Why Firms Use Derivatives: Evidence from New Zealand
28 Pages Posted: 25 Aug 2010
Date Written: January 23, 2010
The objective of this paper was to find the underlying motives for using foreign exchange derivatives by non-financial companies listed on the New Zealand stock exchange and to identify which existing theories of derivatives are the most appropriate for the New Zealand corporate sector. We used logistic regression, Pearson correlation and univariate analysis methods to test four different hedging theories – foreign risk theory, scale economies, underinvestment theory and theory of financial distress. Support is found for scale economies theory – larger firms are more likely to hedge with foreign currency derivatives. This can be explained by financial constraints which small and start-up companies may face. We also find that larger firms use hedging for speculation purposes if shareholders consider it a profit-making activity. The results provide no support for any of the other three tested theories – the proportion of foreign sales, leverage, capital expenses and R&D expenses appear to be weak incentives to use foreign exchange derivatives.
JEL Classification: J23
Suggested Citation: Suggested Citation