The Effect of Foreign Currency Hedging on External Financing

Abstract

Existing theory offers two divergent views on the effect of hedging on external financing. One view is that hedging allows a firm to reduce its reliance on external finance when capital market imperfections make external finance more costly than internally generated funds. A contrasting view is that by reducing information asymmetries and/or volatility, hedging reduces external financing costs and hence motivates firms to increase their reliance on external financing. In this paper, I provide empirical evidence on the effect of foreign currency hedging on external financing. My results suggest foreign currency hedgers raise more external financing than nonhedgers. In addition, although financially constrained hedgers raise less external financing than financially unconstrained hedgers, financially constrained hedgers raise more external financing than financially constrained nonhedgers. Further, I find that the difference in external financing between hedgers and nonhedgers is driven by both debt and equity financing.