Firm Performance and Managing Downside Business Risk

Abstract

This research focuses on the ultimate impact of hedging effectiveness on firm performance. Successful risk management in firms should lead to a lesser occurrence of lower business outcomes than higher outcomes (e.g., positive skewness in quarterly earnings per share). We empirically estimate the hedging profile of 5,586 non-financial firms (spanning 25 industries) from their quarterly earnings per shares (EPS) and relate it to Tobin’s Q, excess stock returns, ROE and ROA. The estimation controls for important firm characteristics (e.g., median EPS, firm size, leverage, market risk, earnings management, firm-industry fixed effects) and endogeneity. The resulting coefficient for EPS skewness – after controlling for median EPS and other firm characteristics – identifies the impact of the firm's hedging profile on firm performance. We find a strong positive relation between firm performance and the hedging profile as Tobin’s Q, ROE and ROA rise by 0.035, 2.6% and 1.4%, respectively, when EPS skewness rises by one (14% of firms). Study results provide further support for shareholder maximization and signaling theories of hedging.