Corporate Hedging and Collateral Constraints: Evidence from a Difference-in-Difference Approach

Abstract

Financially constrained firms have incentives to hedge in order to protect against declines in their financial status. Conversely, lack of collateral may prevent them from doing so. We bring evidence from a difference-in-difference approach to shed light on this central question in corporate hedging theory. We use hand-collected data from the oil and gas industry that incorporates an exogenous shock that sharply increased the cost of external financing. The evidence supports collateral-based theories of risk management. We document a broad absolute decrease in the use of hedging and a significant relative decrease in hedging in financially constrained firms.

Keywords: Corporate hedging; financial distress, risk management, financial constraints, collateral constraints

JEL Classification: G30, G32