Managing Foreign Exchange Rate Economic Exposure

Abstract

AbstractThe foreign exchange (FX) economic exposure of the firm is now receiving the attention once showered on the other two traditional FX exposures, transaction and translation. This economic exposure, recently referred to as competitive or strategic, is now seen by many financial managers as the primary exposure. Our preliminary opinion is that what is commonly referred to as competitive exposure management is a simplified economic exposure which, although potentially useful, is generally not applicable to most multinational firms and their own economic exposure profiles.SummaryAt present we know little of the magnitude of active economic exposure management. Few firms are willing to either publicize or discuss their economic exposure or competitive exposure management programs, either because of their unwillingness to divulge information which they believe is inherently competitive, or to provide details of financial contracts and derivatives which could result in heavy criticism from investors or financial analysts.The numbers of firms actively managing economic exposure is unknown, though it has been estimated in the United States at between 50 and 100, while 20 to 30 major European multinationals are thought to be active at a minimum. Whether this reflects differences in corporate governance, goals and methods of financial management, or even the incentives and performance evaluation methods of management and management's effectiveness, are questions for future research.19This paper is a first attempt at systematizing the analysis of economic exposure management. We have attempted to clarify old and new terminology in order that the subject may be linked to the previous and contemporary literatures of international financial management in specific, and international business in general. Our suggested taxonomy of what we prefer to simply call economic exposure is helpful in understanding which firms may or may not find economic exposure management beyond diversification of production and financing (natural hedging) useful or practical. We have also provided some basic principles which firms must address if they are to truly consider the hedging of economic exposure, and be cognizant of contractual hedging's effectiveness. Although little data exists at present regarding the degree of current corporate activity in economic exposure management, it is believed that continued exchange rate volatility on world markets combined with increasing degrees of direct international activity by firms will only serve to increase the level of interest.