Theoretical Analysis: Risk Theories And Firm Performance

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2.1 Theoretical review 2.1.1 Risk Theories and Firm Performance The R-FP nexus has been essentially considered both theoretically and empirically. The study of this nexus was borne from the work of (Berger & DeYoung, 1997) who studied the relationship between problem loans and cost efficiency of banks. Again, the focus on bank risk heightened after the financial crisis while that of firm performance is due to globalisation and competition among others. To understand the R-FP link, preceding studies have explored the risk theory of profit, prospect theory, too big to fail theory and agency theory. The theory of agency (principal-agent problem) is the conflict of interest that may arise between the principal and the agents of a corporation.…show more content…
This theory propounded in 1907 was by (Hawley, 1893) and holds that profit is reward for taking risk involved in the business. The business activities from which risk comes include product obsolence, a sudden fall in prices, superior substitutes, natural calamity or scarcity of crucial materials. It views risk as annoying, anxiety and disutilities among businessmen and thus the need for a profit above actuarial business risk. In this paper, (Hawley, 1893) argued that profit comes in two parts: first, it represents compensation for actuarial or average loss incidental to the various classes of risks necessarily assumed by the entrepreneur; and second the remaining part represents an inducement to suffer the problems of being exposed to the risk. Symbolically, this theory draws a positive relationship between risk and profit. It stipulates that the higher the risk, the higher the profit and the lower the risk, the lower the profit. It also holds that any type of risk gives rise to profit regardless of the risk being avoidable or not. Hawley’s theory recognises the essence of the coordination which Clarke spoke of but adds believes that profit is attendant upon profit only when coordination happens to be an incident of ownership; and that profit arise from the risk of ownership. As a result, profit is fully recognised at the end of product making profit a…show more content…
Craver observed that the reward for avoiding risk and not for bearing risk is profit, because to him only entrepreneurs that are able to avoid risk make profits. This draws a rather negative relationship between risk and profit. The inference of a positive relationship between risk and profit has no empirical support. Again, the profit is earned from all functions of the organisation and not only through risk. As such environmental variables need to be used in determining the relation between risk and performance (profit). Thirdly, Hawley failed to distinguish predictable risk from the unpredictable risk. In line with (Knight, 1957) unpredictable or unforeseeable risks which are not insurable give rise to profit. This theory comes into play in the R-FP nexus with the view that profit represents financial performance. Succinctly, there are varied views on the R-FP nexus with Hawley inference a positive link and others a negative

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