Investor Reactions to Derivative Use: Experimental Evidence
43 Pages Posted: 26 Feb 2006
Date Written: February 15, 2006
How do investors evaluate managers who choose to use or not use derivatives once the outcomes of those decisions become known? Competing theories make different predictions, and we test these in three experiments. Results show that even when outcomes are held constant, investors are more satisfied and assign a higher value to a company that uses derivatives than to one that does not use derivatives. This finding is consistent with decision justification theory. Additional tests reveal that this result occurs because investors believe that firm managers who use derivatives to address risk exposures exhibit a higher level of decision-making care. In contrast, we find that speculative use of derivatives is not assumed to result from careful thought, resulting in harsher judgments about management. Overall, our study adds to our understanding of how investors judge companies who use derivatives, given the outcomes that result from such use.
Keywords: Derivatives, valuation, judgment and decision making
JEL Classification: M41, G12, G30
Suggested Citation: Suggested Citation