Hedging Study Motive And Effect

The research on non-financial companies hedging began in the early1970’s, among the west countries, especially the United States. However, there has been no consistent findings associate with it. Therefore, there is doubt whether non-financial companies can hedging for the company (shareholders) create value. According to the theory of hedging, as the risk management cannot rise, the value of shareholders in the MM ideal world, hedging of non-financial company is able to create the shareholders’value only if the capital markets are real but not perfect. For example, the hedging can reduced cost of financial distress and the expensive external financing, improve liabilities proportion, take the advantage of tax shield, and coordinate the relationship between the investing and financing activities and the behavior of managers, and decrease the income tax. Nevertheless, the conclusion of empirical tests is confusing. Some studies are in favor of the theory (or partially supporting), and the others achieve the differed or even the diametrically opposed consequences.A serious accidents has occurred in the practice of hedging in China, such as the events of Zhuzhou smelting, China Aviation Oil, China Eastern Airlines and China Ocean shipping. The enterprises in these cases suffered from huge losses as they invested derivatives for hedging purposes. Some bankrupted, some did not as the government paid for their bills. According to the "events" above, it can be seen that hedging will lead to fatal losses of value rather than it will add the value of corporate. Therefore, whether the cases above are common or not has been a significant problem. If it is common phenomenon, the hedging cannot raise the enterprise value, which the fact may inconsist with the theory analyzed before. However, is the theory wrong?To analysis hedging behavior, firstly, an analysis framework should be established. In this paper, the new system economics is regard as the framework. People are assumed as maximize itself utility of full rational of opportunities doctrine in the framework. It also assumes that the corporate is consist of series of contracts and its nature is binding the contracts among factors of production. Enterprise is the sum of the formation and executive process of contracts. The most important characteristic of the modern enterprise system is the separation of ownership and control. The managers with entrepreneurial talent will be on behalf of the owners to run the production material. Owner of all factors of production are to maximize their own utility and shareholders and managers are the most important stakeholders. Both sides are to maximize their own utility, and they have different utility functions. As a result their interests will come into conflict.Hedging may give rise to the movement of cash flow from its intensive side to others, which will not add the total cash flow of the company. This only declines the fluctuation of cash flow. It also eliminates the possibility of extreme, cash flow phenomenon and financial distress, reduce the expensive external financing expenditure under maxim cash flow and distress cost, improve liabilities capacity, take the advantage of tax shield and decrease the income tax when tax function is convex. As a consequence, the so-called friction costs should be decreased the company value should be increased. Nevertheless, hedging is costly. If the cost exceeds the value enhancement of the company, the value of the company will deprecate. As it has been analyzed from the perspective of the company or shareholders, the following part will focus on the managers respect. Managers have centralized rightof control, such as high salary, in-service consumption, and transferring the company resources for profit. However, if they lose their position, they also lose all right above in the corporate. In addition, the cost of job-hopping is very expensive. Therefore, manager must maintain their current position to protect from firing and being replaced. Consequently, managers will not tend to take risk unless the return is relatively high. Extremely poor performance is a great threat to manager to keep their position. So managers make strenuous efforts to get rid of it. Hedging is an efficient tool to help they avoid the law level performance even though hedging costs more than its revenue. In stock right decentralized "weak shareholders and top managers" cases, shareholders have little motivation and ability to control corporate while manager are granted by Board of Directors to the make the contract decision directly. In fact, they beco’me the master of a company(Morck, Shleifer&Vishny1988). Therefore managers do not afford any cost for their opportunistic behavior.The empirical tests in this paper prove that the theoretical analysis above is correct.Initially, according to the theoretical assumption provided by the previous main stream hedging researches, if the incentive of hedging is maximizing the corporate value, based on the characters of different companies, managers should be targeted to make decision on both the possibility and degree of hedging. As a consequence, hedging will be highly related with the corporate characters. The theory that the motive of hedging decision is to maximize the value of company can be proved, if hedging related to company characteristics, and the direction is the same as the hypothesis in the subsequent empirical test. However, if the condition above is not satisfied, this theory may not correct.Secondly, based on the result of researches in this paper, the incentive of hedging may not maximizing company value. Does the hedging increase the corporate value or decrease it? From the point of maximizing corporate value, the empirical test is designed to prove the effect of hedging on the value of company. Due to the consequence of the test, it can