Does hedging enhance firm value in good and bad times

Published date05 March 2018
Date05 March 2018
AuthorNafis Alam,Amit Gupta
Subject MatterAccounting & Finance,Accounting/accountancy,Accounting methods/systems
Does hedging enhance rm value
in good and bad times
Nafis Alam
Henley Business School, University of ReadingMalaysia, Johor Bahru, Malaysia, and
Amit Gupta
GE Power Solutions, Kuala Lumpur, Malaysia
Purpose The purpose of thispaper is to examine if the hedging strategy of the rm adds value to the rm,
and if so, is the source of the benet consistentwith the hedging theory?
Design/methodology/approach The paper used data from 129 top non-nancial Indian companies
spanninga period of 2008-2015and analyzed using the ordinary least squares regressiontechnique.
Findings The study nds that rms engagedin hedging compared to non-hedgers have less volatilityin
the rms value.The use of hedging during the nancial crisis is foundto be value enhancing for the hedgers.
The results also found that some rms do not disclose the notional value of derivatives clearly, which
highlightsthe need of clear regulation for derivativedeclaration in the annual reports.
Research limitations/implications Research implicationsof this study are to gain an insight into the
hedging effectivenessin the highly volatile Indian marketas compared to developed countries. High volatility
in the exchange rate of Indian rupee further makes it one of the most relevantmarkets to study the effect of
hedgingon the rms value.
Practical implications Mostly hedging is done purely for risk management, and if managers try to
time the market by selective hedging, it can bring a negative impact for the rm. Findings show that
managers should manage their hedging strategy based on changing the economic environment and not
purely on the rmsnancialvalue.
Originality/value To the authorsbest knowledge, this is the rst study to extract the dollar value of
derivativeusage of sample rms and analyze its effectiveness in enhancing rm value in the presence of other
nancial parameters. This will be an advancement of previous studies, which used hedging as a dummy
variable only. Most studies on this topic are carriedout in developed countries; there is a limited research on
developing marketssuch as India, and past studies have been more genericone like determinants of hedging
and overallderivative scenario.
Keywords Financial crisis, Hedging, Firm value, Accounting standard, Financial strategy
Paper type Research paper
Risk management plays an important role in corporate nancial strategy. Assuming
Modigliani and Millers (1958) hypotheses are valid, companiesnancial policies do not
have any impact on rm value in a perfect capital market. If nancial markets are efcient,
hedging activities by a rm does not add any valuebecause the investor would then be able
to build such a diversied portfolio that wouldallow them to eliminate the risks and would
make the payment of a premium for the rm adopting a hedging policy unnecessary.
However, when some of the assumptions made by Modiglianiand Miller (1958) are relaxed,
it is possible to show that a companys hedging policy would add value to the rm. Smith
and Stulz (1985) show that tax reasons and the possibility of incurring in costs of nancial
distress could lead hedging to add value to the rm.Similarly, Froot et al. (1993) noted that
Received26 March 2017
Revised4 August 2017
Accepted5 September 2017
InternationalJournal of
Accounting& Information
Vol.26 No. 1, 2018
pp. 132-152
© Emerald Publishing Limited
DOI 10.1108/IJAIM-03-2017-0041
The current issue and full text archive of this journal is available on Emerald Insight at:
nancial market imperfectionsand the problem of underinvestment would cause hedging to
have a positive impact on rm value.
Some rms feel that hedging methods are more speculative and hence they refrain from
hedging related activities.There are few rms which believe that shareholders value cannot
be increased by hedging and individual shareholders can do the same by using derivative
instruments or by diversifying (Giddy and Dufey, 1992). The International Fischer Effect
suggests that changes in exchange rates can be balanced out by changes in ination and
interest rates (Sivakumar and Sarkar, 2008). However, market imperfections and related
costs make currency risk management an important area of worry for rms (Giddy and
Dufey, 1992).
In recent years, the Indian rupee has been very volatile adding nancial pressures to
rms with exposure to foreign currency transactions. Given recent crisis and uncertainties
in a market such as the nancial crisis of 2008-2009, the European sovereigndebt crisis, the
Yuan depreciation and a recentrate hike from Federation Bank of US, the Indian Rupee has
uctuated wildly (See panelA and B in Figure 1).
From Figure 1, it can be seen that theIndian rupee fell from a strong position of 40 INR/
US$ in the beginning of 2008 to high of 55 INR/US$ at the peak of crisis in 2008. In the
immediate post crisis period,the Indian rupee uctuated between 45 INR/US$ to 65 INR/US$
showing a high level of uctuation. In these circumstances, rms in India like other parts of
the world used hedging tools to protectthemselves from currency volatility.
There are many studies to explain the motivation for hedging. Main motives include
savings of taxes, reduction in nancial distress and transaction costs, reduction in under
investment decisions, lower agency cost, improving liquidity and multinational natures of
rms to name few.
The effects of hedgingin developed economies have been mixed. Some researchersfound
that hedging increased the value of the rm (Allayannis and Weston, 2001;Carter et al.,
2006;Nguyen and Faff, 2002;Graham and Rogers, 2000).However a few studies also found
Figure 1.
Indian rupee
exchange rateagainst
Does hedging
enhance rm

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