Taking a View: Corporate Speculation, Governance and Compensation

Abstract:     
Using a unique dataset from a well-known survey on derivatives use, this paper examines several questions about the use of derivatives to take a view on interest-rate and currency movements. Tests of what motivates firms to take a view suggest that they view speculation as a profitable activity. Firms specialize in taking a view on either interest rates or exchange rates, and specialization in FX contracts is positively related to the extent of the firm's foreign operations. However, the data do not support other theories of rational speculation such as the Campbell and Kracaw (1999) model. We also examine the association between speculation and governance mechanisms including compensation-based incentives, bonding contracts, and internal controls. Compensation-related incentives of the CFO, but not the CEO, are associated with the likelihood that a firm actively takes derivatives positions based on a market view. Moreover, firms with governance structures that allow for greater managerial power and indicate fewer shareholder rights, in general, are more likely to take a view, but these firms also have more extensive and sophisticated internal controls and monitoring mechanisms specifically related to derivatives activities. Finally, we examine whether investors using publicly available information in corporate disclosures could identify firms that openly admit to speculation in the confidential survey. The answer is that they cannot.

Number of Pages in PDF File: 54

Keywords: Speculation, Compensation, Governance

JEL Classification: G31, G34

working papers series