Determinants of corporate hedging decision evidence from Croatian and Slovenian companies

4 Criteria related to large Croatian companies: a value of total assets higher than 108 million kuna, 2 income in the last 12 months higher than 216 million kuna, and/or 3 annual number

Full length article

Danijela Milos Sprcica,∗, Zeljko Sevicb

a Faculty of Business and Economics Zagreb, J.F Kennedy 6, 10000 Zagreb, Croatia

b Caledonian Business School, Glasgow Caledonian University, Cowcaddens Road, Glasgow G4 0BA, Scotland, UK

Determinants of corporate hedging

Large non-financial companies

Croatia and Slovenia

a b s t r a c t

ThispaperpresentstheresearchresultsondeterminantsofporateriskmanagementdecisionsinlargeCroatianandSloveniannon-financialcompanies.Researchhasrevealedthattheexploredhedgingrationaleshavelittlepredictivepowerinexplainingcor-porateriskmanagementdecisionsbothinCroatianandSloveniancompanies.TheevidencebasedonbothunivariateandmultivariateempiricalrelationsbetweenthedecisiontohedgeinCroatiannon-financialcompaniesandfinancialdistresscosts,agencycosts,costlyexternalfinancing,taxes,managerialutilityandhedgesubstitutes,failstoprovideanysupportforanyofthetestedhypothesesbutone–costlyexternalfinancingmeasuredbyinvestmentexpenditures-to-assetsratio Thesame analysisconducted fortheSloveniancompanieshas shown that there is no statistically significantexplanatoryvariableforthedecisiontohedge;thereforeitisnotdependentonanyofthepredictedtheoriesofhedging

cor-© 2011 Elsevier B.V All rights reserved

∗ Corresponding author Tel.: +385 1 2383103; fax: +385 1 2335633.

E-mail addresses: dmilos@efzg.hr (D.M Sprcic), Zeljko.Sevic@gcal.ac.uk (Z Sevic).

1 The analysis of corporate risk management includes the group of financial risks; interest-rate, exchange-rate and commodity price risk management.

0275-5319/$ – see front matter © 2011 Elsevier B.V All rights reserved.

stemmingfrompricefluctuations– directlyorindirectlyinfluencethevalueofacompany.Whether

counterparts

companies

lines

2 Theorising the framework

and Titman,1998).In theMM world, financialdistress is assumed tobecostless Hence,

oth-ers,CampbellandKracaw(1987),Bessembinder(1991),Dolde(1995),Mian(1996)andHaushalter(2000)

and Soenen (1993) there are three sound reasons based on agency costs why

prob-lems (see Jensen and Smith, 1985) Finally, hedging reduces the probability of financial

Bessembinder(1991),MintonandSchrand(1999)andHaushalteretal.(2002)supportthishedgingrationale

(1996)

bySmithandStulz(1985).Resultsofsomeempiricalstudieshaveconfirmedthishypothesis(e.g.see: Tufano, 1996; Gay and Nam, 1998)while, in contrast, Getzy et al (1997) and Haushalter(2000) have not found evidence that corporate hedging is affected by managerial sharehold-ings

mar-ket.BreedenandViswanathan(1996)and DeMarzoandDuffie(1995) havearguedthatyounger

the-ory

Haushalter(2000)havearguedthatlargerfirmsaremorelikely tohedge.Oneofthekeyfactors

program

(aformof negativeleverage) Greateruseofthese substituterisk management activitiesshould

1993)

2 In Croatian: Zakon o raˇcunovodstvu, Narodne novine 146/05.

3 In Slovene: Zakon o gospodarskih druˇzbah, Uradni list 15/05.

4 Criteria related to large Croatian companies: a value of total assets higher than 108 million kuna, (2) income in the last

12 months higher than 216 million kuna, and/or (3) annual number of employees higher than 250 Criteria related to large Slovenian companies: a value of total assets higher than 3400 million tolars, (2) operating income in the last 12 months higher than 6800 million tolars, and/or (3) annual number of employees higher than 250.

