Title: Risk Sharing, Fiduciary Duty, and Corporate Risk Attitudes
Authors: James E. Smith, Duke University
Date: March 7, 1999
Status: working paper

In this paper, we consider the problem of deriving a corporate utility function to reflect the preferences of the company's shareholders.  Though we cannot uniquely determine the corporate utility function (except under very special circumstances), we derive bounds on corporate risk tolerances and certainty equivalents based on the preferences of the shareholders.  We characterize the corporate utility function in two cases:  (a) where the company takes the shareholder's interests in firm profits to be fixed proportions and (b) where the shareholder's interests are assumed to be Pareto efficient.  In both cases, illustrative calculations show that risk tolerances for corporations with well-diversified shareholders should be substantially higher than the risk tolerances reported in the decision analysis literature.  If the shareholders are not well diversified, a closer consideration of the shareholders' risk preferences is required and substantial risk aversion may be expected.

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