Interest Rate Derivatives and Firm Value: Evidence from Mandatory Versus Voluntary Hedging

Abstract

This paper examines the impact of interest rate derivatives enforced by creditors and interest rate derivatives used voluntarily on firm value, separately in a sample of 3881 firm-years from 1998 to 2005. Voluntary hedging positions include derivatives for corporate risk management practices and those for private benefit of managers. Consequently, these derivatives might not have the positive impact on firm value predicted by risk management theories. However, there is no managerial incentive in the use of derivatives mandated by credit agreements. Therefore, shareholders refer to mandatory term of derivatives obliged by creditors and classify these instruments as real risk management practices and reward such positions by a premium on firm value. This argument is strongly supported by the results of this empirical research in which we find an economically large and statistically significant positive impact from mandatory interest rate derivatives on firm value and no significant impact from voluntary ones.