Abstract
The Modigliani and Miller (1958) irrelevance proposition suggests that in perfect capital markets a firm’s hedging policy does not affect its value, since shareholders can undo any hedging activities implemented by the firm. Recent theories, however, argue that when capital markets are imperfect, hedging can increase a firm’s value by influencing its expected taxes, expected financial distress costs and investment decisions.1 More recently, researchers have examined the effect of hedging with derivatives on firm value. For example, Allayannis and Weston (2001) find that in a broad sample of firms, the value of firms that hedge foreign currency risk is, on average, 4.87 percent higher than non-hedgers, and Carter, Rogers and Simkins (2006) find that fuel hedging increases firm value by 5 to 10 percent for a sample of US airlines.
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