Corporate hedging, firm risk, value, and performance : evidence from UK firms

Ahmed, Hany Bahgat

Business
October 2016

Thesis or dissertation


Rights
© 2016 Hany Bahgat Ahmed. All rights reserved. No part of this publication may be reproduced without the written permission of the copyright holder.
Abstract

This study investigates the corporate hedging decisions associated with firm value, performance, and risk. A number of theories in risk management literature suggest that, in market imperfections, the use of derivative instruments for hedging purposes increases firm value overall by mitigating agency costs and a firm’s returns variability. Using a sample of UK nonfinancial listed firms during the period 2005-2012, we examine: (i) the effect of investment inefficiency on corporate hedging decisions; (ii) the impact of the use of foreign currency (FX), interest rate (IR), and commodity (CM) derivatives on firm value and performance; and (iii) the association between the corporate risk hedging and both stock returns volatility and the cost of equity capital implied in stock prices. We document new evidence regarding the effect of investment inefficiencies on hedging decisions. We find that hedging is strongly and positively associated with underinvestment or overinvestment, which confirms Morellec and Smith’s (Review of Finance, 2007, 11, 1-23) theoretical analysis. We find strong evidence that derivative usage has differential firm valuation and performance effects depending on the financial risk type, contract type, and time of hedging strategies. Consistently, we find that FX risk hedging positively influences firm value and performance, while there is no significant result of IR risk hedging associated with the firm value creation which means that IR derivatives can be used for hedging or speculative purposes. Not surprisingly, the results show that forwards and swaps for FX risk hedge are positively and significantly associated with firm value over the time period, while firms associated with financial constraints are highly motivated to use options contracts. Finally, our results show that the stock returns volatility, on average, is lower when firms exercising hedging decisions overall, where a decline in the implied cost of equity is substantial. Our empirical results confirm these predictions and robust after employing various methods (e.g. special regressor, instrumental variables (IV-GMM), treatment effects, propensity score matching (PSM), and difference-in-differences (DiD)) to address potential endogeneity issues. However, our findings indicate that, consistent with the notion of the positive theory of financial risk management, the corporate hedging has economic values to derivative users.

Publisher
Business School, The University of Hull
Supervisor
Guney, Yilmaz; Andrikopoulos, Athanasios
Qualification level
Doctoral
Qualification name
PhD
Language
English
Extent
2 MB
Identifier
hull:17764
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