5 The list has been published by the special edition of Privredni vjesnik (in English: Business Herald).

6 http://www.GVIN.com is intended for both synthetic business overview of individual companies or industries and for extremely sophisticated analysis GVIN.com data cover 3 main information domains: market information, Slovenian companies, and management and governance In this research domain “Slovenian companies” has been used, which enabled analysis of

research

inAppendixA

(BrymanandCramer,1997).BothSlovenianandCroatianresearchsamplesweresmall,unrelatedand

companies

Kracaw,1987;Bessembinder,1991;Dobson andSoenen,1993;Dolde,1995;ShapiroandTitman,1998;Mian,1996;Haushalter,2000).Theagencycostofdebtargumentimpliesthatthebenefits

prob-lem (Mayers and Smith, 1982, 1987; MacMinn, 1987; MacMinn and Han, 1990; Bessembinder,1991;Dobson and Soenen,1993;Mintonand Schrand, 1999;Haushalteret al.,2002).Theargu-

Gay and Nam, 1998; Minton and Schrand, 1999; Allayannis and Ofek, 2001; Haushalter et al.,

2002)

etal.,1993;Nanceetal.,1993;Mian,1996;GrahamandSmith,1996).Additionally,theinformational

(Nanceetal.,1993;Dolde,1995;Mian,1996;Getzyetal.,1997;Haushalter,2000).Therefore,apositive

7 Unlike OLS regression, logistic regression does not assume linearity of relationship between the independent variables and the dependent, does not require normally distributed variables, does not assume homoscedasticity, normally distributed error terms are not assumed, does not require that the independents be interval or unbounded, and in general has less stringent

personal wealth position associated with the stock holdings and the capitalisation of their

1984; Smith and Stulz, 1985; Tufano, 1996; Fatemi and Luft, 2002) We test the

1996)

is

andWeston (2001) and Cumminset al (2001)have useda dichotomous variablethat equalled

approach

Weston,2001;Allayannisand Ofek,2001)andthebookvalueoftotalsalesrevenues(Allayannisand Weston, 2001) Leveragewas used as a proxy for theimpact of fixed claims on the deci-

(Hoytand Khang, 2000; Allayannisand Weston, 2001; Mian,1996)and the interestcover ratio

Nance et al., 1993) The coefficients on all variables presented were predicted to be tive

1995; Haushalter, 2000) The coefficient on this variable was predicted to be negative Other

have predicted that a greater share of institutional investors’ ownership is positively related

hedge

et al., 1997; Smith and Stulz, 1985) Investment opportunities are also measured as the ratio

1993;Getzyetal.,1997;SmithandStulz,1985;Dolde,1995).Thecoefficientsonthesevariables

posi-tive

2000;Haushalter,2000).Theincentivesformanagerstohedgeshouldbeincreasinginboththese

risk

insignificant

(Tables1and2)

Descriptive statistics of independent variables – Croatian sample.

Share owned by institutional

Total value of tax loss

carry-forward and carry backs

Total value of tax loss

carry-forward and carry

backs-to-total assets

Value of equity owned by

Source: Croatian survey data.

Variables that are presented in absolute values are in Euro 000.

Descriptive statistics of independent variables – Slovenian sample.

Share owned by institutional

Total value of tax loss

carry-forward and carry backs

Total value of tax loss

carry-forward and carry

backs-to-total assets

Value of equity owned by

Source: Slovenian survey data.

Variables that are presented in the absolute values are in Euro 000.

rationale

Cumminsetal.,2001).Thisresulthasnotbeensupportedbythecorrelationanalysis.Otherunivariate

companies

Independent sample t-test – Croatian hedgers/non-hedgers.

Levene’s test for equality of variances

t-Test for equality

of means

Group statistics

analysed companies

Mean Std deviation

Quick ratio

Source: Croatian survey data.

