The role of corporate hedging: Evidence from oil and gas producers
Abstract
Financial theory offers an array of explanations for corporate hedging. However, financial economists have not reached any definitive conclusions regarding whether corporations' hedging policies are consistent with theory. To examine this question, this study uses a database of the risk management activities of one-hundred oil and gas producers. For the years 1992-1994, I empirically investigate the influence of financing policy, tax structure, operating technology, compensation policy, and ownership structure on hedging policy. I find that a company's hedging policy is significantly linked to its capital structure. The percentage of production hedged is strongly positively correlated with the ratio of total debt-to-total assets. Likewise, I find that companies that retain cash instead of paying dividends and companies with unrated debt hedge a greater percentage of production. In addition, after controlling for factors that influence the likelihood of hedging, smaller firms hedge more extensively. The results are consistent with what I label the "underinvestment", "probability of financial distress" and "financing and investment coordination" hypotheses. Collectively, these results suggest that hedging serves to alleviate financial contracting costs. Additionally, consistent with the predictions of "managerial risk aversion" hypothesis and Tufano (1996), I find an inverse relationship between the extent that corporations hedge and their use of performance-contingent managerial compensation. Variables pertaining to the number of options held by managers, the ratio of stock option pay-to-cash salary and bonus, and the use of a stock option plan are all significantly negatively related to the percentage of production hedged. Although a company's hedging policy is strongly correlated with its compensation policy, I find no evidence of a positive relation between the percentage of production hedged and managerial ownership. The results provide no evidence that a company's tax structure or operating technology influences its hedging policies.
Degree
Ph.D.
Advisors
McConnell, Purdue University.
Subject Area
Finance|School finance
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