Tech Report Number
1994-022
Abstract
We examine explanations for corporate policy choices related to the use of derivative financial instruments. Recent corporate disclosure requirements allows us to replicate and extend the work of Nance, Smith and Smithson (1993, NSS) using a larger sample. We extend previous research by considering interest rate and foreign exchange hedging separately, using continuous rather than binary measures of hedging, and including variables measuring level of multinationality and exposure to interest rate and foreign exchange rate changes. The findings document robust empirical relationships among corporate policy decisions and firm characteristics. In a tobit regression analysis, our results suggest that firms which use more derivatives are more multinational, less liquid, more subject to progressive taxation, less subject ot regulation, and larger. They have more growth opportunities, and issue less debt by foreign operations, to reduce conflicts between bondholders and shareholders, and to reduce the higher default rish associated with lower liquidity. Contray to expectiation, hedging is associated with lower dividen payouts, possibly due to the correlation of dividend payout with growth opportunities. Overall, this study confirms the findings of NSS that the determinants of derivative usage are rish reducing hedges. Our conditional results are stronger for hedgers of foreign exchange rish exposure than for hedgers of interest rate risk exposure. One possible explanation is that there is a difference in the level of hedging achieved by the use of different derivatives. Foreign exchange derivatives hedge the exposure created by foreign invenstments and foreign currency transactions. Objectives for using interest rate derivatives are more ambiguous. As indicated int he notes to financial statements, interest rate derivatives are used to modify the debt structure and thus the capital structure of firms. It is likely that interest rate derivatives are motivated by arbitrage opportunities created by capital market imperfections and transaction cost differences in addition to hedging interest rate exposure.
Date of this Version
1-1-1994