The Exchange Rate Exposure of UK Nonfinancial Companies: Industry-Level Analysis

Abstract

In line with the financial theory, any change in an exchange rate should affect the value of a firm or an industry. However, earlier research did not fully support this theory, which is surprising in view of the considerable exchange rate fluctuations over the last three decades. This study extends previous research on the foreign exchange rate exposure by investigating contemporaneous and lagged exchange rate exposure of UK nonfinancial companies at the industry level. The analyses are conducted over the total period from 1981 to 2001 and over three subperiods. Since the UK joined the ERM on October 8, 1990 and remained a member until September 16, 1992, the sample period is split into three subperiods: Pre-ERM, In-ERM and Post-ERM subperiods. Therefore, the study also aims to identify the sensitivity of industries' stock returns to exchange rate movements over these three subperiods. The current study is different from previous studies as it considers the impact of the actual and unexpected changes in exchange rates on industries' stock returns. The findings show that a higher percentage of UK industries are exposed to contemporaneous exchange rate changes than those reported in previous studies. There is also evidence of significant lagged exchange rate exposure. This lagged exchange rate exposure goes in line with the findings of previous studies, in that it shows some market inefficiencies in incorporating exchange rate changes into the returns of firms and industries. Generally, the sensitivities of UK industries' stock returns to exchange rate fluctuations are most evident in the period before joining the ERM and after departure from the ERM (post-ERM). The proportion of industries with a significant exchange rate exposure declined when the pound was in the ERM and increased again after the UK left it. The findings of the study have significant implications for public policy makers, investors and managers. However, there is a need for research that considers the factors or determinants that might affect a firm's or an industry's exposure to changes in exchange rates.