We survey 392 CFOs about the cost of capital, capital budgeting, and capital structure. Large firms rely heavily on present value techniques and the capital asset pricing model, while small firms are relatively likely to use the payback criterion. We find that a surprising number of firms use their firm risk rather than project risk in evaluating new investments. Firms are concerned about maintaining financial flexibility and a good credit rating when issuing debt, and earnings per share dilution and recent stock price appreciation when issuing equity. We find some support for the pecking-order and trade-off capital structure hypotheses but little evidence that executives are concerned about asset substitution, asymmetric information, transactions costs, free cash flows, or personal taxes. Key words: capital structure, cost of capital, cost of equity, capital budgeting, discount rates, project valuation, survey. 1 We thank Franklin Allen for his detailed comments on the survey instrument and the overall project. We

This paper studies the hedging policies of oil and gas producers between 1992 and 1994. My evidence shows that the extent of hedging is related to financing costs. In particular, companies with greater financial leverage manage price risks more extensively. My evidence also shows that the likelihood of hedging is related to economies of scale in hedging costs and to the basis risk associated with hedging instruments. Larger companies and companies whose production is located primarily in regions where prices have a high correlation with the prices on which exchangetraded derivatives are based are more likely to manage risks. DESPITE THE PREVALENCE OF CORPORATE RISK MANAGEMENT and the effort that has been devoted to developing theoretical rationales for hedging, there are no widely accepted explanations for risk management as a corporate policy. Important questions remain regarding the determinants of the extent to which a company hedges, the impact of risk management on a firm’s value, and the interaction between a firm’s hedging policy and its other policy decisions. To address some of these questions, I examine the risk management activities of 100 oil and gas producers for 1992 to 1994. In particular, I investigate whether the fraction of production an oil and gas producer hedges against price fluctuations is related to its financing policy, tax status, compensation policy, ownership structure, and operating characteristics. I document a wide variation in hedging policies among oil and gas producers. My tests find that this variation is associated with several differences in the firms ’ characteristics. The fraction of production hedged is positively related to the differences in financial leverage, measured as the ratio of total debt to total assets, and it is greater for oil and gas producers

There are two tax incentives for corporations to hedge: to increase debt capacity and interest tax deductions, and to reduce expected tax liability if the tax function is convex. We test whether these incentives affect the extent of corporate hedging with derivatives. Using an explicit measure of tax function convexity, we find no evidence that firms hedge in response to tax convexity. Our analysis does, however, indicate that firms hedge to increase debt capacity, with increased tax benefits averaging 1.1 percent of firm value. Our results also indicate that firms hedge because of expected financial distress costs and firm size.

Using a unique dataset of East Asian non-financial companies, this paper examines a firm's choice between local currency, foreign currency, and synthetic local currency (hedged foreign currency) debt. We also exploit the Asian financial crisis of 1997 as a natural experiment to investigate the role of debt type in financial and operating performance. We find evidence of unique, as well as common, factors that determine each debt type's use thus indicating the importance of examining debt at a disaggregated level. Specifically, the use of natural local currency debt is associated primarily with factors found by many other studies to determine total debt levels such as size, profitability, and the market-to-book ratio. Foreign currency debt is used as a complement to local currency debt by firms with substantial capital needs seeking to lower the cost or extend the maturity structure of debt. However, the use of foreign currency debt is also determined by asset and income type consistent with agency cost and financial risk management theories. The use of synthetic local debt is primarily determined by risk management concerns. Finally, contrary to anecdotal reports and existing theory, we find no evidence that unhedged foreign currency debt is associated with significantly worse performance during the Asian crisis. Surprisingly, the use of synthetic local currency debt is associated with the biggest drop in market value, possibly due to currency derivative market illiquidity during the crisis.

