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 Microtechnology industry is hiring – positive developments of past years continue
09.04.2018 | IVAM Fachverband für Mikrotechnik

nachricht RWI/ISL-Container Throughput Index with minor decline on a high overall level
20.03.2018 | RWI – Leibniz-Institut für Wirtschaftsforschung

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: Electrons in the fast lane

Solar cells based on perovskite compounds could soon make electricity generation from sunlight even more efficient and cheaper. The laboratory efficiency of these perovskite solar cells already exceeds that of the well-known silicon solar cells. An international team led by Stefan Weber from the Max Planck Institute for Polymer Research (MPI-P) in Mainz has found microscopic structures in perovskite crystals that can guide the charge transport in the solar cell. Clever alignment of these "electron highways" could make perovskite solar cells even more powerful.

Solar cells convert sunlight into electricity. During this process, the electrons of the material inside the cell absorb the energy of the light....

Im Focus: The lightest electromagnetic shielding material in the world

Empa researchers have succeeded in applying aerogels to microelectronics: Aerogels based on cellulose nanofibers can effectively shield electromagnetic radiation over a wide frequency range – and they are unrivalled in terms of weight.

Electric motors and electronic devices generate electromagnetic fields that sometimes have to be shielded in order not to affect neighboring electronic...

Im Focus: Gentle wall contact – the right scenario for a fusion power plant

Quasi-continuous power exhaust developed as a wall-friendly method on ASDEX Upgrade

A promising operating mode for the plasma of a future power plant has been developed at the ASDEX Upgrade fusion device at Max Planck Institute for Plasma...

Im Focus: ILA Goes Digital – Automation & Production Technology for Adaptable Aircraft Production

Live event – July 1, 2020 - 11:00 to 11:45 (CET)
"Automation in Aerospace Industry @ Fraunhofer IFAM"

The Fraunhofer Institute for Manufacturing Technology and Advanced Materials IFAM l Stade is presenting its forward-looking R&D portfolio for the first time at...

Im Focus: AI monitoring of laser welding processes - X-ray vision and eavesdropping ensure quality

With an X-ray experiment at the European Synchrotron ESRF in Grenoble (France), Empa researchers were able to demonstrate how well their real-time acoustic monitoring of laser weld seams works. With almost 90 percent reliability, they detected the formation of unwanted pores that impair the quality of weld seams. Thanks to a special evaluation method based on artificial intelligence (AI), the detection process is completed in just 70 milliseconds.

Laser welding is a process suitable for joining metals and thermoplastics. It has become particularly well established in highly automated production, for...

All Focus news of the innovation-report >>>

Anzeige

Anzeige

VideoLinks
Industry & Economy
Event News

International conference QuApps shows status quo of quantum technology

02.07.2020 | Event News

Dresden Nexus Conference 2020: Same Time, Virtual Format, Registration Opened

19.05.2020 | Event News

Aachen Machine Tool Colloquium AWK'21 will take place on June 10 and 11, 2021

07.04.2020 | Event News

 
Latest News

Coupled hair cells in the inner ear – „Together we are strong!“

06.07.2020 | Health and Medicine

Innovations for sustainability in a post-pandemic future

06.07.2020 | Social Sciences

Carbon-loving materials designed to reduce industrial emissions

06.07.2020 | Materials Sciences

VideoLinks
Science & Research
Overview of more VideoLinks >>>