Does Hedging Affect Firm Value? Evidence from the Us Airline Industry

34 Pages Posted: 19 Jun 2006

See all articles by David Carter

David Carter

Oklahoma State University - Stillwater - Department of Finance

Daniel A. Rogers

Portland State University - School of Business Administration

Betty J. Simkins

Oklahoma State University - Stillwater - Department of Finance

Abstract

Does hedging add value to the firm, and if so, is the source of the added value consistent with hedging theory? We investigate jet fuel hedging behavior of firms in the US airline industry during 1992-2003 to examine whether such hedging is a source of value for these companies. We illustrate that the investment and financing climate in the airline industry conforms well to the theoretical framework of Froot, Scharfstein, and Stein (1993). In general, airline industry investment opportunities correlate positively with jet fuel costs, while higher fuel costs are consistent with lower cash flow. Given that jet fuel costs are hedgeable, airlines with a desire for expansion may find value in hedging future purchases of jet fuel. Our results show that jet fuel hedging is positively related to airline firm value. The coefficients on the hedging variables in our regression analysis suggest that the "hedging premium" is greater than the 5% documented in Allayannis and Weston (2001), and might be as large as 10%. We find that the positive relation between hedging and value increases in capital investment, and that most of the hedging premium is attributable to the interaction of hedging with investment. This result is consistent with the assertion that the principal benefit of jet fuel hedging by airlines comes from reduction of underinvestment costs.

Suggested Citation

Carter, David A. and Rogers, Daniel A. and Simkins, Betty J., Does Hedging Affect Firm Value? Evidence from the Us Airline Industry. Financial Management, Vol. 35, No. 1, Spring 2006. Available at SSRN: https://ssrn.com/abstract=909669

David A. Carter (Contact Author)

Oklahoma State University - Stillwater - Department of Finance ( email )

Spears School of Business
Stillwater, OK 74078-4011
United States
405-744-5104 (Phone)
405-744-5180 (Fax)

Daniel A. Rogers

Portland State University - School of Business Administration ( email )

P.O. Box 751
Portland, OR 97207-0751
United States
503-725-3790 (Phone)
503-725-5850 (Fax)

Betty J. Simkins

Oklahoma State University - Stillwater - Department of Finance ( email )

336 Business Building
Stillwater, OK 74078-4011
United States
405-744-8625 (Phone)
405-744-5180 (Fax)

HOME PAGE: http://spears.okstate.edu/~simkins

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