The Determinants of the Corporate Hedging Decision: An Empirical Analysis

Abstract

This paper is concerned with testing the hypotheses put forth by Smith and Stulz (1985) and Nance, Smith and Smithson (1993) regarding the four reasons for which a firm will hedge. In this paper, we extend the analysis by assuming that the factors influencing the decision to hedge are different from those influencing the decision on the level of hedging. Our results show that hedgers had lower investment tax credits, had lower fixed claims coverage, were larger, issued more preferred shares, were less liquid, and maintained higher levels of reserves, while the tax level, expenditures on research and development, management ownership, and the level of reserves may influence the decision on the level of hedging. Our results suggest that, indeed, the variables that decide whether or not a firm hedges are quite different from those determining the level of hedging it will engage in. The results from our study indicate that the probability of hedging and the amount of hedging are also influenced by the industry to which a firm belongs.