Hedging Affecting Firm Value via Financing and Investments: Evidence from Property Insurance Use

Abstract

The effect of corporate risk management on firm value has gained significant research attention in recent years but prior studies have invariably focused on the effects of derivatives use due to the lack of data on alternative corporate risk management activities. We provide evidence on the value effects of alternative risk management by examining corporate purchase of property insurance – a commonly used pure hedge of asset-loss risks. Using an insurance dataset from China, we find evidence that there is an inverted U-shape effect of the extent of property insurance use on firm value measured by several versions of Tobin’s Q. Therefore, the use of property insurance up to a certain degree has a positive effect on firm value, however, over-insurance appears detrimental to firm value. Given that the inflection points occur at relatively high levels of the observed insurance spending, insurance use appears beneficial to the majority of our sample firms. The estimated average hedging premium is about 1.5%. We show that one avenue for insurance to create value in China is that it helps firms secure valuable new debt financing and enhance investment.