Foreign Currency Exposure and Hedging: Evidence from Foreign Acquisitions

Abstract

While theoretical research suggests that many firms should have significant exchange rate exposure, empirical research has documented a low stock price reaction to exchange rate movements. Against this backdrop, this paper examines a sample of U.S. firms that engage in large acquisitions abroad, entailing that exchange rate risk with regards to the currency of the target country is relevant for the sample firms around the time of the deal. Despite strong priors, the stock returns of the sample firms show empirically surprisingly little exchange rate exposure before or after the transaction. However, despite the fact that individual time-series estimates of currency exposure are frequently not statistically significant, the results show that they are still economically meaningful and significantly different from zero on average. While the propensity to use derivatives in the target currency increases with the size of the target firm, the use of derivatives or foreign currency debt overall does not seem to play much of role in managing currency risk in the context of foreign acquisitions. In contrast, there is evidence consistent with the foreign target firms providing operational hedging benefits to the acquiring firms that reduce the impact of exchange rate risk on their stock returns.

Keywords: Exchange Rates, Exposure, Hedging, Derivatives, Mergers, Acquisitions

JEL Classification: G3, F4, F3