Brm Financial and Quantitative Analysis
JOURNAL OF FINANCIAL AND QUANTITATIVE ANALYSIS
Vol. 46, No. 4, Aug. 2011, pp. 967–999
COPYRIGHT 2011, MICHAEL G. FOSTER SCHOOL OF BUSINESS, UNIVERSITY OF WASHINGTON, SEATTLE, WA 98195
doi:10.1017/S0022109011000275
The Effects of Derivatives on Firm Risk and Value
Sohnke M. Bartram, Gregory W. Brown, and Jennifer Conrad ∗
¨
Abstract
Using a large sample of nonfinancial firms from 47 countries, we examine the effect of derivative use on firm risk and value. We control for endogeneity by matching users and nonusers on the basis of their propensity to use derivatives. We also use a new technique to estimate the effect of omitted variable bias on our inferences. We find strong evidence that the use of financial derivatives reduces both total risk and systematic risk. The effect of derivative use on firm value is positive but more sensitive to endogeneity and omitted variable concerns. However, using derivatives is associated with significantly higher value, abnormal returns, and larger profits during the economic downturn in 2001–2002, suggesting that firms are hedging downside risk.
I.
Introduction
Derivatives are financial weapons of mass destruction.
—Warren E. Buffett, 2003 Berkshire Hathaway Annual Report
The financial crisis of 2008–2009 has brought new scrutiny to the use of financial derivatives. Recent proposals in major countries, including the United
States, call for greater regulation of over-the-counter (OTC) derivatives, including conditions for marking positions to market prices, trade registration, trade clearing, exchange trading, and higher capital and margin requirements.
∗ Bartram, s.m.bartram@lancaster.ac.uk, Lancaster University, Management School, Lancaster
LA1 4YX, United Kingdom, and State Street Global Advisors; Brown, gregwbrown@unc.edu, Conrad, j conrad@unc.edu, Kenan-Flagler Business School, University of North Carolina at Chapel Hill,
CB 3490, Chapel Hill, NC 27599. We thank Hendrik Bessembinder (the editor),
Vol. 46, No. 4, Aug. 2011, pp. 967–999
COPYRIGHT 2011, MICHAEL G. FOSTER SCHOOL OF BUSINESS, UNIVERSITY OF WASHINGTON, SEATTLE, WA 98195
doi:10.1017/S0022109011000275
The Effects of Derivatives on Firm Risk and Value
Sohnke M. Bartram, Gregory W. Brown, and Jennifer Conrad ∗
¨
Abstract
Using a large sample of nonfinancial firms from 47 countries, we examine the effect of derivative use on firm risk and value. We control for endogeneity by matching users and nonusers on the basis of their propensity to use derivatives. We also use a new technique to estimate the effect of omitted variable bias on our inferences. We find strong evidence that the use of financial derivatives reduces both total risk and systematic risk. The effect of derivative use on firm value is positive but more sensitive to endogeneity and omitted variable concerns. However, using derivatives is associated with significantly higher value, abnormal returns, and larger profits during the economic downturn in 2001–2002, suggesting that firms are hedging downside risk.
I.
Introduction
Derivatives are financial weapons of mass destruction.
—Warren E. Buffett, 2003 Berkshire Hathaway Annual Report
The financial crisis of 2008–2009 has brought new scrutiny to the use of financial derivatives. Recent proposals in major countries, including the United
States, call for greater regulation of over-the-counter (OTC) derivatives, including conditions for marking positions to market prices, trade registration, trade clearing, exchange trading, and higher capital and margin requirements.
∗ Bartram, s.m.bartram@lancaster.ac.uk, Lancaster University, Management School, Lancaster
LA1 4YX, United Kingdom, and State Street Global Advisors; Brown, gregwbrown@unc.edu, Conrad, j conrad@unc.edu, Kenan-Flagler Business School, University of North Carolina at Chapel Hill,
CB 3490, Chapel Hill, NC 27599. We thank Hendrik Bessembinder (the editor),