Essays on corporate financial risk management: theory and evidence

The thesis comprises three essays on corporate financial risk management. In particular, it studies theoretically and empirically the determinants of the firm{level financial hedging in distinct market conditions, as well as with various managerial compensation schemes. In Chapter 2, we re-examine the conventional models of corporate hedging in the presence of external financing frictions and asymmetric information on asset value. We emphasize that in the presence of external financing needs and information asymmetry issues, a firm should consider both the value- and information-enhancing aspects of hedging. With market learning, firms with an under-estimated profitability would have more incentive for hedging, especially when they obtain favorable profitability shocks or in a market boom. Hedging is more sensitive to the profitability shocks than predicted by the complete information models, and is more sensitive to the market belief when the firm realizes an unfavorable profitability shock. The results also provide a possible explanation on the mixed empirical evidence on corporate hedging policies. Chapter 3 reconciles the conventional theories and mixed evidence of corporate incentives for hedging in the presence of growth options and external financing frictions using recent oil and gas firms data. My theoretical model makes testable predictions for the following empirical regressions. Using panel data for commodity price hedging, I show that hedging decision positively relates to the asset's profitability, the severity of information asymmetry, and the potential of expansion due to the prospective growth opportunities, and negatively relates to the inherent hedging costs. Further, I find decreasing marginal effects of informational asymmetry and growth potential on hedging decision. In Chapter 4, I theoretically explore the association between managerial compensation scheme for derivative earnings and the alignment of interests of firm managers and outside investors. I find that, as investors treat the derivative gains as a measure of a manager's financial skill, there is an effective conflict between managers and shareholders in respect of determining corporate financial hedging policy. I find a V-shape of contracting efficiency against the price of firm product and the price of the underlying asset of hedging derivatives. I conclude that cash compensation for profitable derivatives is the key distorting the manager's objective, under the fair-value based accounting criteria for hedge.