Corporate Governance and the Hedging Premium Around the World

Abstract

This paper examines the use of foreign currency derivatives (FCDs) as a proxy for risk management and its potential impact on firm value in a broad sample of firms from thirty-nine countries between 1990 and 1999. Our sample allows us to exploit differences in corporate governance across firms and countries, their impact on risk management policies and their value implications. We find that on average, hedging is associated with higher firm value around the world and that corporate governance is an important factor in assessing the value of risk management. The hedging premium is statistically significant and economically large for firms with strong internal corporate governance (such as those with an institutional blockholder) and those which reside in countries with strong external governance (such as those with an English legal origin), and insignificant for firms with weak internal governance and those which reside in countries with weak external governance. Finally, hedging is (not) valuable even when internal corporate governance is weak (strong), if the firm happens to reside in a country with strong (weak) external governance. Overall, our findings suggest that both firm-level and country-level corporate governance play a significant role in understanding when risk management is associated with higher value. Moreover, our results imply that risk management is one channel through which stronger corporate governance translates into higher firm value.