Essay on International Evidence on Financial Derivatives Usage

In the recent past, financial derivatives have developed increased attention, since most claims have been accusing them of being the leading cause of financial crisis. With the use of the new database, we realize that the traditional test of the theories provides the little power to offer an explanation on the determinants of the cooperate derivatives usage (Graham, 2002). Instead, what is shown is that the derivative usage is identified endogenously with other operating and financial decisions through means that are intuitive with no relation to any particular theories from why firms experience hedge. Through the use an example, the usage of the derivative act as leverage especially when it comes to determining the level and the maturity of dividend policy, debt, foreign operating hedge and holding of liquid assets.

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One of the main findings is that corporate risk management plays a significant role in increasing the firm value in conditions where the capital market imperfections such as convex tax schedule and bankruptcy costs or underinvestment problems are in existence, (Bunkanwanicha, 2008). This has been having been put to a challenge through the recent empirical studies, showing different consequences to the financial market. The recent empirical studies that have been using samples of United States firms have been providing some of the evidence in support to the theories. With other studies providing the suggestion that risk management frequently results from the principle-agent conflicts that exist between shareholders and managers or from additional factors in the market that are not well motivated by the current theory of risk management. Considering the findings as a whole, the empirical studies can remain controversial since the conclusions show a broadly accurate sample.

From the findings, it is evident that the hedging and capital structure suffers from an endogenous challenge, meaning that the role of derivatives in the capital decisions it more complicated that it was considered before. In the process of analyzing the derivatives and the impact they have on the cost of capital, we realize that the derivative can lower the capital expenditure. On the other hand, in a situation where firms are using derivatives in managing their risk, the demand for covenants in place to restrict the investment will be in small quantity. It happens since firm will have to pay the lower cost on their private loans so that hedging have an effect on the firms financial costs(Campello,2011). In addition to this, we realize that the use of derivatives in a market that is well developed helps in the reduction of the cost of financing debt. Through this, we understand that the use of derivatives in a market that is well developed will be positively related to a capital structure cost that is lower.

However, in analyzing the relationship the relationship that exist between the use of capital structure and derivatives, the characteristic of firms which are using derivatives and are experiencing higher growth rate, tend to make use of higher debt level in their capital structure. In the long run, they tend to use more derivatives in managing their risk. On the other hand, it has been realized that derivatives are used among all the sectors, and its application will be much higher during the financial crisis. Additionally, I believe that cultural difference plays a significant role and firms who are working in the different culture will not have the same capital structures as a result of their various ownership structures. This will finally have a consequence on the capital performance if the same capital structure decision is applied the same (Bartram at el, 2009).

Reference

Bartram, S. M., Brown, G. W., & Fehle, F. R. 2009. International evidence on financial derivatives usage. Financial Management, 38(1), 185-206. http://dx.doi.org/10.1111/j.1755-053X.2009.01033.xBunkanwanicha, P., Gupta, J., & Rokhim, R. 2008. Debt and entrenchment: Evidence from Thailand and Indonesia. European Journal of Operational Research, 185(3), 1578-1595. http://dx.doi.org/10.1016/j.ejor.2006.08.025Campello, M., Lin, C., Ma, Y., & Zou, H. 2011. The real and financial implications of corporate hedging. The journal of finance, 66(5), 1615-1647. http://dx.doi.org/10.1111/j.1540-6261.2011.01683.xGraham, J. R., & Rogers, D. A. 2002. Do firms hedge in response to tax incentives?. The Journal of Finance, 57(2), 815-839. http://dx.doi.org/10.1111/1540-6261.00443