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.