Forum for Science, Industry and Business

Sponsored by:     3M 
Search our Site:

 

Controlling for the weather: Hedging increases firm value, new study shows

21.06.2012
A highly debated topic in corporate finance is whether active risk management policies, such as hedging, affect firm value. New research from the University of Notre Dame and Stanford University shows that active risk management policies lead to an increase in firm value.
Hedging refers to insuring against extreme fluctuations in the prices or quantities of commodities/securities.

In "Risk Management and Firm Value: Evidence from Weather Derivatives," forthcoming in the Journal of Finance, co-author Hayong Yun, an assistant professor of finance in Notre Dame's Mendoza College of Business, examines the impact of financial innovation on firm value, investment, and financing decisions. Specifically, the research examines the effect of the introduction of weather derivatives on electric and gas utilities, arguably some of the most weather-exposed businesses in the economy.
Using stock market and financial statement data on 203 companies from 1960 to 2007, the researchers show the utilities most likely to use weather derivatives are those with the greatest cash flow sensitivity to weather. Those that do make use of the derivatives, significantly decrease the volatility of their cash flows, which in turn increase debt borrowings, investments and ultimately their share prices.

Yun says there has been much theoretical research on why hedging can have an impact on increasing firm value, but actually proving such is challenging, largely because firms do not randomize their hedging decisions.

"Our research tries to overcome this endogeneity, or non-random choice of hedging, by comparing examples with and without the possibility of hedging, specifically focusing on utilities heavily exposed to weather risk," Yun says. "For example, utilities in San Diego where weather is always mild and predictable, and in Minnesota, where weather varies greatly from year-to-year, have different weather risk exposure. Before 1997, we believe San Diego utilities enjoyed smoother cash flow than those in Minnesota.
However, after 1997, this weather risk-driven advantage began to disappear because utilities in harsher climates could buy weather derivatives to financially hedge weather risk."

Why do firm values increase when cash flows are smoothened?
"It is partially explained by investment and tax benefits," Yun says. "Banks are reluctant to lend when a company's cash flow is low, hence, companies may be forced to pass up valuable investment projects during those times. Also, by borrowing debt, there is an added benefit of tax exemption for the interest payments."

Yun, who teaches corporate governance, also is an expert in corporate finance, law and economics, bankruptcy, and contract theory.

Hayong Yun | EurekAlert!
Further information:
http://www.nd.edu

More articles from Business and Finance:

nachricht How Strong Brands Translate into Money
15.11.2016 | Kühne Logistics University - Wissenschaftliche Hochschule für Logistik und Unternehmensführung

nachricht Demographic change depresses tax revenues
04.11.2016 | Fraunhofer-Institut für Angewandte Informationstechnik FIT

All articles from Business and Finance >>>

The most recent press releases about innovation >>>

Die letzten 5 Focus-News des innovations-reports im Überblick:

Im Focus: Interfacial Superconductivity: Magnetic and superconducting order revealed simultaneously

Researchers from the University of Hamburg in Germany, in collaboration with colleagues from the University of Aarhus in Denmark, have synthesized a new superconducting material by growing a few layers of an antiferromagnetic transition-metal chalcogenide on a bismuth-based topological insulator, both being non-superconducting materials.

While superconductivity and magnetism are generally believed to be mutually exclusive, surprisingly, in this new material, superconducting correlations...

Im Focus: Studying fundamental particles in materials

Laser-driving of semimetals allows creating novel quasiparticle states within condensed matter systems and switching between different states on ultrafast time scales

Studying properties of fundamental particles in condensed matter systems is a promising approach to quantum field theory. Quasiparticles offer the opportunity...

Im Focus: Designing Architecture with Solar Building Envelopes

Among the general public, solar thermal energy is currently associated with dark blue, rectangular collectors on building roofs. Technologies are needed for aesthetically high quality architecture which offer the architect more room for manoeuvre when it comes to low- and plus-energy buildings. With the “ArKol” project, researchers at Fraunhofer ISE together with partners are currently developing two façade collectors for solar thermal energy generation, which permit a high degree of design flexibility: a strip collector for opaque façade sections and a solar thermal blind for transparent sections. The current state of the two developments will be presented at the BAU 2017 trade fair.

As part of the “ArKol – development of architecturally highly integrated façade collectors with heat pipes” project, Fraunhofer ISE together with its partners...

Im Focus: How to inflate a hardened concrete shell with a weight of 80 t

At TU Wien, an alternative for resource intensive formwork for the construction of concrete domes was developed. It is now used in a test dome for the Austrian Federal Railways Infrastructure (ÖBB Infrastruktur).

Concrete shells are efficient structures, but not very resource efficient. The formwork for the construction of concrete domes alone requires a high amount of...

Im Focus: Bacterial Pac Man molecule snaps at sugar

Many pathogens use certain sugar compounds from their host to help conceal themselves against the immune system. Scientists at the University of Bonn have now, in cooperation with researchers at the University of York in the United Kingdom, analyzed the dynamics of a bacterial molecule that is involved in this process. They demonstrate that the protein grabs onto the sugar molecule with a Pac Man-like chewing motion and holds it until it can be used. Their results could help design therapeutics that could make the protein poorer at grabbing and holding and hence compromise the pathogen in the host. The study has now been published in “Biophysical Journal”.

The cells of the mouth, nose and intestinal mucosa produce large quantities of a chemical called sialic acid. Many bacteria possess a special transport system...

All Focus news of the innovation-report >>>

Anzeige

Anzeige

Event News

12V, 48V, high-voltage – trends in E/E automotive architecture

10.01.2017 | Event News

2nd Conference on Non-Textual Information on 10 and 11 May 2017 in Hannover

09.01.2017 | Event News

Nothing will happen without batteries making it happen!

05.01.2017 | Event News

 
Latest News

Water - as the underlying driver of the Earth’s carbon cycle

17.01.2017 | Earth Sciences

Interfacial Superconductivity: Magnetic and superconducting order revealed simultaneously

17.01.2017 | Materials Sciences

Smart homes will “LISTEN” to your voice

17.01.2017 | Architecture and Construction

VideoLinks
B2B-VideoLinks
More VideoLinks >>>