Do Firms Hedge During Distress?
51 Pages Posted: 10 Jun 2019
Date Written: May 20, 2019
Firms are less likely to use derivatives as they approach distress, even though theory predicts risk management is more valuable then. By expanding the definition of hedging to include purchase obligations (POs) – non-cancelable forward contracts with suppliers – we are able to understand how firms hedge and whether hedging matters. Firms rely on POs during distress, often switching from derivatives to these contracts. Firms also initiate POs in response to liquidity shocks. Moreover, compared to derivatives, PO hedging enables higher investment levels during distress. Firms adjust – but do not cease – hedging when constrained and this mitigates underinvestment.
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