Cheap Talk and Decision Making in Financial Institutions : Implications for the Risk Management Organization

This paper investigates the question of how risk management should be embedded in a financial firm's hierarchy. We take an innovative approach to answering this question by combining capital market theory with game-theoretic thinking. We develop a theory for the integration of risk management -- the provider of risk information -- into an organization based on private information and differences in preferences. A simple model compares the payoffs from uninformed decision making, solo decision making, independent decision making, and coordinated decision making when information about a project's expected return and risk is dispersed in the organization. Our findings have a number of implications for the organization of risk management