The Underinvestment Problem and Corporate Derivatives Use

Financial Management, Vol. 27, No. 4, Winter 1998

Posted: 12 Feb 1999

See all articles by Gerald D. Gay

Gerald D. Gay

Georgia State University - Department of Finance

Jouahn Nam

Pace University - Lubin School of Business

Abstract

We analyze the underinvestment problem as a determinant of corporate hedging policy. We find evidence of a positive relation between a firm?s derivatives use and its growth opportunities, as proxied by several alternative measures. For firms with enhanced investment opportunities, derivatives use is greater when they also have relatively low cash stocks. Firms whose investment expenditures are positively correlated with internal cash flows tend to have smaller derivatives positions which suggests potential natural hedges. Our findings support the argument that firms? derivatives use may partly be driven by the need to avoid potential underinvestment problems.

JEL Classification: G31, G32

Suggested Citation

Gay, Gerald D. and Nam, Jouahn, The Underinvestment Problem and Corporate Derivatives Use. Financial Management, Vol. 27, No. 4, Winter 1998. Available at SSRN: https://ssrn.com/abstract=144202

Gerald D. Gay (Contact Author)

Georgia State University - Department of Finance ( email )

Robinson College of Business
Atlanta, GA 30303-3083
United States
404-413-7321 (Phone)
404-413-7312 (Fax)

Jouahn Nam

Pace University - Lubin School of Business ( email )

1 Pace Plaza
New York, NY 10038-1502
United States
212-346-1818 (Phone)
212-346-1573 (Fax)

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