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This paper aims to examine the foreign exchange (FX) risk effects of cash flow hedge accounting (HA). To the extent the HA qualification criteria and detailed documentation give investors confidence that FX derivatives effectively hedge risk, market-assigned FX risk premiums will be lower for firms using cash flow HA.
Probit analyses rely on the HA designation to examine the decision to use cash flow HA. Primary analyses test the hypothesized relationship between the magnitude of FX risk premiums and such HA use. Additional analyses allow for the interaction between cash flow HA use and the extent of FX derivatives use.
Hypothesis tests indicate that the magnitude of the FX risk premium is, on average, lower for firms designated as effective cash flow hedgers. In additional tests, the evidence suggests that the market assigns a lower FX risk premium to firms using a higher level of FX derivatives as effective cash flow hedges.
The findings suggest that cash flow HA provides risk-relevant information to investors. Such positive effects of HA on investors’ understanding of risk management may guide US accounting regulators in their efforts to improve HA. Corporate treasurers also may benefit from these insights into evaluating the use of HA.
Responding to the call for research on the risk relevance of cash flow HA, this paper merges the HA literature with the FX risk management literature to directly examine the relationship between HA use and FX risk premiums for manufacturing firms. The authors take an innovative approach using FX rates to which each firm is most exposed and provide evidence consistent with the argument that this approach is helpful in understanding both the decision to use cash flow HA and the effect of such HA use on market-assigned FX risk premiums.
Using market-risk disclosures as an empirical context, and drawing on the diffusion of innovations (DOIs) model, this paper contributes new sociological perspectives to a…
Using market-risk disclosures as an empirical context, and drawing on the diffusion of innovations (DOIs) model, this paper contributes new sociological perspectives to a theorization of compliance. We propose that stakeholder behaviors during accounting standard-setting discussion and adoption phases are motivated by social, political, and economic factors. These phases interrelate, and consequently, any analysis of managerial disclosure decisions benefit from considering them together, rather than in isolation, as is typical.
The authors use a mixed-methods design, including detailed analysis of semi-structured interviews (n = 26), constituents’ comment letters (n = 106), annual report disclosures (FTSE 350: firm-year observations n = 1,131), technical meetings, and standard-setting documents.
Results suggest that constituents initially supported introduction of a set of mandatory market-risk disclosures, but implied costs of the proposed and subsequently approved requirements outweighed perceived benefits and efficiencies. This study elaborates on these issues, exploring how and why a financial reporting innovation that stakeholders deemed technically inefficient was diffused. Although the authors were told that compulsion (i.e., forced-selection) dominates disclosure decisions, some freedom of choice remains, as evidenced by greater than 40% non-compliance during the first year of adoption. Respondents indicate that theoretically, market-risk disclosure adoption decisions rest on assessment of the costs of disclosure (e.g., preparation and competition) versus non-disclosure (e.g., litigation and reputation). Second-phase adoption is more straightforward because the costs of disclosure decrease over time.
Although mixed-methods research offers several advantages, self-selection bias, issues with coding reliability, and interviewer/interviewee bias are possible. It is impossible to achieve a truly holistic understanding of standard-setting, and therefore the authors acknowledge that findings are not generalizable, though the risks were minimized.
Recognizing that disclosure choices are not made in political and social vacuums, this study suggests that sociological perspectives such as innovation-diffusion inform a theory of compliance.
Based on basic financial models and reports in the business press, exchange rate movements are generally believed to affect the value of nonfinancial firms. In contrast…
Based on basic financial models and reports in the business press, exchange rate movements are generally believed to affect the value of nonfinancial firms. In contrast, the empirical research on nonfinancial firms typically produces fewer significant exposures estimates than researchers expect, independent of the sample studied and the methodology used, giving rise to a situation known as “the exposure puzzle”. To this end, this paper aims to systematically analyze the existing empirical evidence of the exposure phenomenon and to attempt to understand the possible source of the exposure puzzle.
The paper provides a survey of the existing research on the exposure phenomenon for nonfinancial firms. A simple model of exposure elasticity is also used to demonstrate the substantial impact of operational hedging on exposure elasticities. Furthermore, the evidence on the nature of firms’ financial derivative usage is considered.
It is suggested that the exposure puzzle may not be a problem of empirical methodology or sample selection as previous research has suggested, but is simply the result of the endogeneity of operative and financial hedging at the firm level. Given that empirical tests estimate exchange exposures net of corporate hedging, both firms with low gross exposures that do not need to hedge and firms with large gross exposures that employ one or several forms of hedging, may exhibit only weak exchange rate exposures net of hedging. Consequently, empirical tests yield only small percentages of firms with significant stock price exposures in almost any sample.
