Corporate Hedging: The Relevance of Contract Specifications and Banking Relationships

This article examines the contribution of hedging to firm valueand the cost of hedging in a unified framework. Optimal hedgingand firm value are explicitly linked to firm risk, the typeof debt covenants and the relative priority of the hedging contract.It is shown that in some cases hedging is possible only if thecounterparty to the forward contract also holds a significantportion of the debt. Also, the spread in the hedging contractreduces the optimal amount of hedging to less than the minimum-variancehedge ratio. Among other results this article elucidates whysome firms hedge using forward contracts while other firms hedgein the futures markets, as well as why higher priority forwardcontracts are more efficient hedging vehicles. JEL Classificationnumbers: G13, G22 and G33.