DP15885 Efficiency or resiliency? Corporate choice between financial and operational hedging
|Author(s):||Viral V. Acharya, Heitor Almeida, Yakov Amihud, Ping Liu|
|Publication Date:||March 2021|
|Keyword(s):||Financial constraints, financial default, liquidity, operational default, resilience, Risk management|
|JEL(s):||G31, G32, G33|
|Programme Areas:||Financial Economics|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=15885|
We propose that firms face two potential defaults: Financial default on their debt obli- gations and operational default such as a failure to deliver on obligations to customers. Hence, financially constrained firms substitute between saving cash for financial hedg- ing to mitigate financial default risk, and spending on operational hedging, which mitigates operational default risk. Whereas corporate financial hedging increases in leverage, operational hedging declines in leverage. This results in a positive relation- ship between operational spread (markup) and financial leverage or credit risk, which is stronger for financially constrained firms.We present empirical evidence supporting this relationship.