How do firms manage their interest rate exposure?

Abstract

Purpose This paper aims to identify how non-financial firms manage their interest rate (IR) exposure. IR risk is complex, as it comprises the unequal cash flow and fair value risk. The paper is able to separate both risk types and investigate empirically how the exposure is composed and managed, and whether firms increase or decrease their exposure with derivative transactions. Design/methodology/approach The paper examines an unexplored regulatory environment that contains publicly reported IR exposure data on the firms’ exposures before and after hedging. The data were complemented by indicative interviews with four treasury executives of major German corporations, including two DAX-30 firms, to include professional opinions to validate the results. Findings The paper provides new empirical insights about how non-financial firms manage their interest rate exposure. It suggests that firms use hedging instruments to swap from fixed- to floating-rate positions predominantly in the short-to medium-term, and that 63 [37] per cent of IR firm exposure are managed using risk-decreasing [risk-increasing/-constant] strategies. Practical implications Interviewed treasury executives suggest that the advanced disclosures benefit various stakeholders, ranging from financial analysts and shareholders to potential investors through more meaningful analyses on firms’ risk management activities. Further, the treasury executives indicate that the new data granularity would enable firms to carry out unprecedented competitive analyses and thereby benchmark and improve their own risk management. Originality/value The paper is the first empirical study to analyze the interest rate activities of non-financial firms based on actually reported exposure data before and after hedging, rather than using proxy variables. In addition, the new data granularity enables a separate analysis of the cash flow and fair value risk to focus on the non-financial firms’ requirements.

The role of managerial characteristics in FX risk management: Who increases risk?

“…Between the hedge ratio range of −2 < HR < −1 , the overhedging changes the sign of the exposure, which could be a sign for speculative intentions. However, Hecht and Lampenius (2019) demonstrate that these positions have a mean of HR − 1.18 and attribute this only slight under-/overhedging to imperfect hedge conditions in the real world (Hull 2015), which is why we classify such positions as risk-decreasing. Within the limits of −2 < HR < 0 market views in the context of selective hedging (e.g., Adam et al 2015;Beber and Fabbri 2012;Glaum 2002) may also be included in the hedging decision, but due to the general reduction of the exposure, we classify this strategy as risk-decreasing and therefore clearly distinguish it from a risk-increasing or a risk-constant strategy.…”

“…4 In position paper n°2009-16 (Autorité des Marchés Financiers 2009) in the FX reporting section, the AMF recommends risk management disclosures on exposures before and after hedging that by far exceed the specifications of IFRS 7.33 and 7.34. In analogy to Hecht and Lampenius (2019), "Appendix 1" illustrates the recommended format of FX information by the AMF.…”

“…We do so by calculating firm-, year-and currency-specific hedge ratios ( HR ), i.e., the percentage of FX exposure covered by derivative instruments. In line with Hecht (2019) and Hecht and Lampenius (2019), we define the hedge ratio in t (HR t ) as HR t = H t ∕E b t , where H t denotes the hedging instruments and E b t the exposure before hedging in t . Note that both the hedging instruments, i.e., nominal volumes, ( H ) and the exposure before hedging ( E b ) can be long and short, i.e., positive and negative, consequently also HR can take positive and negative values.…”

“…Firms use derivative instruments to decrease or increase their risk exposure, or in other words, these financial contracts are used for hedging or speculative purposes in corporate risk management (e.g., Allayannis and Ofek 2001;Géczy et al 2007;Hecht 2019;Hecht and Lampenius 2019;Hentschel and Kothari 2001). While the literature on the determinants of hedging and speculative strategies traditionally focused on firm characteristics, several recent studies indicate the influence of managerial characteristics on risk management choices.…”

The Mystery of Zero-Leverage Firms: Evidence from Nigerian Quoted Firms

“…In terms of firm size, small firms, when borrowing funds, usually encounter higher informational costs. Further, smaller firms may experience high ex-ante costs of financial weakness, especially if they cannot afford to diversify in a manner that their investors could not have replicated (Giambona, Graham, Harvey & Bodnar, 2018;Hecht, 2019;Buckley, Chen, Clegg & Voss, 2020). Small firms may also have lower debt capacity, particularly if their size is closely associated with lower tangible assets-in-place.…”