Corporate Risk Management

CHAPTER 20Real Implications of Corporate Risk Management

Many contributions in the literature focus on hedging value and risk implications for firms (e.g., Guay, 1999; Allayannis and Westion, 2001; Jin and Jorion, 2006). Yet empirical findings on the value implications of risk management are fairly mixed and inconclusive.¹ Methodological problems related to endogeneity of derivative use and other firm decisions, sample selection, sample size, and the existence of other potential hedging mechanisms (e.g., operational hedge) are often blamed for this mixed empirical evidence.

This chapter revisits the question of hedging virtues in a more comprehensive and multifaceted manner for a sample of US oil producers while using a different econometric methodology. To better gauge the actual implications of hedging, we examine its effects on the following firm objectives:

1. Firm value: Measured by the Tobin's q to verify if hedging is associated with value creation for shareholders.
2. Firm risk: Measured by both idiosyncratic and systematic risk, and firms' stock returns sensitivity to oil price fluctuations. One would expect that hedging should attenuate firms' exposure to the underlying market risk factor, which leads to lower firm riskiness. We will analyze in particular whether firms are hedging or speculating by using derivatives.
3. Firm accounting performance: Measured by the return on equity (ROE). We will confirm whether hedging effects translate into higher accounting profits or not. ...