If firms react rationally to their exposures, most firms will either have no exposure to start with, or reduce their exposure to levels that may be too small to detect empirically. Consequently, the exposure puzzle may not be a problem with methodology or theory, but mainly the result of endogeneity of operative and financial hedging at the firm level.
Identifies some gaps in corporate risk management research and presents a study of risk management practices in large, non‐financial German firms. Compares the perceived relevance of different types of risk with the intensity of their management and reports that no respondents admitted major difficulty in developing a risk management system. Finds that firm survival is rated as the top goal of risk management, that respondents are closer to risk‐neutral than risk‐averse for financial risks, that around half centralize treasury management and 88 per cent use derivatives. Ranks the types of derivatives used and the importance of associated problems; shows how foreign exchange risk, US $ exposure and interest rate risk are managed; and assesses attitudes towards foreign exchange and interest rate risk management. Considers consistency with other research and calls for more.
The purpose of this paper is to analyse the Spanish business sector’s economic exposure to currency risk in Latin America between 2010 and 2016, testing the effectiveness…
The purpose of this paper is to analyse the Spanish business sector’s economic exposure to currency risk in Latin America between 2010 and 2016, testing the effectiveness of hedging with derivatives for the reduction of this risk.
Economic exposure is tested with the Jorion model (1990) using both a currency basket and an individualised analysis for the main currencies sustaining business activities between Spain and Latin America: the Mexican peso, Brazilian real, Argentine peso, Chilean peso, and Colombian peso. For the hedging analysis, dynamic panel data models were estimated using a generalised method of moments.
The results reveal that the number of firms with significant economic exposure is sensitive to the temporal frequency of the observations. The evidence denotes that the firms’ export profile is predominant, both when considering a basket of Latin American currencies and when individually considering the five main pairs of currencies. The only exception is the Argentine peso, where firms’ import profile is slightly higher. The Chilean peso stands out as the currency with the greatest number of firms with significant exposure.
This work provides unpublished evidence on economic exposure to currency risk in Latin America in a recent period characterised by two main aspects: an important devaluation of some Latin American currencies with respect to the euro; and an enhancement of Spanish business activities in the region to favour growth during the recent recession of the Spanish economy.
este trabajo analiza la exposición económica al riesgo cambiario en Latinoamérica por parte del sector empresarial español entre 2010 y 2016. Asimismo, evalúa la efectividad de la cobertura con productos derivados en su reducción.
la exposición económica es estimada a través del modelo de Jorion (1990), utilizando tanto una cesta de divisas como un análisis individualizado para las principales divisas que sustentan la actividad entre España y Latinoamérica, a saber, Peso mexicano, Real brasileño, Peso argentino, Peso chileno, y Peso colombiano. Respecto al análisis de la cobertura, se estiman modelos dinámicos con datos de panel a través del método generalizado de momentos.
los resultados muestran que el número de empresas con exposición económica significativa es sensible a la frecuencia temporal de las observaciones. Asimismo, la evidencia denota que el perfil exportador de las empresas es mayoritario, tanto al considerar una cesta de divisas latinoamericanas como, individualmente, los cinco principales pares de divisas. La única excepción es el peso argentino, donde el perfil importador de las empresas es levemente superior. Asimismo, el peso chileno destaca como la divisa con mayor número de empresas con exposición significativa.
este trabajo aporta evidencia inédita sobre la exposición económica al riesgo cambiario en Latinoamérica en un período reciente caracterizado por dos aspectos principales: i) una importante depreciación de algunas divisas latinoamericanas respecto al euro; ii) una potenciación de la actividad empresarial española en esa región para favorecer su crecimiento durante la reciente recesión de la economía española.
This paper explores the sensitivity of Chinese stock returns to changes in trade-weighted indexes of the renminbi (RMB) and the currencies of China's trading partners from…
This paper explores the sensitivity of Chinese stock returns to changes in trade-weighted indexes of the renminbi (RMB) and the currencies of China's trading partners from 1999 to 2003. It analyses this exposure elasticity cross-sectionally using accounting variables to proxy for size and costs of financial distress. It finds that internationally oriented Chinese companies have experienced exchange exposure particularly against the yen. It also finds that, against a trade-weighted index, there is no empirical evidence that Chinese firms are engaged in hedging activities. However, when exposures are measured in yen terms, it finds that Chinese firms, particularly exporters, engage in active currency hedging.
