Hedging, Investment Efficiency, and the Role of the Information Environment
Journal of Accounting, Auditing, and Finance, Forthcoming
47 Pages Posted: 28 Feb 2020
Date Written: February 7, 2020
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: Suggested Citation