Academic journal article Management Dynamics

Hiding Behind the Hedge: The Relevance of Firm Value in Corporate Hedging

Academic journal article Management Dynamics

Hiding Behind the Hedge: The Relevance of Firm Value in Corporate Hedging

Article excerpt


The field of corporate hedging has received increasing attention in recent years, because managers, owners, shareholders, and other stakeholders in firms need to know how to manage the multitude of financial risks that firms face in an increasingly competitive global market. It is therefore of the utmost importance that firms protect and increase their firm value. The main focus of the study was to discover whether hedging practices, particularly hedging with derivatives, add to firm value for a sample of the 40 largest non-financial firms listed on the Johannesburg Stock Exchange (JSE) between 2008 and 2012.

Firm value was proxied by Tobin's Q, the ratio between the combined market value of a firm's equity and debt and its replacement value (Tobin and Brainard, 1977; Tobin, 1969). The definition of firm value in this study corres-ponds to similar studies that have used Tobin's Q as a proxy for firm value (Bielmeier and Nansing, 2013; Búa, González, López and Santomil, 2013; Jankensgârd, 2013). This study added to the methodology, however, by including other determinants of firm value: return on assets (ROA), return on equity (ROE), the market value of equity, economic value added (EVA), and market value added (MVA).

Prior studies on corporate hedging, such as the work of Allayanis, Lel and Miller (2012), Bartram, Brown and Fehle (2009) and Géczy, Minton and Schrand (1997), have focused on developed markets, and in particular on firms in the United States (US). In South Africa, very little research has thus far been done on either the extent of corporate hedging with derivatives or the impact on, and value relevance of, corporate hedging on firms' value. This study attempts to add to the body of knowledge about the use of derivatives in South Africa, and about the impact of hedging strategies using derivatives on the value of a firm.

Some recent international studies have investigated the effect of corporate hedging on firm value. A study of firms in 47 countries reports that using derivatives had a positive effect on firm value (Bartram, Brown and Conrad, 2011). Using derivatives seems to add a value premium to firms in Sweden, but only if they follow a highly centralised approach (Jankensgârd, 2013: 23). In Spain, a value premium for hedging with derivatives was noted, and the volume of hedging with currency derivatives and foreign currency debt added to firm value, while operational hedging did not (Búa, González, López and Santomil, 2013: 30). In Germany, however, the use of derivatives for non-financial firms did not appear to add value (Bielmeier and Nansing, 2013: 38). It is clear that there is not yet consensus on whether or not the use of derivatives as part of a corporate hedging strategy is a value-adding exercise for businesses.

The remainder of this study is organised as follows: a review of relevant available literature on the topic of derivatives hedging is presented next, followed by an explanation of the research methodology and a discussion of the empirical results from the various analyses. The study ends with a summary of the findings, conclusions, and suggestions for future research.


A significant amount of prior research has focused on finding the determinants of corporate hedging and on using derivatives as part of a hedging policy. Contemporary research in the field of risk management can be broadly categorised into three components: (i) empirical evidence on the determinants of hedging policy and risk management practices; (ii) evidence on the extent of and motivation behind hedging practices using samples of firms; and (iii) literature on whether risk management adds to firm value.

Determinants of hedging policy and risk management practices

Contemporary corporate risk management theory suggests that firm value can be increased by active and involved management, given the existence ofmarket imperfections. There are various capital market imperfections that lead firms to pursue active corporate risk management to enhance shareholder value, such as transaction costs, agency costs, the risk of financial distress and bankruptcy costs, and the existence of taxes (Aretz, Bartram and Dufey, 2007: 445). …

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