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Managerial hedging ability and firm risk

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Abstract

Modern portfolio theory suggests that undiversified executives would choose to diversify their significant holdings of their firm’s stock if the opportunity was available. Recent work suggests that managerial hedging is more prevalent than in years past as more innovative hedging instruments have become available to executives. Typically, unrestricted shares are used in these hedging transactions whereas restricted shares are not. In this paper, I examine whether a CEO’s composition of firm stockholdings between restricted and unrestricted shares impacts the level of risk undertaken by the firm. I document a negative and statistically significant relationship between firm risk and the proportion of CEO total shareholdings that are unrestricted and this negative relationship holds for alternative measures of firm risk. This result supports the notion that the composition of a CEO’s portfolio of firm stock between restricted and unrestricted shares is a significant determinant of firm risk.

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Notes

  1. Short selling positions expose investors to unlimited losses. In June 2006, AMEX unveiled a series of new ETF products known as “Short ProShares” and “Ultra-short ProShares” ETFs. These ETFs create synthetic portfolios through the use of futures contracts that allow the investor to profit from downside movements in stock indices, sectors and commodities by purchasing shares without unlimited loss potential resulting from short selling.

  2. Bhagat and Welch (1995) and Kothari et al. (2002) find that R&D expenditures are more risky than investment dollars allocated to property, plant and equipment. Crutchley and Hansen (1989) suggest that R&D expense is an uncertain, intangible asset that inherently increases firm risk.

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Authors and Affiliations

  1. College of Business, Department of Finance and Economics, Creighton University, 2500 California Plaza, Omaha, NE, 68178, USA

    Lee M. Dunham

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  1. Lee M. Dunham
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Correspondence to Lee M. Dunham.

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Table 6 Definition of variables used in study
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Dunham, L.M. Managerial hedging ability and firm risk. J Econ Finan 36, 882–899 (2012). https://doi.org/10.1007/s12197-010-9160-9

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  • DOI: https://doi.org/10.1007/s12197-010-9160-9

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