The document titled “International Evidence on Financial Derivatives Usage” by Söhnke M. Bartram, Gregory W. Brown, and Frank R. Fehle provides a comprehensive analysis of the use of financial derivatives by non-financial firms across 48 countries, including the United States. The study covers a sample of 7,292 firms and aims to fill the gap in understanding how and why firms use derivatives, especially outside the U.S. Here are the key points and findings from the document.
Overview and Objectives
The study has four main objectives:
- Documenting Derivatives Usage: It examines the use of foreign exchange (FX), interest rate (IR), and commodity price (CP) derivatives, comparing characteristics of users across countries and firms.
- Motivations for Derivative Use: It investigates the economic rationales behind derivative use, such as risk management and speculation.
- Country-Level Analysis: It explores country-specific factors that influence derivative usage.
- Impact on Firm Value: It assesses whether the use of derivatives is associated with higher firm value.
Key Findings
- Prevalence of Derivatives Use:
- Across all countries, 59.8% of firms use some type of financial derivative.
- FX derivatives are used by 43.6% of firms, IR derivatives by 32.5%, and CP derivatives by 10.0%.
- U.S. firms have similar usage rates, with 64.0% using derivatives, 36.9% using FX derivatives, 40.3% using IR derivatives, and 16.3% using CP derivatives.
- Types of Derivatives:
- For FX risk, forwards are the most common (35.3%), followed by swaps (11.0%) and options (9.6%).
- For IR risk, swaps are the most popular (28.8%), with options used by 7.3%.
- CP derivatives are used more evenly across forwards, futures, swaps, and options.
- Firm-Specific Factors:
- Firms using derivatives tend to be larger, more profitable, and have higher leverage.
- Derivatives use is associated with higher foreign assets, sales, and income for FX derivatives, and higher leverage for IR derivatives.
- Firms with higher growth opportunities and more tangible assets are less likely to use derivatives.
- Country-Specific Factors:
- The size of the local derivatives market is a significant factor in determining derivatives use.
- Economic, financial, and political risks, as well as the legal environment, also play roles but are less consistently significant.
- Better shareholder rights and lower ownership concentration are associated with higher derivatives use.
- Impact on Firm Value:
- The study finds positive valuation effects primarily for firms using IR derivatives.
- The use of derivatives is likely to be associated with higher firm value, supporting the idea that risk management can enhance firm value.
Theoretical Implications
The findings support some traditional theories of risk management, such as the financial distress hypothesis, which suggests that firms use derivatives to reduce the probability of financial distress. However, the study also finds evidence that contradicts some theoretical predictions, indicating that more profitable firms and those with fewer growth opportunities tend to hedge more.
Conclusion
The study concludes that while firm-specific factors are crucial in determining derivatives use, country-specific factors also play a significant role. The mixed results highlight the complexity of derivatives usage and suggest that a wide range of factors influence firms’ decisions to use derivatives. The positive association between derivatives use and firm value underscores the importance of risk management in corporate finance.
This document provides valuable insights into the global use of financial derivatives, highlighting both commonalities and differences across countries and firms. It emphasizes the need for a nuanced understanding of the motivations and impacts of derivatives use in the context of international finance.
After reading this document I have a better understanding of global derivatives usage, bridging gaps in prior studies that predominantly focused on U.S. firms.