Debt Financing and Risk Management
57 Pages Posted: 15 Jan 2021
Date Written: August 17, 2020
We obtain detailed data on bank lending agreements and derivative positions of U.S. oil and gas producers during the 1999-2019 period to study interactions between financing and hedging decisions. Using the emergence of fracking technology as an exogenous shock to firms' financing needs, we document sharp increases in debt financing accompanied by increased hedge ratios and longer hedge maturities. We document that bank lending contracts often include covenants that require hedging, with the majority specifying an explicit minimum. Our results support the interpretation that these hedge covenants are binding, and are structured to mitigate potential agency conflicts originating from the priority of derivatives in default and incentives for firms to speculate with derivatives. We also show that firms with bank-imposed hedging requirements perform better during the COVID-19 pandemic. Our results support the interpretation that firms' hedging decisions should be viewed as outcomes from constrained optimization shaped in part by prior financing choices.
Keywords: hedging, risk management, debt, covenants, credit boom
JEL Classification: G30, G32, G21
Suggested Citation: Suggested Citation