Time-Inconsistent Investment, Financial Constraints, and Cash Flow Hedging

Posted: 11 Dec 2013 Last revised: 5 Jan 2015

See all articles by Donald D. Lien

Donald D. Lien

University of Texas at San Antonio - College of Business - Department of Economics

Chia-Feng (Jeffrey) Yu

University of Adelaide - Business School; Financial Research Network (FIRN)

Date Written: June 19, 2014

Abstract

This paper studies the interplay between firm investment and cash flow hedging decisions when the decision-maker has time-inconsistent preferences. We show that cash flow hedging acts as a double-edged sword. In some cases, cash flow hedging enhances firm value because the firm can thus invest at the firm-value-maximizing timing. In other cases, however, cash flow hedging may adversely affect firm value because it loosens the financial constraint that works as a commitment device to mitigate premature investment. Our results thus highlight one unexplored potential dark side of hedging and suggest that the optimal hedging decision is the result of a trade-off between flexibility and commitment.

Keywords: Time-Inconsistent Preferences; Investment Timing; Financial Constraints; Cash Flow Hedging

JEL Classification: D92; G02; G11

Suggested Citation

Lien, Donald and Yu, Chia-Feng (Jeffrey), Time-Inconsistent Investment, Financial Constraints, and Cash Flow Hedging (June 19, 2014). International Review of Financial Analysis, Vol. 35, 2014. Available at SSRN: https://ssrn.com/abstract=2365611 or http://dx.doi.org/10.2139/ssrn.2365611

Donald Lien

University of Texas at San Antonio - College of Business - Department of Economics ( email )

6900 North Loop 1604 West
San Antonio, TX 78249
United States
210-458-4313 (Phone)
210-458-4308 (Fax)

Chia-Feng (Jeffrey) Yu (Contact Author)

University of Adelaide - Business School ( email )

10 Pulteney Street
Adelaide, SA 5005
Australia
+61-08-83132073 (Phone)

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

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