Why hedge? Rationales for corporate hedging and value implications
Söhnke Bartram and
Journal of Risk Finance, 2007, vol. 8, issue 5, 434-449
Purpose - In the presence of capital market imperfections, risk management at the enterprise level is apt to increase the firm's value to shareholders by reducing costs associated with agency conflicts, external financing, financial distress, and taxes. The purpose of this paper is to provide an accessible and comprehensive account of these rationales for corporate risk management and to give a short overview of the empirical support found in the literature. Design/methodology/approach - The paper outlines the main theories suggesting that corporate risk management can enhance shareholder value and briefly reviews the empirical evidence on these theories. Findings - When there are imperfections in capital markets, corporate hedging can enhance shareholder value through its impact on agency costs, costly external financing, direct and indirect costs of bankruptcy, as well as taxes. More specifically, corporate hedging can alleviate underinvestment and asset substitution problems by reducing the volatility of cash flows, and it can accommodate the risk aversion of undiversified managers and increase the effectiveness of managerial incentive structures through eliminating unsystematic risk. Lower volatility of cash flows also leads to lower bankruptcy costs. Moreover, corporate hedging can also align the availability of internal resources with the need for investment funds, helping firms to avoid costly external financing. Finally, corporate risk management can reduce the corporate tax burden in the presence of convex tax schedules. While there is empirical support for these rationales of hedging at the firm level, the evidence is only modestly supportive, suggesting alternative explanations. Originality/value - The discussed theories and the empirical evidence are described in an accessible way, in part by using numerical examples.
Keywords: Corporate finances; Risk management; Foreign exchange (search for similar items in EconPapers)
References: Add references at CitEc
Citations: View citations in EconPapers (12) Track citations by RSS feed
Downloads: (external link)
http://www.emeraldinsight.com/10.1108/152659407108 ... RePEc&WT.mc_id=RePEc (text/html)
Access to full text is restricted to subscribers
This item may be available elsewhere in EconPapers: Search for items with the same title.
Export reference: BibTeX
RIS (EndNote, ProCite, RefMan)
Persistent link: https://EconPapers.repec.org/RePEc:eme:jrfpps:v:8:y:2007:i:5:p:434-449
Ordering information: This journal article can be ordered from
Emerald Group Publishing, Howard House, Wagon Lane, Bingley, BD16 1WA, UK
http://emeraldgroupp ... /journals.htm?id=jrf
Access Statistics for this article
Journal of Risk Finance is currently edited by Bonnie Buchanan
More articles in Journal of Risk Finance from Emerald Group Publishing
Bibliographic data for series maintained by Virginia Chapman ().