Independent sample t-test – Slovenian hedgers/non-hedgers.

Levene’s test for equality of variances

t-Test for equality of means Group statistics

Company listed on the stock-exchange

Source: Slovenian survey data.

combinationsof variables representingeach predictedconstruct Ofthese mainfactors,the firstfive are expected to have a positive influence on the firm’s decision to hedge That is, highervalues for factorsrelated tofinancial distress costs,agency costs, capital market imperfections,taxes and managerial utility are expected to be associated with a greater likelihood that thefirmwill engagein hedgingactivities.Thesixth factor (hedgesubstitutes), however,is expected

to have a negative influence on the firm’s hedging decision The dependent variable is coded

1 if thefirm hedges corporate risks and 0 otherwise The relationship betweenthe decision tohedgeanditspotentialdeterminantscanbeexpressedintheformatofageneralfunctionasfol-lows:

where hedge, binary variable which takes on a value of 1 if the firm hedges and 0 ifthe firm does not hedge; FC, the firm’s probability of financial distress or bankruptcy; AC,agency costs of debt facing the firm; CEF, costly external financing; T, the convexity ofthe firm’s tax function; MU, level of managerial wealth invested in the company; HS, theextent of alternative hedging-related financial policies or hedge substitutes utilised by thefirm

Table5reportsmultivariateanalysisresultsrelatingtheprobabilityofhedgingtothe

construct

hedge

Dobson and Soenen, 1993; Nance et al., 1993; Getzy et al., 1997; Allayannis and Ofek, 2001

Table 5

Multivariate results – Croatian sample.

Number of selected cases: 49

Number rejected because of missing data: 1

Number of cases included in the analysis: 48

Independent variables

TAX1 Total value of tax loss carry-forward and carry backs

Estimation terminated at iteration number 7 because

Log Likelihood decreased by less than 01 percent

Variables in the equation

Source: Croatian survey data.

ratio.However, robustness tests employedby replacing investment expenditures-to-assetsratiowith other variables that were used as proxies for capital market imperfections and costlyexternal financing hypothesis have not shown statistically significant results These find-ings suggest that the association between hedging and capital market imperfections is notrobust

Thethirdvariablethatisstatisticallysignificantinourmodelisthefractionofthefirm’sstandingsharesheldby thecompany’s management We arguethat, becausea firm’smanagershavelimitedabilitytodiversifytheirownpersonalwealthpositionassociatedwiththestockhold-ingsandtheirearnings’capitalisation,theyhave strongincentives tohedge.Usuallythat kindofhedgingis notconducted toimprovethevalueof company’sstockholders buttoimprove man-agers’ownwealth.Toavoidthisproblem,managerialcompensationcontractsneedtobedesigned

out-so that when managers increase the value of the firm, they also increase their expected ity.This can usuallybe achieved byadding option-like provisions tomanagerial contracts This

util-Table 6

Multivariate results – Slovenian sample.

Number of selected cases: 40

Number rejected because of missing data: 2

Number of cases included in the analysis: 38

Independent variables

TAX1 Total value of tax loss carry-forward and carry backs

Estimation terminated at iteration number 9 because

Log Likelihood decreased by less than 01 percent

Variables in the equation

Source: Slovenian survey data.

rationalewasfirstlyproposedbyStulz(1984)and hasbeenfurtherexploredbySmithandStulz(1985).Theresultsofsomeempiricalstudieshaveconfirmedthishypothesis(e.g.seeTufano,1996;

maximisa-tion

Overall, it could be concluded that the evidence based on an empirical relation between

hypothe-sis

Table6reportsmultivariateanalysisresultsrelatingtheprobabilityofhedgingtothe

find-ingsofBessembinder(1991),Frootetal.(1993),DobsonandSoenen(1993),Nanceetal.(1993),

Getzyetal.(1997)andAllayannisandOfek(2001)andresearchpredictionthatafirm’sdecisionto

assumption

Haushalter,2000)asproxiesfortheextenttowhichoptionsareusedinmanagers’compensation

