The Strategic CFO

Today’s strategic business decisions require a thorough picture of both the firm’s risk environment and the linkage to financial performance. Thus, senior management cannot pursue a silo approach and consider the company’s capital budgeting and risk management decision as separate and distinct activities. The purpose of this chapter is to highlight that all risk management activities need to be an integral part of the overall business strategy and must be ultimately aligned with the firm’s financing decisions. We present Cash Flow at Risk (CFaR) as a powerful and versatile management tool enabling the firm’s top executives to comprehensively integrate strategic, financial and risk considerations in uniform decision framework.

This chapter discusses how planning approaches that incorporate a consideration of risks, uncertainties and opportunities can help CFOs and their management colleagues to make better and more value-added decisions. Such decisions will be supported by more insightful analysis that incorporates all key considerations in the areas of strategy, operations and finance in an integrated way. We discuss some key possible approaches, and the benefits and challenges when incorporating such thinking into corporate planning processes. We illustrate the discussion with some simple examples. We also discuss the role of the CFO in ensuring the successful implementation of risk-based methodologies.

Academic research on strategy and risk verifies that risk analysis should be a key component of strategic management, and that corporate portfolio management can be an important instrument to manage risk at the corporate level. However, in management practice, there seems to be a missing link between corporate strategy and corporate risk management. In this chapter, we outline a stepwise approach to the risk-return management of the corporate portfolio that can contribute to establishing this link. A company that applies this approach will not only enhance its corporate risk management by integrating a strategic perspective, but also enhance its corporate-level decision making by integrating a risk perspective.

Business conditions are fraught with uncertainty and risks. These uncertainties hold with them valuable information. When uncertainty and risk become resolved or known through the passage of time, action, and events, decision makers can make the appropriate midcourse corrections through a change in business decisions and strategies. Real Options analysis incorporates this learning and flexibility model, akin to having a strategic road map, whereas traditional analyses that neglect this managerial flexibility and risk will grossly undervalue certain projects and strategies as well as lead to bad choices and decisions.

A strategically minded CFO will realize that strategic corporate risk management is about finding the right balance between risk prevention and proactive value generation. Efficient risk and performance management requires adequate assessment of risk and risk exposures on the one hand and performance on the other. Properly designed, a risk measure should provide information on to what extent the firm’s performance is at risk, what is causing that risk, the relative importance of non-value-adding and value-adding risk, and the possibilities to use risk management to reduce total risk. In this chapter, we present an approach – exposure-based cash-flow-at-risk – to calculating a firm’s downside risk conditional on the firm’s exposure to non-value-adding macroeconomic and market risk and to analyzing corporate performance adjusted for the impact of non-value-adding risk.

Capital markets have evolved from geographically dispersed asset specific investor- and trading communities to international, partially integrated networks of transaction partners across multiple asset classes (Capital Markets 2.0). This new environment is characterized by a set of changes, which creates new opportunities as well as challenges for the financial manager. The chapter selects three of the typical dynamics in Capital Markets 2.0 and discusses their implications on typical decisions to be made by financial managers.

The Chief Financial Officer (CFO) plays an increasingly important role in corporations. While apparently omnipresent in today’s business practice, research has yielded remarkably limited insight into the role, prerequisites, and key success factors of CFOs. Similarly, practitioner publications frequently provide guidance for CFOs, but generally focus on anecdotal evidence. The present chapter contributes to filling the gap in our understanding of the CFO. On the one hand, it traces the development of the CFO function from its inception to present, linking key changes how the function is perceived and filled to market imperatives. On the other hand, it addresses the current state of the function, in particular the responsibilities the function has grown to comprise and its increasing strategic involvement.

To stay competitive, firms have to keep up a certain investment expenditure flow, and in addition, have to be in a position to take advantage of unexpected investment opportunities, which come up irregularly. The challenge for today’s CFOs is then to overcome the silo approach of financial institutions, and instead develop a strategic perspective on capital structure management based on maximizing equity value and optimizing reserve borrowing capacities throughout the business cycle. When managing the corporate capital structure, CFOs invariably are confronted with two fundamental questions: First, should they return excess cash to shareholders, save it, or invest it in positive NPV projects, and second, should they finance new growth opportunities by adding debt or drawing on equity? Indeed, achieving the optimal capital structure – the composition of debt and equity that a company uses to finance its operations and strategic investments – has attracted considerable attention from academics and practitioners alike.

This chapter studies financial contracting from the perspective of the firm. It is assumed that the firm can be regarded as the principal and that it tries to control the behaviour of its investors. The purpose of the chapter is, therefore to study some customary legal ways for the firm to reduce agency costs and manage risk in its dealings with investors. It is further assumed that the characteristic finance-related legal problems of a non-financial firm relate to the availability and cost of funding and the exit of investors rather than the performance of its own financial investments. The chapter focuses on the most typical strategic questions inherent in funding and exit: the funding mix; the availability of funding; leverage; share ownership structure; and the decision whether to go public or private.

