Is operational hedging a substitute for or a complement to financial hedging?

This paper investigates operational hedging by firms and how operational hedging is related to financial hedging by using a sample of 424 firm observations, which consist of 212 operationally hedged firms (firms with foreign sales) and a size- and industry-matched sample of 212 non-operationally hedged firms (firms with export sales). We find that non-operationally hedged firms use more financial hedging, relative to their levels of foreign currency exposure, as measured by the amount of export sales. On the other hand, though operationally hedged firms have more currency exposure, their usage of financial derivatives becomes much smaller than that of exporting firms. These results can explain why some global firms use very limited amount of financial derivatives for hedging purpose despite much higher levels of currency risk exposure. We also show that hedging increases firm value.     

The governance of risk management: The importance of directors’ independence and financial knowledge

We test the effects of the independence and financial knowledge of directors on risk management and firm value in the gold mining industry. Our original hand‐collected database on directors’ financial education, accounting background, and financial experience allows us to measure the effect of financial knowledge on risk management activities. We show that directors’ financial knowledge increases firm value through the risk management channel. This effect is strengthened by the independence of the directors on the board and on the audit committee. Extending the dimension of education, we show that, following unexpected shocks to gold prices, firms with financially educated directors are more effective in hedging than average firms in the industry. Firms that hedge more also attracts highly educated directors on their board and audit committee. As a policy implication, our results suggest adding the experience and education dimensions to the 2002 Sarbanes–Oxley Act and New York Stock Exchange requirements for better governance.     

Corporate reputation and hedging activities

This study examines whether corporate reputation affects derivative hedging. We posit that high-reputation firms are more likely to engage in hedging due to greater reputation costs and/or their commitment to lower financial risks. We find that high-reputation firms are more likely to engage in hedging, especially when their hedging efforts or effects are more observable to stakeholders. We also find that high-reputation firms are less likely to disclose the notional values of hedging positions and that interest rate hedging by high-reputation firms is detrimental to firm value. Our results shed light on the impact of reputational concerns on corporate risk management and disclosure policies.     

Corporate Risk Management under Information Asymmetry

This paper examines the financial and operational hedging activities of US pharmaceutical and biotech firms that are subject to a high level of information asymmetry stemming from R&D investments during 2001–2006. We find evidence in support of the information asymmetry hypothesis à la Froot, Scharfstein and Stein (1993) that hedging helps mitigate the under‐investment problem. Specifically, we find that the use of financial derivatives is associated with greater firm value and that the value enhancement is larger for firms subject to greater information asymmetry and better growth opportunities. There is a synergy between financial hedging and operational hedging where the latter is used to counter product development risk. The results are robust with respect to alternative performance measures, industry‐specific growth measures, and the endogeneity problem. Our work is differentiated from existing studies that examined commodity‐based industries without addressing information asymmetry.     

Hedging Affecting Firm Value via Financing and Investment: Evidence from Property Insurance Use

I provide evidence about the value effects of alternative risk management by examining corporate purchase of property insurance, a commonly used pure hedge of asset-loss risks. Using an insurance data set from China, I find that there is an inverted U-shape effect of the extent of property insurance use on firm value measured by several versions of Tobin's Q. Therefore, the use of property insurance, to a certain degree, has a positive effect on firm value; however, over insurance appears detrimental to firm value. Given that the inflection points occur at relatively high levels of the observed insurance spending, insurance use appears beneficial to the majority of my sample firms. The estimated average hedging premium is about 1.5%. I demonstrate that an avenue for insurance to create value in China is that it helps firms secure valuable new debt financing and enhance investment.     

Financial Regulation,Exchange Rate Exposure,and Hedging Activities: Evidence from Korean Firms

ABSTRACT

In this article, we attempt to estimate whether firm-specific exchange rate exposures affected by hedging activities can be improved through financial regulation or supervision. To analyze this, we compose three-step estimations by using a sample of KOSPI 200 firms during 1,803 trading days between 2005 and 2012. We first estimate the relationship between exchange rate exposure and hedging activities and see whether financial regulation had any effect on hedging activities. Furthermore, using TSLS analysis, we estimate the effect of hedging activities on exchange rate exposure, which is caused by tightened financial regulation in the form of corporate governance. We report the following findings. First, firms are less likely to be exposed to exchange risk with more hedging activities. Second, corporate governance has a strongly positive effect on the hedging activities. Firms use more hedging tools when they have a strong structure of shareholder’s protection, clear outside ownership, and a better monitoring system; but the relationship becomes weaker in times of crisis.     

