Effect of Finanacial Hedging on the Incentives for Corporate Diversification: The Role of Stakeholder Firm-Specific Investments
Sonya S. Lim
DePaul University - Department of Finance
Heli C. Wang
Hong Kong University of Science & Technology (HKUST) - Department of Management & Organization
Journal of Economic Behavior and Organization, Vol. 62, 2007
HKUST Business School Research Paper No. 07-17
Financial hedging and corporate diversification are often considered substitutive means of risk management, implying that rapid development of financial hedging markets will yield less need for firms to manage risk through costly diversification. Building on a stakeholder-based view of risk management, we show that financial hedging and corporate diversification are more often complementary than substitutive. Financial hedging reduces a firm's systematic risk, encouraging firm-specific investment by stakeholders. Larger firm-specific investment loads excessive idiosyncratic risk on the stakeholders, increasing the benefits of reducing idiosyncratic risk through diversification. Therefore, financial hedging can increase a firm's incentives to manage risk through diversification.
Number of Pages in PDF File: 18
Keywords: Risk management, Financial hedging, Corporate diversification, Stakeholders, Firm-specific investments
JEL Classification: G30, L29
Date posted: July 20, 2007
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