In this chapter we examine the role of the CFO in setting risk management strategy with respect to macroeconomic risk, in particular, and we consider the information requirements for setting a strategy that is consistent with corporate objectives. We argue that macroeconomic risk management requires a broad approach encompassing financial, operational and strategic considerations. Furthermore, several interdependent sources of risk in the macroeconomic environment must be taken into account. Once this interdependence among, for example, exchange rates, interest rates and inflation is taken into account macroeconomic risk management can be considered a relatively self-contained aspect of Integrated Risk Management (IRM) provided relevant information is available to management. Financial risk management cannot be considered a self-contained part of macroeconomic risk management, however, since value increasing investments in flexibility of business operations affect corporate exposure.

In this chapter, we address a stochastic programming formulation of capacity-planning problems with the possibility of later (capacity) adjustment in an uncertain setting. The capacity-planning problem is expressed thanks to a stochastic linear program with multiple recourses. Next, the stochastic program is refined based on the insights provided by real options analysis and a solution algorithm is proposed to express the optimal sequence of capacity adjustment adapted to the actual uncertainty resolution. Finally, the hysteresis property of the optimal solution is presented and discussed in a general case.

For many years academic literature presented what was commonly referred to as “enterprise-wide risk management” as the ultimate target of real-life risk management. Given today’s complexities with integrated logistics networks, outsourced components of the core business, and elevated levels of uncertainty which coincide with the lack of stability of financial markets, the ancient paradigm of enterprise-wide risk appears to have become outdated and somewhat mal-focused. This chapter introduces the complexities of a new generation of risk management in real life, and provides insight into those multiple aspects which do not need to be reinvented, versus those aspects which should become the main focus of urgently needed hands-on research in the not so distant future.

Short- and long-term cash flow management has become a major concern for many companies in different industries, particularly given the recent financial crisis. Liquidity and funding have become more volatile, scarcer and, as a consequence, grown in strategic relevance. This chapter presents a structured approach to two aspects of cash flow management that have become increasingly important as a result of the crisis. One is reducing the impact of market volatility on the liquidity of commodity-related companies. The other is including an analysis of competitors’ funding situation in any strategic considerations. While liquidity management via contract optimization and hedging is particularly useful in the short term, competitor analysis yields its full value over a longer period. In addition, short-term liquidity management can be supported by quantitative models and tools, whereas long-term funding analysis and management need to rely much more heavily on qualitative tools such as scenario planning. The challenge for CFOs is to ensure that appropriate tools and processes are in place to deal with the new requirements, and to cooperate with other business units even more closely than in the past.

This chapter discusses heuristic approaches to the fundamental question how climate change impacts the strategic agenda of the CFO. As global warming introduces a significant threat to our future environment, corporate decision makers have to react to mitigate the risks arising from this phenomenon. These risks include physical risk, reputational risk and operational risk. The CFO in his new role as a strategic manager and independent counterpart to the CEO finds himself in a unique position to mitigate the risks and to turn them into opportunities. Opportunities may arise in various ways, ranging from more efficient uses of energy to creating innovative products.

This chapter focuses on the management framework and the value creation processes relevant for service-driven enterprises. The management framework consists of three pillars: acquisition of financial means, value development and sustaining/growth. The ability to embed value creation into these three pillars will determine whether the CFO can take on a more prominent role in business decision processes and deliver strategic value to the enterprise. We shall cover how value can be created in operations/processes, services, people (clients/employees), market/competitors, regulation compliance and risk management and how the CFO can make a difference by using IT (Information Technology), advanced analytics and optimization to extract vital information of business insights for strategic decision.

One of the consequences of the Subprime crisis is the accentuated need for financial innovations, which allow for the proper evaluation of investment projects. In this chapter, the innovation of using variable interest rates in real options pricing methods is presented in theory as well as in practice. The big advantage of these methods over the traditional Net Present Value (NPV) approach is that they allow to include the project’s optionalities into its evaluation. But traditional methods of real options pricing use a constant risk-free interest rate for discounting. This is clearly not appropriate when looking at long-term projects, typical examples of which are pharmaceutical R&D projects or oil drilling endeavors. The longer the runtime of a project, the more options are likely to arise. This was particularly obvious in the last decade, when the interest rate development showed steady upward trends followed by abrupt downward movements. There is no doubt that movements like these have a strong impact on the evaluation of investment projects. This chapter describes one method of how to determine non-constant risk-free rates and presents two case studies that analyzed various types of real options.