Inflation Risk and Real Corporate Governance
14 Pages Posted: 24 Dec 2011
Date Written: December 24, 2011
Abstract
Purpose: To detect how inflation impacts on economic margins and cash flows, so modifying the relationship among different stakeholders and the nexus of their explicit or implicit contracts. Proper inflation detection is a prerequisite for effective contracting and corporate governance modelling, so as to preserve stakeholder value even in real (deflated) terms.
Design/methodology/approach: This paper examines how inflation, linked to other macroeconomic variables, such as interest or currency rates, can affect the company’s operating margins and cash flows, so modifying the equilibriums among different stakeholders.
Findings: Inflation has a deep impact on operating leverage and cash flows, affecting with its volatility the risky cost of collected capital. Inflation risk stands out as a powerful, albeit often unperceived, stakeholder wealth redistributor.
Research limitations: Macroeconomic causes and implications of inflation are just summarized, as well as price level deviations and implications for specific industries, to be customized case after case.
Practical implications: Inflation may not always be a zero sum game, with compensating winners and losers. Prompt monitoring and resilient contractual design ease inflation risk detection and mitigation, together with proper and flexible financial modelling.
Originality/value: Inflation and corporate governance are seldom considered as linked issues; the impact of inflation on economic margins and financial flows, which represent the company’s strategic key parameters, is originally presented in an intuitive and practical way.
Keywords: inflation risk, leverage, cost of capital, nexus of indexed contracts
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