Exposure,hedging, and value: New evidence from the U.S. airline industry

For a variety of reasons, the U.S. airline industry is a natural sample to analyze the relation between corporate risk exposure, hedging policy, and firm value. First, we find that airline exposures to fuel prices are higher when fuel prices are high or when they are rising. Second, we analyze the relation between exposure coefficients and the percentage of next year's fuel requirement hedged by airlines. In response to higher fuel price levels, rising fuel prices, and higher levels of exposure to fuel prices, airlines tend to increase their hedging activity. Finally, we explore the previously documented jet fuel hedging premium illustrated in Carter, Rogers, and Simkins (2006). We find a positive hedging premium in our analysis; however, the interaction of hedging and exposure does not affect firm value. We conclude that airlines increasing hedging activity because of higher fuel price exposure are not valued higher compared to those airlines employing more stable hedging policies.     

Real earnings management and cost of capital

This study investigates whether a firm’s cost of equity capital is influenced by the extent of a firm’s real activities management. Using a large sample of U.S. firms, we find that our proxy for the cost of capital is positively associated with the extent of earnings management through the real activities manipulation after controlling for the effect of the accrual-based earnings management. We also provide evidence suggesting that this positive association stems from managerial opportunism rather than from the measurement errors in our real earnings management proxies. The main findings are robust to a battery of sensitivity tests. Collectively, our results suggest that real earnings management activities exacerbate the information quality of earnings used by outside investors, and thus the market demands a higher risk premium for these activities, which is incremental to the risk premium for the accrual-based earnings management.     

The determinants of Norwegian exporters’ foreign exchange risk management

Abstract

This paper examines foreign exchange (FX) hedging by Norwegian exporting firms to provide empirical evidence on the determinants of the hedging decision. The paper contributes to prior studies by, first, focusing on exporters to ensure that the companies in the sample have FX exposure, thereby allowing a more rigorous test of the theoretical determinants of hedging, and, secondly, in contrast to most previous studies that have focused on FX external hedging instruments, the use of both internal and external instruments is examined. Univariate, multivariate and multinominal analyses all provide evidence consistent with the firm value maximization hypotheses of underinvestment and risk aversion. Also, the following characteristics of firms—size, extent of internationalization and liquidity—are found to be related to the decision to hedge FX risk. However, the evidence on the links between the firm characteristics and the decision to hedge is not consistent across internal and external FX hedgers, and also varies for individual hedging instruments. Therefore it is argued that the empirical evidence on the theoretical determinants cannot be generalized to cover the full range of FX hedging strategies (which includes internal hedging instruments). Unlike empirical studies for other countries the evidence for Norwegian firms does not support the hypothesis that the avoidance of financial distress and the need to resort to external capital markets is a significant determinant of the hedging decision. Whilst the evidence suggests that country-specific factors may play a role in determining the use of FX hedging, it does not imply that the different policies adopted are necessarily inconsistent with the firm value maximization hypothesis.     

Coberturas financieras con derivados y su incidencia en el valor de mercado en empresas colombianas que cotizan en Bolsa

The financial theory (Modigliani & Miller, 1958) rises that risk management was not an issue for companies because shareholders could make their own hedging management through portfolio diversification; however, further studies conflict with that statement and show that corporate financial hedging improves performance and increases the value thereof (Ahmed, Azevedo, & Guney, 2014; Allayannis & Weston, 2001; Allayannis & Ofek, 1998). Efficient management of market risks, which is based on the use of financial derivatives, demands strategic and efficient managers in hedging that adds value to the firm, especially in against shocks and imbalances from a macroeconomic and financial nature. Empirical evidence analyzes the performance of the Q-Tobin as an indicator of the effect of hedging strategies of exchange rate associated to the market value. This paper aims to find evidence in Colombia on the effect of using derivatives in the market value of the firm. Its added value lies in the analysis made by economic sectors, identified by CIIU codes and grouped into 5 sectors (Agricultural, Commercial, Industrial or Manufacturing, Services and Construction). The methodology includes several models estimating regression panel data, using a Pooled regression with estimators of fixed and random effects by maximum likelihood estimator. In general, it was found a premium due to hedging, statistically and financially significant, for companies exposed to exchange rate risks that use derivatives by an average of 6.3% on the market value. Moreover, mixed results were found regarding the analyzed variables in the model.     

