The effects of management compensation on firm hedging: Does SFAS 133 matter?

This paper analyzes whether executive compensation in the form of options or stocks affects a firm's decision to hedge. In particular, we investigate whether SFAS 133, a regulation designed to increase transparency of derivative reporting, alters the relationship between managerial compensation and derivative use. We demonstrate that when management is compensated with options, the firm uses less derivatives to hedge interest rate and currency risk. Whereas, compensation of management with shares increases a firm's hedging activity. Results thus highlight the importance of agency conflict in the payment of managerial options and the firm's use of hedging instruments. Passage of SFAS 133 significantly affects derivative use and agency conflict.