CEO Entrenchment and Corporate Hedging: Evidence from the Oil and Gas Industry

Abstract

Using a unique data set with detailed information on the derivative positions of upstream oil and gas firms during 1996–2008, we find that hedging intensity is positively related to factors that amplify chief executive officer (CEO) entrenchment and free cash flow agency costs. There is also robust evidence that hedging is motivated by the reduction of financial distress and borrowing costs, and that it is influenced by both intrinsic cash flow risk and temporary spikes in commodity price volatility. We present a comprehensive perspective on the determinants of corporate hedging, and the results are consistent with the predictions of the risk management and agency costs literatures.

Policy uncertainty, derivatives use, and firm-level FDI

“…In contrast, Charumathi and Kota (2012) state that no evidence exists to support this hypothesis. Supanvanij and Strauss (2010) find that tax loss carry-forwards are an important factor in determining the use of foreign currency derivatives, while Kumar and Rabinovitch (2013) indicate that firms use derivatives to increase the present value of tax losses. In contrast, Gay, Lin, and Smith (2011) do not find any evidence in support of the tax incentive to increase debt capacity.…”

CEO entrenchment and corporate liquidity management

“…Ghosh et al (2011) find that firms with an entrenched CEO use less leverage and issue debt with shorter maturities to reduce liquidity risk and to preserve their ability to enhance their wages and reputations through empire building. Kumar and Rabinovitch (2013) also find that firms with an entrenched CEO are more likely to engage in hedging to diminish firm risks. 3 Studies on the effect of agency conflict on corporate liquidity policy have generally focused on the cash component of liquidity and, overall, find that entrenched managers hold greater than optimal levels of cash and are likely to misuse the freely available cash for their own purposes (Jensen, 1986;Dittmar et al, 2003;Chen and Chuang, 2009).…”

CEO Tenure and Risk-Taking

“…We believe the direct effect of CEO tenure on risk-taking may be subject more to this omitted variable bias. In this case, because the correlation between CEO tenure and hedging is uncertain based on the evidence in the literature (Tufano, 1996;Kumar and Rabinovitch, 2013), the direction of the bias is also ambiguous.…”