On the Determinants of Corporate Hedging

Finance theory indicates that hedging increases firm value by reducing expected taxes, expected costs of financial distress, or other agency costs. This paper provides evidence on these hypotheses using survey data on firm's use of forwards, futures, swaps, and options combined with COMPUTSTAT data on firm characteristics. Of 169 firms in the sample, 104 firms use hedging instruments in 1986. The data suggest that firms which hedge face more convex tax functions, have less coverage of fixed claims, are larger, have more growth options in their investment opportunity set, and employ fewer hedging substitutes.     

Hedging and Value in the U.S. Airline Industry

This article discusses the findings and practical import of the authors' study of the fuel hedging activity of 28 U.S. airlines during the period 1992‐2003. The aim of the study was to answer the following question: Does fuel hedging add value to the airlines and, if so, how? The airline industry provides a natural experiment for investigating the relation between hedging and value for a number of reasons: (1) the industry is by and large competitive and remarkably homogeneous; (2) airlines are exposed to a single, volatile input commodity—jet fuel—that represents a major economic expense for all competitors; and (3) fuel price increases cannot be easily passed through to customers because of competitive pressures in the industry. The results of the study show that jet fuel hedging is positively related to airline firm value. Those airlines that hedged their fuel costs had Tobin's Q ratios that were 5‐10% higher, on average, than those of airlines that did not hedge. What's more, the higher the proportion of future fuel requirements hedged, the larger the valuation premium. The authors' results also suggest that the main source of value added by hedging in the airline industry is its role in preserving the firm's ability to take advantage of investment opportunities that arise when fuel prices are high and airline operating cash fl ows and values are down. Consistent with this argument, the study finds that the value premium associated with hedging increases with the level of the firm's capital spending. The authors also report that the most active hedgers of fuel costs among the airlines are the larger firms with the least debt and highest credit ratings. This result is somewhat surprising, at least to the extent that smaller airlines are expected to have larger financial distress costs (as a percentage of firm value) and hence greater motive to hedge. One explanation is that the smaller airlines have lacked either sufficient resources or the strategic foresight to acquire a derivatives hedging capability. A second possibility—one that is consistent with the study's main findings—is that the largest airlines also have the highest costs of financial distress (even as a percentage of firm value) in the form of larger growth opportunities that could be lost as a result of high leverage and financial risk. In other words, only the largest airlines are typically able to buy distressed assets during periods of industry weakness; to the extent this is so, such firms may also have the most to gain from hedging.     

Risk perception and risk management in the Middle East market: theory and practice of multinational enterprises in Saudi Arabia

This exploratory study investigates the risk perception and risk management strategies of Western multinational enterprises in the Middle East. A sample of 49 German companies operating in Saudi Arabia provides the empirical setting for this research. The study reveals that cultural risk is assessed as more important in the business environment than political, financial, and economic risk. The most critical risk factors are not sufficiently included in the methodology of country risk measures, which are often used as a source for country‐specific risk information. In terms of risk management strategies, participating firms use mostly informal approaches rather than structured hedging or insurance products. Furthermore, we find that firm size has implications on the perception of some risk factors and for the level of risk management sophistication.     

Investability and Firm Value

We study how investability, or openness to foreign equity investors, affects firm value in a sample of over 1,400 firms from 26 emerging markets. We find that, on average, investability is associated with a 9% valuation premium (as measured by Tobin's q). This significant valuation premium persists in firm‐fixed effects regressions, although the magnitude and robustness of the premium is somewhat lower. Analysis of the components of Tobin's q shows that firms that become investable experience significant increases in both market values and physical investment. These effects are strongest for firms that face country‐level or firm‐level financial constraints prior to becoming investable.     

Hedging and earnings management in the light of IFRS implementation: Evidence from the UK stock market

This study examines the association between IFRS implementation, hedging and earnings management. It identifies the financial attributes of firms that utilise hedging and explores the IFRS transition process for hedgers and non-hedgers. This study also investigates the effects of a firm’s decision to use hedging or earnings management on firm value. The findings show that the transition to IFRSs has affected the equity, earnings, leverage and liquidity of hedgers in a significantly positive manner as opposed to non-hedgers, who presented a generally significant negative change in their respective figures. Hedgers tend to be larger sized and exhibit higher profitability, growth, leverage and liquidity. Hedgers also tend to have foreign revenues, be cross-listed in foreign stock markets and audited by a Big 4 auditor. This study reports that hedging and earnings management display an inverse relation. Firm value is found to be positively related to hedging and negatively related to discretionary accruals and managerial opportunism. Effective corporate governance mechanisms are found to display a negative association with discretionary accruals and a positive relation with firm value.     

