Does derivatives use reduce the cost of equity?

Abstract

This paper examines the impact of hedging on the cost of equity capital. Using handcollected data on derivatives use for a sample of German non-financial firms, we find that user firms have a 109 basis point lower industry-adjusted cost of equity than non-users. This reduction in the cost of equity of users is attributable to their lower market, size, and value risk factor exposures. The observed negative relation between derivatives use and the cost of equity remains robust to specifications that account for potential endogeneity arising from a firm's derivatives hedging and capital structure decisions. We find that the reduction in the cost of equity is largest for smaller firms and for firms making use of foreign currency and interest rate derivatives. Moreover, new derivatives users experience a significant reduction in the cost of equity in the first year of adoption. Finally, using expected default frequency data, we show direct evidence that firms' derivatives use reduces financial distress risk.

Research on the Effect of Executive Incentive Institutional Innovation on the Cost of Equity—Evidence From Chinese Listed Companies

“…The second is the risk compensation method, or “ex post,” as used in the Gorden and CAPM models. Equity cost was calculated using historical data in the Fama–French three-factor model (Fama and French, 1993 ; Chen et al, 2013 ; Ahmed et al, 2018 ; Shen and Zhang, 2020 ; Luong et al, 2021 ; Rjiba et al, 2021 ). All five models provide a reasonable estimate of the cost of equity.…”

“…Also, the calculation method using the higher-order equation is relatively complex. Thus, based on the method used by most scholars (Chen et al, 2013 ; Ahmed et al, 2018 ; Chu et al, 2020 ; Pfister et al, 2020 ; Shen and Zhang, 2020 ; Husser and Paulet, 2021 ; Luong et al, 2021 ; Rjiba et al, 2021 ), after considering the available parameters, we adopted four models—Gorden, PEG, CAPM, and OJ—to calculate the cost of equity as follows:…”

“…Shen and Zhang ( 2020 ) investigated the relationship between CEOs' internal debt and the cost of equity. Ahmed et al ( 2018 ) found that the investment of corporate derivative instruments can reduce the cost of equity. Thus, this paper is the first to fully discuss the governance effect of executive incentives (mainly executive compensation incentives) on the cost of equity, considering China's unique characteristics.…”

An innovative tool for cost control under fragmented scenarios: The container freight index microinsurance

“…On the other hand, there is no effective financial derivative for container freights, which makes SMIEEs helpless towards fluctuations of container freights. Previous studies indicate that financial derivatives can be used to significantly reduce business costs and financial risks for non-financial enterprises ( Gay et al, 2011 , Ahmed et al, 2018 ) and reduce logistic costs and increase firm value in the shipping industry ( Kavussanos and Visvikis, 2006 , Tsai et al, 2009 ). From a practical perspective, the development of global container freight derivatives is far behind the development of dry bulk cargo and tanker freight derivatives, which is unfavorable to controlling the additional costs caused by the fluctuation of freights.…”

Does hedge disclosure influence cost of capital for European banks?

“…The heavy reliance on quantitative information over the years as a proxy for hedging is perhaps because of the difficulties in capturing and quantifying such information from corporate disclosure (Acheampong & Elshandidy, 2021), as it require rigorous data processing and becomes challenging with regards to data dimensionality. Also, prior studies focus largely on markets outside Europe and less attention is given to financial firms (e.g., Ahmed et al, 2018;Bartram et al, 2011;Carter et al, 2006;Gay et al, 2011). Our paper therefore bridges these gaps by adopting a different analytical lens to examine the association between textual hedge disclosure and cost of capital of European banks over a thirteen-year period.…”