THE IMPACT OF DERIVATIVES USE ON FIRM VALUE: DO SMALLER FIRMS BENEFIT MORE? (EVIDENCE FROM BORSA ISTANBUL)

Abstract

While the impact of derivatives use on firm value is still debated theoretically and empirically, whether smaller or larger firms benefit more from the use of derivatives is largely untouched empirically. In this context, the impact of the intensity of derivatives use on firm value separately for smaller and larger firms using derivatives is analyzed with the 2010-2021 annual data of 70 non-financial Borsa Istanbul (BIST) firms. Difference and System Generalized Method of Moments (GMM) estimation results of the dynamic panel data model show that derivatives use positively and significantly affects firm value in smaller firms, and there is no significant effect of derivatives use on firm value in larger firms. Theories proposing that derivatives use can increase firm value are valid for smaller firms. On the other hand, in BIST, smaller firms benefit more than larger firms from derivatives use. The results of the analysis are also consistent with theories suggesting that the value-enhancement effects of derivatives use for hedging are concentrated in smaller firms. The results are encouraging for smaller firms discussing the decision related to financial risk management with derivatives.

Keywords

• Financial risk management
• Derivatives
• Hedging
• Firm value
• Panel data

References

1. Akpinar, O., & Fettahoglu, A. (2016). Does the use of derivatives affect firm value? Evidence from Turkey. Journal of Transnational Management, 21(2), 53-61.
2. Allayannis, W., & Weston, J. P. (2001). The use of foreign currency derivatives and firm market value. The Review of Financial Studies, 14(1), 243-276.
3. Anderson, T. W., & Hsiao, C. (1982). Formulation and estimation of dynamic models using panel data. Journal of Econometrics, 18(1), 47-82.
4. Arellano, M., & Bond, S. (1991). Some tests of specification for panel data: Monte carlo evidence and an application to employment equations. The Review of Economic Studies, 58(2), 277-297.
5. Arellano, M., & Bover, O. (1995). Another look at the instrumental variable estimation of error-components models. Journal of Econometrics, 68(1), 29-51.
6. Ayturk Y., Gurbuz A. O., & Yanik S., (2016). Corporate derivatives use and firm value: Evidence from Turkey. Borsa Istanbul Review, 16(2), 108-120.
7. Banks, E. (2004). Alternative risk transfer: Integrated risk management through insurance, reinsurance and the capital markets. John Wiley & Sons.
8. BIS (the Bank for International Settlements), (2009). Issues in the Governance of Central Banks. BIS Publication.

