Financial Hedging, Corporate Cash Policy, and the Value of Cash

Wenyi Sun,Yeqin Zeng,Chao Yin

doi:10.1111/1467-8551.12520

Abstract

AbstractWe study the implications of financial hedging for corporate cash policy and the value of cash holdings. Using a web crawler program to collect data on the use of financial derivatives between 1993 and 2016, we find that US public firms with financial hedging programs have smaller cash reserves but a higher value of cash than firms without hedging contracts in place. Our empirical results are robust when controlling for potential endogeneity issues, corporate governance, cash regimes and alternative measures of cash holdings. Further, we find that financial hedging not only increases the investment sensitivity to internal cash, but also has a positive effect on investment efficiency. The positive effect of financial hedging on the value of cash is more pronounced for firms with more financial constraints, higher information asymmetry and weaker corporate governance. Collectively, our paper highlights the importance of corporate cash policy as a channel through which financial risk management increases firm value.

Highlights

In the presence of asymmetric information, external borrowing is more costly than using internally generated funds, and firms are more likely to reserve cash to meet the need for future investment expenditures (Myers and Majluf, 1984)
Based on a large sample of US public firms from 1993 to 2016, we find strong evidence that cash holdings are negatively associated with firm financial hedging activities
We show that the value of corporate cash holdings increases with firms’ financial hedging activities

Summary

Introduction

In the presence of asymmetric information, external borrowing is more costly than using internally generated funds, and firms are more likely to reserve cash to meet the need for future investment expenditures (Myers and Majluf, 1984). + μt + θj + i,t where i is firm index, t is year index, j is industry index, Cash holdingsi,t is the ratio of cash and marketable securities to total assets, and Financial hedging proxyi,t is an indicator variable measuring the use of financial derivatives. In columns (1) and (2), the coefficients of the financial hedging proxy variables are negative and statistically significant at the 1% level after controlling for observable firm characteristics, indicating that derivatives users hold less cash than non-users.

Results

Conclusion