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Corporate derivatives and foreign exchange risk management A case study of non‐financial firms of Pakistan

Corporate derivatives and foreign exchange risk management A case study of non‐financial firms of... Purpose – The purpose of this paper is to identify the factors affecting firms' decision to use foreign exchange (FX) derivative instruments by using the data of 86 non‐financial firms listed on Karachi Stock Exchange for the period 2004‐2007. Design/methodology/approach – Required data were collected from annual reports of listed firms of Karachi Stock Exchange. Non‐parametric test was used to examine the mean difference between users and non‐users operating characteristics. Logit model was applied to analyze the impact of firm's financial distress costs, underinvestment problem, tax convexity, profitability, managerial ownership and foreign exchange exposure on firms' decision to use FX derivative instruments for hedging. Findings – Results explain that firms having higher foreign sales are more likely to use FX derivative instruments to reduce exchange rate exposure. Moreover, financially distressed large‐size firms with financial constraints and fewer managerial holdings are more likely to use FX derivatives. Research limitations/implications – Incomplete financial instrument disclosure requirements restricted researchers to using binary variable as a dependent variable instead of notional value or fair value of derivative usage. Practical implications – The study shows that in the presence of amateur derivative market, Pakistani corporations possessing higher agency costs of debt, agency costs of equity, and financial constraints will benefit more by defining hedging policies coherent with the firm's investment and financing policies in order to enhance firm value. Originality/value – Until now, no earlier empirical study focused on the determinants of a firm's hedging policies in Pakistan, in the presence of volatile exchange rates,. The current study, therefore, attempts to identify the factors which affect the firm's decision to use derivative instruments for hedging FX exposure of non‐financial firms in Pakistan. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png The Journal of Risk Finance Emerald Publishing

Corporate derivatives and foreign exchange risk management A case study of non‐financial firms of Pakistan

Talat Afza; Atia Alam
The Journal of Risk Finance , Volume 12 (5): 12 – Nov 8, 2011
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Publisher
Emerald Publishing
Copyright
Copyright © 2011 Emerald Group Publishing Limited. All rights reserved.
ISSN
1526-5943
DOI
10.1108/15265941111176145
Publisher site
See Article on Publisher Site

Abstract

Purpose – The purpose of this paper is to identify the factors affecting firms' decision to use foreign exchange (FX) derivative instruments by using the data of 86 non‐financial firms listed on Karachi Stock Exchange for the period 2004‐2007. Design/methodology/approach – Required data were collected from annual reports of listed firms of Karachi Stock Exchange. Non‐parametric test was used to examine the mean difference between users and non‐users operating characteristics. Logit model was applied to analyze the impact of firm's financial distress costs, underinvestment problem, tax convexity, profitability, managerial ownership and foreign exchange exposure on firms' decision to use FX derivative instruments for hedging. Findings – Results explain that firms having higher foreign sales are more likely to use FX derivative instruments to reduce exchange rate exposure. Moreover, financially distressed large‐size firms with financial constraints and fewer managerial holdings are more likely to use FX derivatives. Research limitations/implications – Incomplete financial instrument disclosure requirements restricted researchers to using binary variable as a dependent variable instead of notional value or fair value of derivative usage. Practical implications – The study shows that in the presence of amateur derivative market, Pakistani corporations possessing higher agency costs of debt, agency costs of equity, and financial constraints will benefit more by defining hedging policies coherent with the firm's investment and financing policies in order to enhance firm value. Originality/value – Until now, no earlier empirical study focused on the determinants of a firm's hedging policies in Pakistan, in the presence of volatile exchange rates,. The current study, therefore, attempts to identify the factors which affect the firm's decision to use derivative instruments for hedging FX exposure of non‐financial firms in Pakistan.

Journal

The Journal of Risk Finance – Emerald Publishing

Published: Nov 8, 2011

Keywords: Pakistan; Foreign exchange; Risk management; Foreign exchange derivatives; Hedging; Foreign exchange exposure; Non‐financial firms

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