Risk and firms’ costs

This study examines the economic rationale for limiting firms’ risk. We argue that risk increases the cost of doing business for two reasons. First, risk causes operating inefficiencies and imposes adjustment costs. Second, diverse stakeholders must be compensated for their risk-bearing. We find empirical support for positive risk-cost relations using various model specifications and risk measures, and across different manufacturing industries and time periods.We also examine the direct and moderating effects of bankruptcy risk.The relation of distance from bankruptcy to firms’ costs depends on whether relations are contemporaneous or lagged and whether bankruptcy is an immediate threat or not.