Openness, hedging incentives and foreign exchange exposure: A firm-level multi-country study
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The benefits of openness to trade are well established, but the disadvantages of openness are less well understood. At the firm level trade is the principal source of exposure to exchange rate movements, and exchange exposure can be moderated by a range of hedging techniques. In this paper we ask two questions. First, do firms in open economies bear higher levels of exchange exposure than those in more closed economies? Second, is a strong corporate governance environment – one in which managers are incentivised to maximise shareholder value by hedging – associated with reduced firm-level exchange exposure? Using a sample of 3788 firms from 23 developed countries for the period 1984–2003, we show that the more open the economy, the more exposed are its firms to exchange rate movements, and this relation holds after controlling for firm size, industry and several financial variables. We also find a strong inverse relation between a firm's exchange exposure and the extent of creditor protection in the country in which it is based. This is consistent with managers acting to reduce the likelihood of financial distress in countries where bankruptcy costs are high, and it underlines the importance of institutional incentives in encouraging value-enhancing risk management activities.
Keywordsexchange risk pricing firm exposure foreign exchange management and risk economic openness openness to trade corporate governance
The authors thank the three anonymous reviewers for their helpful and insightful comments, and the Finance Editor Lemma Senbet for his wisdom and patience in guiding the paper through the review process. Thanks also to Zheng Yin and Yan Ping Zhong for excellent research assistance.
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