8 Like the total option holdings held by officers and directors or the market value of shares that could be owned by managers

evidence

made

open

Appendix A Survey questionnaire

SURVEY QUESTIONNAIRE

1 Does your company manage financial risks? ( NOTE: it is possible to mark several answers)

a) Yes, we manage all kinds of financial risk (currency, interest-rate and price risk) b) Yes, but we manage only interest-rate ris k

c) Yes, but we manage only currency risk

d) Yes, but we manage only price risk

e) No, we do not manage financial risks at al

NOTE: If your company manages financial risks, please answer to all questions If your c ompany does not manage financia l risks, plea se go directly to the question number 5

2 Which of the following instruments are used in your company as a currency risk managemen t tool?

NOTE: it is possible to mark more than one instrument If some of instr uments numbered bellow is used in your company, please mark it with X and give a grade to it regarding its importance in risk management strategy For instruments you are not using, do not mark it at a l

Instrument In use Importance 1-3 (1 less important, 2

important, 3 very important)

1 Natural hedge or netting

2 Matching currency structure of as sets and liabilities (e.g de bt in fore ign

currency)

3 Currency forwa rd

4 Currency futures

5 Currency swa p

6 Stock-Excha nge Currency option

7 OTC (over-the-counter) currency option

8 Structured derivatives (e.g currency swaption)

9 Hybrid securities (e.g convertible bonds or preferred stocks)

10 Operational hedging (International diversi fication – moving part of the

business abroad)

11 Something else? Please name what!

3 Which of the following instruments are used in your company as a n interest-rate risk management tool?

NOTE: it is possible to mark more than one instrument If some of instruments numbered bellow is used in your company, plea semark it with X and give a grade to it regarding its importance in risk management strategy For instruments you are not using, do not mark it at al

Instrument In use Importance 1-3 (1 less important, 2

important, 3 very important)

1 Matching maturity of assets and liabilities

2 Interest rate forward

3 Interest rate futures

4 Interest rate swap

5 Stock-Exchange interest rate option

6 OTC (over-the-counter) interest rate

option

7 Structured derivatives (e.g cap, floor, collar, c orridor or swaption)

8 Hybrid securities (e.g convertible bonds or preferred stocks)

9 Something else? Please name what!

4 Which of the following instruments are used in your company as a price risk management tool?

NOTE: it is possible to mark more than one instrument If some of instr uments numbered bellow is used in your company, please mark it with X and give a grade to it regarding its importance in risk management strategy For instruments you are not using, do not mark it at a l

Instrument In use Importance 1-3 (1 less important, 2

important, 3 very important)

1 Natural hedge or netting

2 Managing assets and liabil ities

3 Commodity forward

4 Commodity futures

5 Commodity swap

6 Commodity option

7 OTC (over-the-counter) commodity option)

8 Structured derivatives (combination of swaps, future contacts and options)

9 Business diversifica tion through mergers, acquisitions, and other business

combinations)

NOTE: We would like to ask all survey participants, those whose companies manage as well as not manage financia l risks, to complete the following section of a questionnaire (please provide data related to the previous business year).

5 What is the share of your company owned by management? (e.g 23%) - - -%

6 Does management own call options on your company’s common stocks?

9 What was your company’s book value of the total common equi ty?

Total common eq uity

10 What was your company’s book value of the total a ssets (long and short-term)?

Total assets

11 What was your company’ s book value ofthe total short-term assets?

Total short-term assets

12 What was your company’s book value of the money and short-term securities?

Money and short-term securities

13 What was your company’s value of the interest cos t

Interest cost s

14 What was the value of the earnings before interest and taxes (EBIT)?

Earnings before interest and taxes

15 What was the value of the research and development (R&D) e xpenditures?

Research and development expenditure s

16 What was the value of the total sales reve nues of your company ?

Total sales revenues