be seen that hedging affect the corporate value negatively, or at least not significant. Therefore, the motive of hedging is not promoting the company value and hedging does not increase the value of firms.Furthermore, it proves that the motive of hedging is management entrenchment. The managers should choose the hedging policy according to the scenario of cash flow in order to achieve the goal of management entrenchment. From aspect of management entrenchment, the empirical test is designed to prove the effect of.management entrenchment on the value of company. This study is based on the advanced management theory. The demographic characteristics of administrators are regarded as proxy variables of management entrenchment to test. Then, using particular approach combing these characteristics to calculate the management entrenchment index which is treated as the degree of management entrenchment. Next, testing the degree of correlation between management entrenchment index and hedging.Lastly, based on the management entrenchment, the hedging effects are studied. Management entrenchment forms barrier, which means the managers do not be bound by corporate governance and control mechanism, or they use of company resources to create illusion that they comply with corporate governance and control mechanism, to benefit themselves instead of the company. Therefore, it is possible for managers to maximize their own interest. The direct impact of manager barrier effect is changes of managers. As a result, due to the former research, in this paper, the managers of listed companies in China for defense form the barriers, and then use hedging gain for themselves-the empirical test of influence change of managers.The innovations of this article are mainly in the following respects. It is the first time applying the framework of new institutional economics to analyze the hedging behavior in theory. Previous studies, hedging behaviors are rarely put in the framework of a unified rigorous study, and the digging of the theoretical mechanism behind hedging behavior is not deep enough. So in this article, the research and analysis of the hedging behavior is under the framework of new institutional economics, especially analyzing hedging effect on shareholders’ utility on the basis of risk-taking and taking the individual utility maximization into consideration, as well as the influence of the hedging behavior in the decision makers---managers, laid a solid theoretical foundation for later research.Then, it breaks through previous assumption that the motivation of hedging is maximizing the value of shareholders, focuses on management entrenchment, builds research of the motivation and effect of hedging which is based on the management defensive motivation. Initially, it theoretically analyzes that the motives of managers for hedging is to manage entrenchment. Then, it establishes the management entrenchment index to measure level of entrenchment, and test the correlation between hedging and managing entrenchment. Secondly using defensive effect metrics--the manager variables tests the effectiveness of management entrenchment by applying the hedging. The result shows the correctness of our assumption.Next, pervious hedging research which is based on maximizing company value exists an outstanding problem. That is failure to settle endogenic problem between hedging and other company features. For instance, hedging and leverage will interact. Hedging reduce fluctuations of cash stream and financial dilemma risk, expanded enterprise liabilities capacity borrowing more of debt (debt interest can gain tax shied benefits). The more debts led to higher leverage, which will require more hedging in order to reduce the cost of financial distress. As a result, hedging and leverage will Staggered rise and interact. This may become a serious endogenic problem. This study will use instrumental variable method and two-stage least squares to solve this problem.Forth, it is the first time using the contingency table to analyze the characteristic of hedging. In this article, both the quantitative and qualitative measurements of variables are applied. For the most important variable-hedging measurement, we adopted qualitative approach. Therefore, different from other former research, the contingency table analysis is adopted in the study of hedging initially. The quantitative measurement of individual variables are made as the following treatment:Firstly calculate the average of each variable, and then use the variable value minus the sample variables mean, next divide the difference into high and low two groups and assigning1and0respectively, which means that the quantitative variables are converted into qualitative variables.However, as this study is tentative, combining with the limitation of the level and capacity of research, there are some shortages. The study on the enterprise hedging is complex. Firstly, on the side of framework, it is known that the research is based on unified of theory framework. Whereas, it can be seen that different people in different period may have different motivation. So the investment decision of hedging also may different. Therefore, the study on hedging behavior not only needs in a framework for unified research, but also need to analyze individual cases. Furthermore, in this paper, the standard to judge whether the company invest hedging is depending on whether derivatives. In fact, the tool of hedging is not just derivatives, but also the operating activities, such as the diversification operations. Thirdly, due to limitations in accounting disclosures, it only obtained whether companies use derivatives or not and the specific number of derivatives are unable to access, which will not able to measure each company’s degree of hedging targets. As a result, to a certain extent, it may affect the accuracy of the empirical results.