Effects of incomplete information on risk management

Abstract

Recent research shows that while the creditors’ interests determine an issuer’s hedging policy, creditors observe incomplete information regarding the cash flow. This study examines hedging effects with incomplete information through a real-option model, thereby deriving associated implications. We show that the difference in firm values between hedged and unhedged policies increases with more incomplete information. The higher the hedging efficiency, the larger the difference in hedging values across the degrees of incomplete information. The hedging effect decreases with shareholders’ bargaining power in renegotiations. Our findings imply that creditors are more likely to impose hedging requirements when facing more incomplete information.