Hedging by Firms: A Managerial Control Perspective

We develop an agency model of the firm to explain the mixed empirical findings concerning the desirability of different forms of hedging: operating hedging either acting alone or in conjunction with financial hedging is only sometimes value-enhancing, but financial hedging acting alone always adds to firm value. Existing models of hedging cannot explain these mixed findings. We then go beyond the existing empirical findings and obtain necessary and sufficient conditions for operating hedging alone to add to firm value, and we identify empirically verifiable sufficient conditions for integrated risk management to increase firm value. The key to our predictions lies in identifying the circumstances under which firms' preferences for hedging either align or conflict with the firms' managers' preferences for hedging.