1. Introduction to Business 3e 19 Part VII: Special Topics Copyright © 2004 South-Western. All rights reserved. Managing Risk

2. Copyright © 2004 South-Western. All rights reserved.19–2 Special Topics

3. Copyright © 2004 South-Western. All rights reserved.19–3 Learning Goals Provide an overview of the tasks involved in risk management. Identify ways in which firms are exposed to the economic environment. Identify a firm’s exposure to firm-specific characteristics. Explain a firm’s exposure to potential lawsuits. Explain alternative remedies for firms that are failing.

4. Copyright © 2004 South-Western. All rights reserved.19–4 Managing Risk

5. Copyright © 2004 South-Western. All rights reserved.19–5 Risk Management Identify exposure to risk –Possible injury from machine use –Potential injury to children –Exposure to terrorist attack Protect against risk –Eliminate risk  Discontinue risky operations or activities –Shift risk to insurance companies –Create fund for future claims (self-insure)

6. Copyright © 2004 South-Western. All rights reserved.19–6 business online

7. Copyright © 2004 South-Western. All rights reserved.19–7 Insurance Offered by the Government Old-age, survivors, disability, and health insurance (OASDHI) –Workers who are disabled for at least 12 months can receive income payments. –People aged 65 years or older receive income payments and hospital benefits. –Spouses of workers who die receive income payments.

8. Copyright © 2004 South-Western. All rights reserved.19–8 Insurance Offered by the Government Unemployment insurance –Workers who are laid off can receive a portion of their previous earnings until they find a new job. –They may also receive assistance in finding a new job. –The length of time in which they can receive these benefits varies among states; the maximum period is usually around six months.

9. Copyright © 2004 South-Western. All rights reserved.19–9 Firm’s Business Risk: Exposure to the Economic Environment Industry conditions –Competition –Industry regulations Economic conditions –Economic growth –Interest rates Global conditions –Economic growth in foreign countries –Exchange rates

10. Copyright © 2004 South-Western. All rights reserved.19–10 Illustration of How to Protect against Risk Exhibit 19.2

11. Copyright © 2004 South-Western. All rights reserved.19–11 Firm’s Exposure to the Economic Environment Exhibit 19.3

12. Copyright © 2004 South-Western. All rights reserved.19–12 Hedging Risk from Economic Conditions Use of derivative instruments –Instruments whose values are derived from values of other securities, indexes, or interest rates  Interest rate swap allows a firm to swap fixed interest payments for payments that adjust to movements in interest rates.

13. Copyright © 2004 South-Western. All rights reserved.19–13 Exposure to Firm-Specific Characteristics Limited funding –Reduce risk by growing and expanding debt capacity Reliance on one product –Reduce risk by diversifying product mix Reliance on one customer –Reduce risk by spreading sales across markets Reliance on one supplier –Reduce risk by using more than one supplier

14. Copyright © 2004 South-Western. All rights reserved.19–14 Exposure to Firm-Specific Characteristics Reliance on a key employee –Reduce risk by purchasing life insurance and making sure that more than one employee can perform each task Exposure to property losses –Reduce risk by enforcing policies and purchasing insurance

15. Copyright © 2004 South-Western. All rights reserved.19–15 Small Business Survey What is the Cost of Employee Injuries?

16. Copyright © 2004 South-Western. All rights reserved.19–16 Exposure to Firm-Specific Characteristics Exposure to liability losses –Reduce risk by enforcing policies that ensure job safety and quality control of products –Purchase liability insurance Exposure to employee compensation claims –Reduce risk by revising jobs to avoid injury, rotate jobs, and provide safety training

17. Copyright © 2004 South-Western. All rights reserved.19–17 Exposure to Firm-Specific Characteristics Exhibit 19.4

18. Copyright © 2004 South-Western. All rights reserved.19–18 Exposure to Lawsuits Firms have been bombarded in recent years by a variety of lawsuits –Consumer sues because of product defects. –Poorly performing employee who is fired. –Employee taking illegal drugs and performing poorly is fired. –Employee promoted as the most qualified - less qualified employees sue. –Employee is fired for walking into office with a loaded gun.

19. Copyright © 2004 South-Western. All rights reserved.19–19 Other Types of Insurance Exhibit 19.

20. Copyright © 2004 South-Western. All rights reserved.19–20 Exposure to Lawsuits Impact on business strategies –Compensating injured persons can force companies into bankruptcy. –Eliminating products from product line to avoid risk of lawsuits. –Withholding products from market to avoid risk of lawsuits. –Attempting to avoid unfavorable judgments by using procedures that are well documented and that demonstrate a firm’s efforts to treat customers and employees properly

21. Copyright © 2004 South-Western. All rights reserved.19–21 Remedies for Business Failures Informal remedies –Extension that provides additional time for firm to generate enough cash to pay its bills. –Composition agreement that provides creditors with a portion of what they are owed. –Private liquidation in which the failing firm sells it assets and distributes the proceeds to creditors. Formal remedies –Reorganization –Liquidation under bankruptcy

22. Copyright © 2004 South-Western. All rights reserved.19–22 Chapter Summary Business risk is the possibility that the firm’s performance will be lower than expected Firms can protect against risk by eliminating it, shifting it, or assuming the risk There are a variety of reasons that firms are exposed to risk - some are economic and others are firm specific Firms are exposed to a variety of potential lawsuits