Hedging, Investment Efficiency, and the Role of the Information Environment

Journal of Accounting, Auditing, and Finance, Forthcoming

47 Pages Posted: 28 Feb 2020

See all articles by Gerald J. Lobo

Gerald J. Lobo

University of Houston - C.T. Bauer College of Business

Tharindra Ranasinghe

American University

Lin Yi

University of Houston, Clear Lake

Date Written: February 7, 2020

Abstract

Extant theories suggest that managers may use hedging either to alleviate underinvestment problems caused by costly external financing or to promote overinvestment by circumventing the scrutiny of external capital markets. We empirically investigate this issue using a hand-collected dataset of hedging and investment behavior of oil and gas exploration and production firms. We do not find evidence that hedging alleviates underinvestment problems. However, we do find a strong positive relation between the extent of hedging and the propensity to overinvest. Further analyses indicate that the relation between hedging and overinvesting is stronger in settings where the firms’ information environment is more transparent. A more transparent information environment makes it easier for outside capital providers to distinguish between value enhancing and value destroying investment decisions, so that greater discretion over internally generated funds becomes more valuable to overinvesting managers. Our study highlights the role of hedging in facilitating overinvestment and the conditions under which this role is likely to be more salient.

Keywords: Derivatives, Hedging, Investment efficiency, Information environment

JEL Classification: G31, G32, M40, M41, M42

Suggested Citation

Lobo, Gerald J. and Ranasinghe, Tharindra and Yi, Lin, Hedging, Investment Efficiency, and the Role of the Information Environment (February 7, 2020). Journal of Accounting, Auditing, and Finance, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3534871

Gerald J. Lobo

University of Houston - C.T. Bauer College of Business ( email )

Houston, TX 77204-6021
United States
713-743-4838 (Phone)
713-743-4828 (Fax)

HOME PAGE: http://www.bauer.uh.edu/acct/acctprofile.asp?search=Gerald%20Lobo

Tharindra Ranasinghe (Contact Author)

American University ( email )

United States

Lin Yi

University of Houston, Clear Lake ( email )

2700 Bay Area Blvd. Box 42
Houston, TX 77058
United States

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