International Evidence on Financial Derivatives Usage

Abstract

Theory predicts that nonfinancial corporations might use derivatives to lower financial distress costs, coordinate cash flows with investment, or resolve agency conflicts between managers and owners. Using a new database, we find that traditional tests of these theories have little power to explain the determinants of corporate derivatives usage. Instead, we show that derivative usage is determined endogenously with other financial and operating decisions in ways that are intuitive but not related to specific theories for why firms hedge. For example, derivative usage helps determine the level and maturity of debt, dividend policy, holdings of liquid assets, and international operating hedging.

Corporate derivatives use and the cost of equity

“…When considered in conjunction with their associated risk premiums, both components contribute to the reduction in the cost of equity with the lower SMB beta appearing to have the largest effect. This latter finding is consistent with the notion that firm's derivatives use is associated with the need to mitigate financial distress risk as shown in several studies including, for example, Berkman and Bradbury (1996), Gay and Nam (1998), Howton and Perfect (1998), Graham and Rogers (2002), and Bartram et al (2009). Along these lines, Fama and French (1996) and Vassalou and Xing (2004) find evidence that the SMB factor contains information regarding a firm's default risk and which is priced in the cross-section of returns.…”

“…(1997), Gay and Nam (1998), Howton and Perfect (1998), Guay (1999), Haushalter (2000), Graham and Rogers (2002), Dionne and Triki (2005), and Bartram et al (2009). returns and default risk suggesting that investors require higher returns for bearing default risk. Dichev (1998), however, finds empirical evidence that firms with greater bankruptcy risk do not earn higher than average returns and concludes that bankruptcy risk is not systematic.…”

Interest rate sensitivity of the European stock markets before and after the euro introduction

“…For example, a recent study by Bartram et al (2009) shows that while in the U.S., 37.7% of the firms used FX derivatives and 40.4% of them used interest rate derivatives, the corresponding figures for Germany were 39.2% (FX derivatives) and 24.2% (interest rate derivatives). For the entire Europe, FX hedging was more common than in the U.S. (50.9%), but much fewer firms hedged their interest rate exposures (32.4%).…”

“…The data forBartram et al (2009Bartram et al ( ) are from 2000Bartram et al ( to 2001 According to the BIS statistics, the euro denominated OTC interest rate derivative market has grown by about 220% from the first half of 1999 to the end of 2006. During the same time period, the notional amount of exchange traded derivative contracts has grown by almost 350%.…”

Is operational hedging a substitute for or a complement to financial hedging?

“…Bartram et al (2004) report that 65% of U.S. firms use derivatives and 37.4% of U.S. firms use foreign exchange derivatives. The large volume of derivatives used by U.S. firms emphasizes the importance of hedging for firms and has stimulated significant research, resulting in the emergence of a rich body of literature that explores the various channels through which hedging can contribute to increased firm value (e.g., Froot et al, 1993;DeMarzo and Duffie, 1995;Smith and Stulz, 1985;Geczy et al, 1997;Haushalter, 2000;Graham and Rogers, 2002;Carter et al, 2004b).…”