A bottom up approach to unlevered risk in a financial and managerial perspective

This chapter aims to propose a bottom-up conceptual framework as a complement in risk return analyses that is particularly suitable for private firms and ultimately, the study of the relationship between managerial choices and firm exposition to the unlevered systematic risk. This theoretical framework considers both a financial and managerial perspective in conducting a managerial analysis of the unlevered beta that can be used as a tool to evaluate, in static and dynamic terms, the correlation between the unlevered systematic risk and firm’s structure. Our analysis is based on a revision of the CAPM (Capital Asset Pricing Model), which is the main tool used by financial analysts to estimate the risk-return profile of a single stock. Particularly, the proposed revision of the CAPM is founded on the idea that the unlevered systematic risk of a single firm can be analyzed in terms of the function of its structural characteristics and environmental volatility. This approach pursues two goals: the first is the adaptation of the CAPM logic to the risk-return analysis of unlisted firms and the second is the analysis of the connection between the dynamics of unlevered systematic risk and the managerial choices affecting firm’s structure. This approach can be very useful for start up firms and for those countries, as Italy, that are in need to foster innovation and to meet the EU targets, by 2020. The chapter is structured into five sections. The first section provides a literature review of the CAPM as well as the beta estimation, which is a measure of the systematic risk pertaining to a single asset. The second section explains our approach, considering the role of intrinsic business risk and operating leverage. The third section presents an analysis of the unlevered beta, according to the bottom-up approach, both in the stationary and development states. The fourth section analyzes the dynamic state as a factor that may increase or decrease the unlevered systematic risk. Finally, a managerial matrix of unlevered betas combines the analysis of the stationary and development states that proposes some useful managerial insights on the investigated issues.