Version 1.4 United States based HDG Inc. (pseudonym) is an industry leading manufacturer of durable equipment with sales in more than 50 countries. Foreign sales account for just under half of HDG’s gross revenue. This study investigates the firm’s foreign exchange risk management program. The analysis relies primarily on a three month field study in the treasury of HDG. Detailed descriptions of the organizational and operational procedures of the firm’s hedging activity are presented. Precise examination of factors affecting why and how the firm manages its foreign exchange exposure are explored through the use of internal firm documents and communiqués, extensive discussions with management, and data on more than 3100 foreign-exchange derivative transactions over a three and a half year period. Results indicate that many commonly cited reasons for corporate hedging are not the primary motivation for why HDG undertakes a risk management program. Instead, informational asymmetries, facilitation of internal contracting, and competitive pricing concerns motivate hedging. How HDG hedges depends on foreign exchange volatility, exposure volatility, technical factors, and recent hedging outcomes.

Previous research offers little large-sample evidence on the magnitude of non-financial firms ' risk exposure hedged by financial derivatives. In a sample of 234 large non-financial corporations that use derivatives, we find that if the median firm simultaneously experiences a three standard deviation change in interest rates, currency exchange rates, and commodity prices, it will collect $15 million of cash from its entire derivatives portfolio and that the entire derivatives portfolio will rise in value by $31 million. These dollar amounts are modest relative to firm size, operating cash flows, investing cash flows and other firm benchmarks. The findings raise questions about the role of derivatives securities held by non-financial firms.

This paper extends the investigation of the effect of managerial motives on hedging policy. I utilize a proxy variable that incorporates CEO incentives to increase risk versus stock price. The variable is directly measured using the characteristics of CEO portfolios of stock and option holdings. Furthermore, CEO risk-taking incentives are modeled as a choice variable to eliminate the simultaneity bias of modeling risk-taking incentives as an exogenous variable. CEO risk-taking incentives are negatively related to net derivative holdings for a large cross-sectional sample of firms. This effect is only weakly apparent in one-stage models of risk management. If modeled as a simultaneous system of equations, a strong negative link between CEO risk-taking incentives and the amount of derivative holdings exists. This result is consistent with the notion that derivatives are used for hedging purposes. Both the characteristics of stock and option holdings are important in determining cross-sectional differences in corporate derivative holdings.

This paper examines whether firms are hedging or timing the market when selecting the interest rate exposure of their new debt issuances. I use a more accurate measure of the interest rate exposure chosen by firms by combining the initial exposure of newly issued debt securities with their use of interest rate swaps. The results indicate that the final interest rate exposure is largely driven by the slope of the yield curve at the time the debt is issued. These results suggest that interest rate risk management practices are primarily driven by speculation or myopia, not hedging considerations.

This paper examines risk management strategies for natural gas firms that face multiple risks (e.g., price and volume risk) and have a variety of financial and non-financial tools available to manage those risks. Natural gas firms' risk exposures to price and volume risk were changing significantly during the sample period due to a unique series of regulatory changes, including price deregulation. Natural gas firms used a combination of gas storage, cash holdings, line-ofbusiness and geographic diversification to hedge increasing volume risk and changing exposure to price risk. The firms extensively use commodity derivatives when available. Holding cash and storing gas are complementary strategies that are used by similar types of firms. While the use of derivatives and storing gas are related, firms appear to use derivatives to manage price risk and gas storage to manage volume risk. Finally, the various strategies are effective. Natural gas pipeline firms that pursue financial or operational hedging activities have smaller and less variable sensitivities to price changes than firms that do not, especially post-deregulation.

This paper examines the use of credit derivatives by US bank holding companies from 1999 to 2003 with assets in excess of one billion dollars. Using the Federal Reserve Bank of Chicago Bank Holding Company Database, we find that in 2003 only 19 large banks out of 345 use credit derivatives. Though few banks use credit derivatives, the assets of these banks represent on average two thirds of the assets of bank holding companies with assets in excess of $1 billion. Few banks are net buyers of credit protection and disclose using credit derivatives to hedge loans. Banks are more likely to be net protection buyers if they engage in asset securitization, originate foreign loans, and have lower capital ratios. The likelihood of a bank being a net protection buyer is positively related to the percentage of commercial and industrial loans in a bank’s loan portfolio and negatively or not related to other types of bank loans. The use of credit derivatives by banks is limited because adverse selection and moral hazard problems make the market for credit derivatives illiquid for the typical credit exposures of banks.