Corporate Hedging: An Agency Costs & Accounting Perspective

Abstract

This study provides empirical evidence on the determinants of the various types of hedging activities conducted by US manufacturing firms. Using a hand collected data set on the notional amounts hedged, I find that agency costs & managerial ability positively impact a firm's decision to hedge their interest rate and foreign exchange risks. To test for capital market benefits, I demonstrate that firms that hedge are able to take on more debt, and hold less cash as a result of the reduced cash flow variance and agency conflicts achieved by hedging. I also show that firms that hedge interest rate risks experience lower stock market volatility around a global economic shock. In order to analyze how firms and auditors account for corporate derivative usage, I split the amounts hedged by their accounting designation as under FAS 133. I provide evidence that firms and auditors find the accounting complexity of foreign exchange hedges greater than that of interest rate hedges.