Hostname: page-component-7c8c6479df-xxrs7 Total loading time: 0 Render date: 2024-03-28T07:42:09.468Z Has data issue: false hasContentIssue false

The Effects of Derivatives on Firm Risk and Value

Published online by Cambridge University Press:  17 May 2011

Söhnke M. Bartram
Affiliation:
Lancaster University, Management School, Lancaster LA1 4YX, United Kingdom, and State Street Global Advisors, s.m.bartram@lancaster.ac.uk
Gregory W. Brown
Affiliation:
gregwbrown@unc.edu
Jennifer Conrad
Affiliation:
Kenan-Flagler Business School, University of North Carolina at Chapel Hill, CB 3490, Chapel Hill, NC 27599, j_conrad@unc.edu

Abstract

Using a large sample of nonfinancial firms from 47 countries, we examine the effect of derivative use on firm risk and value. We control for endogeneity by matching users and nonusers on the basis of their propensity to use derivatives. We also use a new technique to estimate the effect of omitted variable bias on our inferences. We find strong evidence that the use of financial derivatives reduces both total risk and systematic risk. The effect of derivative use on firm value is positive but more sensitive to endogeneity and omitted variable concerns. However, using derivatives is associated with significantly higher value, abnormal returns, and larger profits during the economic downturn in 2001–2002, suggesting that firms are hedging downside risk.

