: Toronto Rotman School of Management on the Bright Side of Diversification Risk

Article excerpt

Concerns over excessive risk-taking in corporate America have become prevalent since the global financial crisis began in 2008. These concerns have led to regulatory attempts to rein in excessive risk-taking. However, executives worry that the proposed rule changes may stifle companies' ability to grow or, in the case of banks, their ability to maintain liquidity. A worst-case scenario might see the federal government create a better regulatory mousetrap to prevent excessive risk-taking, only to have companies hire lawyers to circumvent the mousetrap, resulting in the same excessive risk-taking behaviour we started with. There may, however, be a more palpable remedy: employee ownership in the form of an equity stake for non-executive employees.

Benefits of equity

Research suggests that providing an equity stake to non-executive employees increases productivity, reduces turnover and leads to both workers and owners being better off. However, a key concern with employee ownership is that it leads to an increase in diversification risk for employees. Diversification risk arises because the returns from an employee's investment in company stock and an employee's human capital (i.e. an employee's collective set of skills that he/she uses to generate future employment returns) are closely connected. To understand this tight bond, think of a firm like Southwest Airlines, where employees own a large equity stake in the company and have a lot of firm-specific skills that are not readily transferable. If Southwest goes bankrupt, not only do the workers lose their equity stake, they also lose that portion of their human capital that wasn't portable to another job.

It's possible, however, that some diversification risk has an upside for the economy, given current regulatory concerns over excessive risk-taking. …

Search by... Author
Show... All Results Primary Sources Peer-reviewed

Oops!

An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.