The last decade has witnessed alarmingly volatile movement of the value of Turkish Lira against foreign currencies. For example, as the statistics of Turkish Central Bank (2004) say, the nominal value of Turkish Lira vis-a-vis 1 Euro depreciated from 628,301 TL on January 1, 2001 to 1,303,172 TL on January 1, 2002. This ever-increasing degree of exchange rate volatility has elevated the management of foreign exchange (FX) exposure to the position of prominent managerial concern.
Foreign exchange risk, the adverse affects of the changes in exchange rates on a company cash flow and eventually on a company value, is usually broken down into three categories: translation exposure, transaction exposure and economic exposure. Translation exposure, which is valid for only multinational companies, may occur while consolidating a subsidiary's financial statements in the parent company's currency. Marshall (2000) presents the view that the translation exposure should not be managed as it is purely an accounting concept not related to cash flows. On the contrary, Sucher and Carter (1996) point out that although there is no cash flow impact, hedging the translation exposure could be appropriate when a company is close to specified debt limitations and currency movements may lead the translated group accounts to show a breach of borrowing covenants. Additionally, the decision on hedging the translation exposure is influenced by the financial reporting requirements at play in the reporting country (Marshall, 2000).
Transaction risk, on the other hand, is the adverse effect of FX rate changes on cash flows, which is derived from the time lag between foreign currency-denominated contract date and the settlement date. As stated in the International Encyclopedia of Business and Management (1996), the concept of economic exposure links exchange rates to the value of the firm as it attempts to capture the impact of exchange rate movements on the net present value of its future cash flows. In contrast to transaction exposure, economic exposure takes a longer view of how future cash flows will respond to changing exchange rates; therefore it does not lend itself to easy quantification. As Martin and Mauer (2003: 438) put forward, economic exposure arises from changes in the sales prices, sales volumes, and the costs of inputs of the firms and its competitors as a result of exchange rate changes. Bradley and Moles (2001: 52) argue that absence of foreign currency transactions does not automatically eliminate economic exposure as even purely domestic firms with foreign-domiciled competitors or with suppliers sourcing abroad are affected from FX rate movements.
Most of the empirical firm-level studies of FX management focus on multinational companies (MNCs) or indigenous companies from developed countries. This study contributes to general knowledge by presenting evidence which relates to companies in an emerging market economy, Turkey. Furthermore, selection of small and medium-sized enterprises (SMEs) warrants special importance, because, as stated by Molindretos and Tsanacas (1995), the smaller-sized companies are often overlooked in studies of this nature. Given the fact that SMEs are regarded as the powerhouse of several countries, the success of SMEs has a direct influence on the national economy. Since they constitute 99% of all business establishments and employ 53% of the workforce in the manufacturing sector (Sariaslan, 1994; Taymaz, 1997), SMEs play a very important role in the Turkish economy. Focusing on SMEs and presenting new data and insights into this relatively unexplored research area in Turkey, the study will fill a knowledge gap on the foreign exchange perception and management of Turkish companies.
Managing transaction exposure aims at preserving or maximizing the current home currency cash flows of foreign currency-denominated contracts, whereas economic exposure management is about maximizing firm value by preserving or maximizing the future cash flows from operations. …