Effect of Finanacial Hedging on the Incentives for Corporate Diversification: The Role of Stakeholder Firm-Specific Investments

18 Pages Posted: 20 Jul 2007  

Sonya S. Lim

DePaul University - Department of Finance

Heli C. Wang

Hong Kong University of Science & Technology (HKUST) - Department of Management & Organization

Abstract

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.

Keywords: Risk management, Financial hedging, Corporate diversification, Stakeholders, Firm-specific investments

JEL Classification: G30, L29

Suggested Citation

Lim, Sonya S. and Wang, Heli C., Effect of Finanacial Hedging on the Incentives for Corporate Diversification: The Role of Stakeholder Firm-Specific Investments. Journal of Economic Behavior and Organization, Vol. 62, 2007; HKUST Business School Research Paper No. 07-17. Available at SSRN: https://ssrn.com/abstract=1001887

Sonya S. Lim (Contact Author)

DePaul University - Department of Finance ( email )

1 East Jackson Blvd.
Chicago, IL 60604-2287
United States

HOME PAGE: http://sites.google.com/site/sonyalim/

Heli Wang

Hong Kong University of Science & Technology (HKUST) - Department of Management & Organization ( email )

Clear Water Bay, Kowloon
Hong Kong

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