Innovator or owner? Information sharing, incomplete contracts and governance in financial risk management systems

Financial risk management has become increasingly important in the financial industry during the last decade, especially due to the financial disasters in the mid-1990s. Value-at-risk (VAR), developed by J P. Morgan in the late 1980s, has been the most widely accepted risk measurement methodology because it provides a single number summary of an institution´s portfolio risk. To promote VAR, Morgan provided RiskMetrics, a VAR-based risk management service, for its clients (borrowers). Later, RiskMetrics was spun off as an independent company providing fee-based services. Building upon the theory of incomplete contracts and other related theories, we develop a game theoretic model to explain why adoption of the free RiskMetrics service stalled and how the change in ownership structure of the service led to wider adoption. In particular, we examine a situation where the borrowers have heterogeneous portfolio riskiness and this differential riskiness affects the value they can gain from the service and the impact of the service provider exploiting their private risk information. Our results suggest that the most important roadblock to borrowers´ adoption of the free service might have been the potential damage from the service provider´s information exploitation. When the service was spun off borrowers´ concern was reduced due to the multi-party independent ownership structure, which led to wider adoption. The spin-off was Morgan ´s strategic move to maximize long-term profits from RiskMetrics.