Corporate Hedging and Capital Structure Decisions: Towards an Integrated Framework for Value Creation

Abstract:     
We suggest a joint optimization model for a firm's hedging and leverage decisions that helps to establish an integrated framework for value creation. Rather than artificially separating the two interrelated parts of the firm's financial policy, we treat both corporate decision variables as endogenous. We argue that exogenous differences between financial distress costs across firms, and particularly across industries, simultaneously influence corporate risk management and capital structure decisions. Using anecdotal evidence, our focus is not on so-called direct bankruptcy costs, but rather on the cross-sectional variation in indirect bankruptcy costs, which may result from a deterioration of relationships with customers, suppliers or other stakeholders prior to the legal act of bankruptcy.

Keywords: corporate hedging, risk management, capital structure, leverage, bankruptcy costs

JEL Classification: D81, G33

Accepted Paper Series