Time-inconsistent investment, financial constraints, and cash flow hedging

Donald Lien and Chia-Feng (Jeffrey) Yu ()

International Review of Financial Analysis, 2014, vol. 35, issue C, 72-79

Abstract: This paper studies the interplay between firm investment and cash flow hedging decisions when the decision-maker has time-inconsistent preferences. We show that cash flow hedging acts as a double-edged sword. In some cases, cash flow hedging enhances firm value because the firm can thus invest at the firm-value-maximizing timing. In other cases, however, cash flow hedging may adversely affect firm value because it loosens the financial constraint that works as a commitment device to mitigate premature investment. Our results thus highlight one unexplored potential dark side of hedging and suggest that the optimal hedging decision is the result of a trade-off between flexibility and commitment.

Keywords: Time-inconsistent preferences; Investment timing; Financial constraints; Cash flow hedging (search for similar items in EconPapers)
JEL-codes: D92 G02 G11 (search for similar items in EconPapers)
Date: 2014
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Citations: View citations in EconPapers (5)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:finana:v:35:y:2014:i:c:p:72-79

DOI: 10.1016/j.irfa.2014.07.009

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