Question

We-Dump-It is in the business of disposing of toxic chemicals. Explain why a legal system might be necessary to increase the private cost of risk for We-Dump-It in order to better align its goal of maximizing firm value with the goal of achieving an efficient level of risk in society

Answer 1

As far as business risk management is concerned maximizing firm value is equal to minimising the cost of risk. Is businesses do not take up the entire cost of the risky activities the total cost of risk in the society will not be minimised. Hence the private cost of risk should be equal to the social cost of risk when businesses maximize value.

If We dump it does not have a legal system to understand the private cost of disposing toxic Chemicals into the society, the business would continue to do so and pollute the environment. Having a legal system to assess the private cost would allow consumers, workers and the business itself to assess the risk. This would be followed by a reduction in prices and increasing the infrastructure required to avoid this pollution. Thus the firm value would increase simultaneously with achieving an efficient level of risk in society.