Foreign Debt Usage in Non‐Financial Firms: a Horse Race between Operating and Accounting Exposure Hedging

Abstract

Previous studies show that foreign exchange exposure from international sales can be hedged by foreign debt. We go beyond the foreign sales measure by using a unique database with detailed exposure information on Danish non-financial firms with international operations. Our results indicate that foreign debt is used to hedge foreign assets and subsidiaries (accounting exposure) as opposed to foreign sales (operating exposure). The paper adds to the literature on corporate hedging by highlighting the importance of accounting exposure in the hedging behavior of corporate managers and the perceived need to reduce risks due to currency mismatches between assets and liabilities.

Dollar Borrowing, Firm-Characteristics, and FX-Hedged Funding Opportunities

“…The latter finding is consistent with the view that the roles of the dollar in trade and debt markets are intertwined (Gopinah and Stein, 2018). It is also consistent with recent evidence of Aabo et al (2015) in the European context, showing that firms with direct asset exposure to euros, pounds, or Swedish kronar issue, on average, more bonds denominated in these currencies for hedging purposes (see also Allayannis et al, 2001;Aabo, 2006;or Hoberg and Moon, 2017; among others). The fact that foreign currency asset-side exposures increase firms' issue of bonds in foreign currency suggests that firms aim at avoiding the build-up of balance-sheet currency mismatches.…”

“…Specifically, we define two binary variables: one measuring dollar accounting exposures ( ) that takes value one if a firm has long-term assets in dollars and another one assessing dollar operational exposures ( ) that takes value one if a firm has dollar revenues. According to Aabo, Hansen, and Muradoglu (2015), the two measures convey different information: the accounting exposure proxy reflects long-term balance-sheet exposures, whereas the operational exposure proxy gauges short-term cash-flow exposures. The distinction is important, since the two types of exposure are associated with different hedging needs.…”

Effects of the exchange rate on the adoption of hedge accounting: evidence from Brasil

“…However, despite our expectations, CASHFX (significant at 1%) did not present a positive relationship with HA, maybe considering that the cash effect of the exchange gains and losses is not directly linked to the accrued losses on the income statements and, consequently, on OCI's balances. In addition, ROE was not significant in our model, also despite our expectations, mainly because we were not able to isolate the exchange rate effect (gains and losses), which is a limitation already discussed by the supporting theory (RICHIE et al, 2006;AABO et al, 2015).…”

“…Empirical studies show that accounting concerns do matter in actual managerial decision making, so a firm that has foreign assets can hedge its balance sheet by creating an offsetting liability (i.e. foreign debt) and thus protect its equity from fluctuations caused by unexpected changes in foreign exchange rates -and due to the lack of detailed exposure information, the empirical literature has been vague in addressing whether foreign debt usage is primarily driven by operating or accounting exposures (AABO et al, 2015), ratifying the theoretical gap and relevance of our study.…”

“…Aabo et al (2015) have also discussed the use of foreign debt to hedge exchange exposure from international sales, pointing out that a firm that receives revenues in foreign currency has two ways of eliminating such positive (long) exposure by financial means: the use of financial derivatives, such as forwards contracts, futures, swaps, and options, or the use of debt denominated in foreign currency, either raising new debt (such as what he verified in Petrobras' case, concerning 2015's DFP) or changing the currency denomination of existing debt.…”