Corporate hedging and the cost of debt

For a large sample of U.S. firms from 1994 to 2009, we empirically examine the impact of corporate hedging on the cost of public debt. We find strong evidence that hedging is associated with a lower cost of debt. The negative effect of hedging on the cost of debt is consistent across industries, and remains economically and statistically significant under various controls and econometric specifications. A cross-sectional analysis based on propensity score matching suggests that hedging initiation firms experience a drop in cost of debt, while suspension firms sustain a jump. We confirm our findings after employing an extensive array of models to address potential endogeneity. The influence of hedging on cost of debt is mainly through the lowering of bankruptcy risk and agency cost, and the reduction in information asymmetry. Finally, hedging mitigates the negative effect of rising borrowing costs on capital expenditure and firm value.     

Risk Management and Firm Value: Evidence from Weather Derivatives

This paper shows that active risk management policies lead to an increase in firm value. To identify the effect of hedging and to overcome endogeneity concerns, we exploit the introduction of weather derivatives as an exogenous shock to firms’ ability to hedge weather risks. This innovation disproportionately benefits weather‐sensitive firms, irrespective of their future investment opportunities. Using this natural experiment and data from energy firms, we find that derivatives lead to higher valuations, investments, and leverage. Overall, our results demonstrate that risk management has real consequences on firm outcomes.     

The Asian exposure of U.S. firms: Operational and risk management strategies

This paper examines the Asian currency exposure of U.S. firms with regard to their international operational and risk management strategies. We find that contemporaneous and lagged changes in real exchange rates have significant impacts on firm value for about 30% of the U.S. firms with Asian operations. The effects of a strong dollar are heterogeneous, with both significantly positive and significantly negative coefficients. The exchange exposure coefficients are then estimated as a function of international operational and risk management variables. A strong dollar has an adverse effect on firm value when the firm has a negative initial exposure position, and is related to exports and local sales activities of the firms. However, asset deployment in Asia raises the exposure in absolute terms regardless of initial exposure condition. Variables for hedging incentives explain exposure in both positive and negative exposure cases. Finally, a disaggregate study by country shows significant intra-regional differences, indicating the different ways in which the U.S. firms used their Asian subsidiaries operationally.     

Does Hedging Affect Firm Value? Evidence from the US Airline Industry

Does hedging add value to the firm, and if so, is the source of the added value consistent with hedging theory? We investigate jet fuel hedging behavior of firms in the US airline industry during 1992–2003 to examine whether such hedging is a source of value for these companies. We illustrate that the investment and financing climate in the airline industry conforms well to the theoretical framework of Froot, Scharfstein, and Stein (1993). In general, airline industry investment opportunities correlate positively with jet fuel costs, while higher fuel costs are consistent with lower cash flow. Given that jet fuel costs are hedgeable, airlines with a desire for expansion may find value in hedging future purchases of jet fuel. Our results show that jet fuel hedging is positively related to airline firm value. The coefficients on the hedging variables in our regression analysis suggest that the “hedging premium” is greater than the 5% documented in Allayannis and Weston (2001), and might be as large as 10%. We find that the positive relation between hedging and value increases in capital investment, and that most of the hedging premium is attributable to the interaction of hedging with investment. This result is consistent with the assertion that the principal benefit of jet fuel hedging by airlines comes from reduction of underinvestment costs.     

The impact of enterprise risk management on the marginal cost of reducing risk: Evidence from the insurance industry

We test the hypothesis that practicing enterprise risk management (ERM) reduces firms’ cost of reducing risk. Adoption of ERM represents a radical paradigm shift from the traditional method of managing risks individually to managing risks collectively allowing ERM-adopting firms to better recognize natural hedges, prioritize hedging activities towards the risks that contribute most to the total risk of the firm, and optimize the evaluation and selection of available hedging instruments. We hypothesize that these advantages allow ERM-adopting firms to produce greater risk reduction per dollar spent. Our hypothesis further predicts that, after implementing ERM, firms experience profit maximizing incentives to lower risk. Consistent with this hypothesis, we find that firms adopting ERM experience a reduction in stock return volatility. We also find that the reduction in return volatility for ERM-adopting firms becomes stronger over time. Further, we find that operating profits per unit of risk (ROA/return volatility) increase post ERM adoption.