Time-Inconsistent Investment, Financial Constraints, and Cash Flow Hedging
Posted: 11 Dec 2013 Last revised: 5 Jan 2015
Date Written: June 19, 2014
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: Suggested Citation