| Theory offers different rationales for hedging including (i) financial distress and bankruptcy cost, (ii) capacity to capture attractive investment opportunities, (iii) information asymmetry, (iv) economy of scale, (v) substitution for hedging, (vi) managerial risk aversion, and (vii) convexity of tax schedule. The purpose of this dissertation is to empirically test the explanatory power of the first five theoretical rationales on hedging done by oil and gas exploration and production (E&P) companies. The level of hedging is measured by the percentage of production effectively hedged, calculated based on the concept of delta and delta-gamma hedging.; I employ Tobit regression, principal components, and panel data analysis on dependent and raw independent variables. Tobit regression is applied due to the fact that the dependent variable used in the analysis is non-negative. Principal component analysis helps to reduce the dimension of explanatory variables while panel data analysis combines/pools the data that is a combination of time-series and cross-sectional.; Based on the empirical results, leverage level is consistently found to be a significant factor on hedging activities, either due to an attempt to avoid financial distress by the firm, or an attempt to control agency cost by debtholders, or both. The effect of capital expenditures and discretionary cash flows are both indeterminable due possibly to a potential mismatch in timing of realized cash flow items and hedging decision. Firm size is found to be positively related to hedging supporting economy of scale hypothesis, which is introduced in past literature, as well as the argument that large firm usually are more sophisticated and should be more willing and more comfortable to use hedge instruments than smaller firms. |