9. Blundell, R., & Bond, S. (1998). Initial conditions and moment restrictions in dynamic panel data model. Journal of Econometrics, 87(1), 115-143.
10. Campbell, T. S., & Kracaw, W. A. (1987). Optimal managerial incentive contracts and the value of corporate insurance. The Journal of Financial and Quantitative Analysis, 22(3), 315-328.
11. Clark, E., & Mefteh, S. (2010). Foreign currency derivatives use, firm value and the effect of the exposure profile: Evidence from France. International Journal of Business, 15(2), 183-196.
12. COSO (the Committee of Sponsoring Organizations of the Treadway Commission). (2004). Enterprise Risk Management: Integrated Framework. Retrieved from https://egrove.olemiss.edu/aicpa_assoc/38/ Accessed December 3, 2022
13. DeMarzo, P. M., & Duffie, D. (1995). Corporate incentives for hedging and hedge accounting. The Review of Financial Studies, 8(3), 743-771.
14. Demsetz, H., & Lehn, K. (1985). The structure of corporate ownership: Causes and consequences. Journal of Political Economy, 93(6), 1155-1177.
15. Dionne, G. (2013). Risk management: History, definition, and critique. Risk Management and Insurance Review, 16(2), 147-166.
16. Dolde, W. (1993). The trajectory of corporate financial risk management. Journal of Applied Corporate Finance, 6(3), 33-41.
17. Fabozzi, F. J., & Drake, P. P. (2009). Capital markets, financial management, and investment management. John Wiley & Sons.
18. Froot, K. A., Scharfstein, D. S., & Stein, J. C. (1993). Risk management: Coordinating corporate investment and financing policies. The Journal of Finance, 48(5), 1629-1658.
19. Garcia, F. J. B. (2017). Financial risk management. Palgrave Macmillan.
20. Guay, W., & Kothari, S. P. (2003). How much do firms hedge with derivatives?. Journal of Financial Economics, 70(3), 423–461.
21. Haushalter, G. D. (2000). Financing policy, basis risk, and corporate hedging: Evidence from oil and gas producers. The Journal of Finance, 55(1), 107-152.
22. Jensen, M. C., & Meckling, W. H. (1976). Theory of the firm: Managerial behavior, agency costs and ownership structure. Journal of Financial Economics, 3(4), 305-360.
23. Jensen, M.C. (1986). Agency costs of free cash flow, corporate finance, and takeovers. The American Economic Review, 76(2), 323-329.
24. Junior, J. L. R., & Laham, J. (2008). The impact of hedging on firm value: Evidence from Brazil. Journal of International Finance & Economics, 8(1), 1-16.
25. Lee, H. (2021). Risk management. Springer.
26. Lintner, J. (1965). The valuation of risk assets and the selection of risky investments in stock portfolios and capital budgets. Review of Economics and Statistics, 47(1), 13–37.
27. Lintner, J. (1969). The Aggregation of Investor's Diverse Judgments and Preferences in Purely Competitive Security Markets. Journal of Financial and Quantitative Analysis, 4(4), 347-400.
28. Loncan, T. R., & Caldeira, J. F. (2014). Capital Structure, Cash Holdings and Firm Value: a Study of Brazilian Listed Firms. Revista Contabilidade & Finanças, 25(64), 46-59.
29. MacMinn, R. D. (1987). Forward markets, stock markets, and the theory of the firm. The Journal of Finance, 42(5), 1167-1185.
30. Marami, A., & Dubois, M. (2013). Interest rate derivatives and firm Value: Evidence from mandatory versus voluntary hedging. Retrieved from https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2336094 Accessed February 22, 2023
31. Markowitz, H. (1952). Portfolio selection. Journal of Finance, 7(1), 77–99.
32. Modigliani, F., & Miller, M. H. (1958). The cost of capital, corporation finance and the theory of investment. The American Economic Review, XLVIII(3), 261-297.
33. Modigliani, F., & Miller, M.H. (1963). Corporate income taxes and the cost of capital: A correction. The American Economic Review, 53(3), 433-443.
34. Mossin, J. (1966). Equilibrium in a capital asset market. Econometrica, 34(4), 768-783.
35. Mowbray, A. H., Blanchard, R. H., & Williams, C. A. (1969). Insurance: Its theory and practice in the United States (6th ed.). McGraw-Hill.
36. Nova, M., Cerqueira, A., & Brandao, E. (2015). Hedging with derivatives and firm value: Evidence for the nonfinancial firms listed on the London Stock Exchange. FEP Working Papers, No: 568.
37. Rogers, J. (2019). Strategy, value and risk (4th ed.). Palgrave Macmillan.
38. Sargan, J. D. (1958). The estimation of economic relationships using instrumental variables. Econometrica, 26(3), 393-415.
39. Sharpe, W. F. (1964). Capital asset prices: A theory of market equilibrium under conditions of risk. The Journal of Finance, 19(3), 425-442.
40. Smith, C. W. (1995). Corporate risk management: Theory and practice. The Journal of Derivatives, 2(4), 21-30.
41. Smith, C. W., & Stulz, R. M. (1985). The determinants of firms' hedging policies. The Journal of Financial and Quantitative Analysis, 20(4), 391-405.
42. Stulz, R. M. (1984). Optimal hedging policies. The Journal of Financial and Quantitative Analysis, 19(2), 127-140.
43. Stulz, R. M. (1990). Managerial discretion and optimal financing policies. Journal of Financial Economics, 26(1), 3-27.
44. Tobin, J. (1969). A general equilibrium approach to monetary theory. Journal of Money, Credit and Banking, 1(1), 15-29.
45. Treynor, J. L. (1961). Market value, time, and risk. Unpublished manuscript dated 8/8/61, #95–209.
46. Vaughan, E. J., & Vaughan, T. (2008). Fundamentals of risk and insurance (10th ed.). John Wiley & Sons.
47. Wald, A. (1943). Tests of statistical hypotheses concerning several parameters when the number of observations is large. Transactions of the American Mathematical Society, 54(3), 426-482.
48. Warner, J. B. (1977). Bankruptcy costs: Some evidence. The Journal of Finance, 32(2), 337-347.
49. Yu, Y. (2021). The relationship between the use of derivatives and firm value under different economic cycles. Master’s thesis, Concordia University. Retrieved from https://spectrum.library.concordia.ca/id/eprint/988492/ Accessed November 15, 2022
50. www.kap.org.tr (the Public Disclosure Platform-PDP)
51. www.bis.org (the Bank for International Settlements-BIS)
52. www.tcmb.gov.tr (the Central Bank of the Republic of Turkey-CBRT)