The purpose of this paper is to investigate the sensitivity of firm value to exchange rate (ER) movements, and the determinants of such exposure for 100 European blue chip…
The purpose of this paper is to investigate the sensitivity of firm value to exchange rate (ER) movements, and the determinants of such exposure for 100 European blue chip companies over 2001-2012.
The authors adopt a disaggregated framework that distinguishes between Eurozone and non-Eurozone firms, and between financial and non-financial firms across the pre-crisis, crisis and post-crisis periods of the recent financial crisis.
The authors find no significant difference between Eurozone and non-Eurozone, and financial and non-financial firms. Exposure is found to be higher during the financial crisis, across all sub-samples of firms. In the majority of cases the exposure coefficient is significantly positive, indicating that European firms’ stock returns are positively (negatively) affected by depreciation (appreciation) of ERs (indirect quotation).
It is recommended that firms’ financial plans budget for higher liquidity levels in order to build up, during “good times”, a natural hedge for the higher exposure likely to be faced during periods characterized by greater financial distress.
The main novelty lies in the adoption of a disaggregated framework that discriminates between pre-crisis, crisis and post-crisis periods in order to ascertain the extent to which the recent financial crisis affected the relationship in question.
In the last two decades, a number of studies have examined the risk management practices within nonfinancial companies. For instance, some studies report on the use of…
In the last two decades, a number of studies have examined the risk management practices within nonfinancial companies. For instance, some studies report on the use of derivatives by nonfinancial firms. Yet, another group of researchers has investigated the determinants of corporate hedging policies. These and other studies of similar focus have made important contributions to the literature. This study sheds light on derivatives use and risk management practices in the UK market.
This paper presents the results of a questionnaire survey, which focused on determining the reasons for using or not using derivatives for 401 UK nonfinancial companies. Furthermore, it investigates the extent to which derivatives are used, and how they are used.
The results indicate that larger firms are more likely to use derivatives than medium and smaller firms, public companies are more likely to use derivatives than private firms, and derivatives usage is greatest among international firms. The results also show that, of firms not using derivatives, half of firms do not use these derivative instruments because their exposures are not significant and that the most important reasons they do not use derivatives are: concerns about disclosures of derivatives activity required under FASB rules, and costs of establishing and maintaining derivatives programmes exceed the expected benefits. The results show that foreign exchange risk is the risk most commonly managed with derivatives and interest rate risk is the next most commonly managed risk. The results also indicate that the most important reason for using hedging with derivatives is managing the volatility in cash flows.
As with other survey research, a major limitation is that responses might represent personal opinions. We cannot verify that the opinions coincide with actions. We suggest that further research could improve the understanding of firms’ derivatives use by including more detailed data, different time spans, and larger samples.
To highlight the extent of derivatives usage and risk management practices in UK nonfinancial companies.
Financial theory predicts that a change in an exchange rate should affect the value of a firm or an industry. To a large extent, past research has not supported this…
Financial theory predicts that a change in an exchange rate should affect the value of a firm or an industry. To a large extent, past research has not supported this theory, which is surprising especially after considering the substantial exchange rate fluctuations over the three decades. This study seeks to extend previous research on the foreign exchange rate exposure of UK nonfinancial companies at the industry level over the period 1981‐2001.
In this study, exchange rate exposure is defined as the change in the value of the firm or industry due to the changes in exchange rates. This study differs from previous studies in that it considers the impact of the changes (actual and unexpected) in exchange rates on firms’ or industries’ stock returns. The approach employs OLS model to estimate foreign exchange rate exposure of 364 UK nonfinancial companies over the period 1981‐2001. All data are collected from the Datastream database.
The findings indicate that a higher percentage of UK industries are exposed to contemporaneous exchange rate changes than those reported in previous studies. There is also evidence of significant lagged exchange rate exposure. This lagged exchange rate exposure is consistent with findings in previous studies that may exist some market inefficiencies in incorporating exchange rate changes into the returns of firms and industries.
Future research in the area should consider additional factors that might affect a firm's and an industry's exposure to exchange rate changes.
The findings of the study have interesting implications for public policy makers who wish to understand links between policies that affect exchange rates and relative wealth affects. These findings should also be of particular importance to investors who under or overweight large multinational corporations.
The study extends previous research on foreign exchange rate exposure of UK companies.