Type
Research Articles
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2011

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Alkeback, P., and Hagelin, N.. “Derivative Usage by Nonfinancial Firms in Sweden with an International Comparison.” Journal of International Financial Management and Accounting, 10 (1999), 105120.CrossRefGoogle Scholar
Allayannis, Y., and Ofek, E.. “Exchange Rate Exposure, Hedging, and the Use of Foreign Currency Derivatives.” Journal of International Money and Finance, 20 (2001), 273296.CrossRefGoogle Scholar
Allayannis, Y., and Weston, J. P.. “The Use of Foreign Currency Derivatives and Firm Market Value.” Review of Financial Studies, 14 (2001), 243276.Google Scholar
Altman, E. I. “Financial Ratios, Discriminant Analysis and the Prediction of Corporate Bankruptcy.” Journal of Finance, 4 (1968), 589609.CrossRefGoogle Scholar
Aretz, K., and Bartram, S. M.. “Corporate Hedging and Shareholder Value.” Journal of Financial Research, 33 (2010), 317371.Google Scholar
Bank for International Settlements. “Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity in 2004” (2005).Google Scholar
Bartram, S. M. “Corporate Risk Management as a Lever for Shareholder Value Creation.” Financial Markets, Institutions and Instruments, 9 (2000), 279324.CrossRefGoogle Scholar
Bartram, S. M.; Brown, G. W.; and Fehle, F. R.. “International Evidence on Financial Derivatives Usage.” Financial Management, 38 (2009), 185206.CrossRefGoogle Scholar
Bartram, S. M.; Brown, G. W.; and Stulz, R. M.. “Why Are U.S. Stocks More Volatile?Journal of Finance, forthcoming (2011).Google Scholar
Berkman, H.; Bradbury, M. E.; and Magan, S.. “An International Comparison of Derivatives Use.” Financial Management, 26 (1997), 6973.CrossRefGoogle Scholar
Bodnar, G. M.; de Jong, A.; and Macrae, V.. “The Impact of Institutional Differences on Derivatives Usage: A Comparative Study of U.S. and Dutch Firms.” European Financial Management, 9 (2003), 271297.CrossRefGoogle Scholar
Bodnar, G. M., and Gebhardt, G.. “Derivatives Usage in Risk Management by U.S. and German Non-Financial Firms: A Comparative Survey.” Journal of International Financial Management and Accounting, 10 (1999), 153187.Google Scholar
Bodnar, G. M.; Hayt, G. S.; and Marston, R. C.. “1995 Wharton Survey of Derivatives Usage by U.S. Non-Financial Firms.” Financial Management, 25 (1996), 113133.CrossRefGoogle Scholar
Bodnar, G. M.; Hayt, G. S.; and Marston, R. C.. “1998 Wharton Survey of Financial Risk Management by U.S. Non-Financial Firms.” Financial Management, 27 (1998), 7091.CrossRefGoogle Scholar
Bodnar, G. M.; Hayt, G. S.; Marston, R. C.; and Smithson, C. W.. “Wharton Survey of Derivatives Usage by U.S. Non-Financial Firms.” Financial Management, 24 (1995), 104114.Google Scholar
Brown, G. W.; Crabb, P. R.; and Haushalter, D.. “Are Firms Successful at Selective Hedging?Journal of Business, 79 (2006), 29252949.CrossRefGoogle Scholar
DeCeuster, M. J. K.; Durinck, E.; Laveren, E.; and Lodewyckx, J.. “A Survey into the Use of Derivatives by Large Non-Financial Firms Operating in Belgium.” European Financial Management, 6 (2000), 301318.Google Scholar
DeMarzo, P. M., and Duffie, D.. “Corporate Incentives for Hedging and Hedge Accounting.” Review of Financial Studies, 8 (1995), 743771.Google Scholar
DiPrete, T. A., and Gangl, M.. “Assessing Bias in the Estimation of Causal Effects: Rosenbaum Bounds on Matching Estimators and Instrumental Variables Estimation with Imperfect Instruments.” Sociological Methodology, 34 (2004), 271310.CrossRefGoogle Scholar
Downie, D.; McMillan, J.; and Nosal, E.. “The University of Waterloo Survey of Canadian Derivatives Use and Hedging Activities.” In Managing Financial Risk, Yearbook 1996, Smithson, C. W., ed. New York: CIBC-Wood Grundy (1996).Google Scholar
Froot, K. A.; Scharfstein, D. S.; and Stein, J. C.. “Risk Management: Coordinating Corporate Investment and Financing Policies.” Journal of Finance, 48 (1993), 16291658.Google Scholar
Géczy, C.; Minton, B. A.; and Schrand, C.. “Why Firms Use Currency Derivatives.” Journal of Finance, 52 (1997), 13231354.Google Scholar
Graham, J. R., and Rogers, D. A.. “Do Firms Hedge in Response to Tax Incentives?Journal of Finance, 57 (2002), 815839.Google Scholar
Graham, J. R., and Smith, C. W. Jr.Tax Incentives to Hedge.” Journal of Finance, 54 (1999), 22412262.Google Scholar
Grant, K., and Marshall, A. P.. “Large UK Companies and Derivatives.” European Financial Management, 3 (1997), 191208.CrossRefGoogle Scholar
Guay, W. R. “The Impact of Derivatives on Firm Risk: An Empirical Examination of New Derivative Users.” Journal of Accounting and Economics, 26 (1999), 319351.Google Scholar
Guay, W., and Kothari, S. P.. “How Much Do Firms Hedge with Derivatives?Journal of Financial Economics, 70 (2003), 423461.Google Scholar
Haushalter, G. D. “Financing Policy, Basis Risk, and Corporate Hedging: Evidence from Oil and Gas Producers.” Journal of Finance, 55 (2000), 107152.Google Scholar
Heckman, J. J. “Sample Selection as a Specification Error.” Econometrica, 47 (1979), 153161.CrossRefGoogle Scholar
Hentschel, L., and Kothari, S. P.. “Are Corporations Reducing or Taking Risks with Derivatives?Journal of Financial and Quantitative Analysis, 36 (2001), 93118.Google Scholar
Jin, Y., and Jorion, P.. “Firm Value and Hedging: Evidence from U.S. Oil and Gas Producers.” Journal of Finance, 61 (2006), 893919.Google Scholar
Koski, J. L., and Pontiff, J.. “How Are Derivatives Used? Evidence from the Mutual Fund Industry.” Journal of Finance, 54 (1999), 791816.CrossRefGoogle Scholar
Leland, H. E. “Agency Costs, Risk Management, and Capital Structure.” Journal of Finance, 53 (1998), 12131243.Google Scholar
Loderer, C., and Pichler, K.. “Firms, Do You Know Your Currency Risk Exposure? Survey Results.” Journal of Empirical Finance, 7 (2000), 317344.CrossRefGoogle Scholar
Mian, S. L. “Evidence on Corporate Hedging Policy.” Journal of Financial and Quantitative Analysis, 31 (1996), 419439.Google Scholar
Modigliani, F., and Miller, M. H.. “The Cost of Capital, Corporation Finance, and the Theory of Investment.” American Economic Review, 48 (1958), 261297.Google Scholar
Nance, D. R.; Smith, C. W. Jr.; and Smithson, C. W.. “On the Determinants of Corporate Hedging.” Journal of Finance, 48 (1993), 267284.Google Scholar
Newey, W. K., and West, K. D.. “A Simple, Positive Semi-Definite, Heteroskedasticity and Autocorrelation Consistent Covariance Matrix.” Econometrica, 55 (1987), 703708.Google Scholar
Rosenbaum, P. R. Observational Studies, 2nd ed.New York, NY: Springer-Verlag (2002).Google Scholar
Rosenbaum, P. R., and Rubin, D. B.. “The Central Role of the Propensity Score in Observational Studies for Causal Effects.” Biometrika, 70 (1983), 4155.Google Scholar
Rountree, B.; Weston, J. P.; and Allayannis, G.. “Do Investors Value Smooth Performance?Journal of Financial Economics, 90 (2008), 237251.CrossRefGoogle Scholar
Sheedy, E.Corporate Use of Derivatives in Hong Kong and Singapore: A Survey.” Working Paper, Macquarie University (2002).Google Scholar
Smith, C. W., and Stulz, R. M.. “The Determinants of Firms’ Hedging Policies.” Journal of Financial and Quantitative Analysis, 20 (1985), 391405.CrossRefGoogle Scholar
Stulz, R. M. “Optimal Hedging Policies.” Journal of Financial and Quantitative Analysis, 19 (1984), 127140.Google Scholar
Tufano, P.Who Manages Risk? An Empirical Examination of the Risk Management Practices in the Gold Mining Industry.” Journal of Finance, 51 (1996), 10971137.CrossRefGoogle Scholar
Zhao, Z.Using Matching to Estimate Treatment Effects: Data Requirements, Matching Metrics, and Monte Carlo Evidence.” Review of Economics and Statistics, 86 (2004), 91107.Google Scholar