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Who hedges more when leverage is endogenous? A testable theory of corporate risk management under general distributional conditions

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  • Lutz Hahnenstein
  • Klaus Röder

Abstract

This paper develops a theory of a firm’s hedging decision with endogenous leverage. In contrast to previous models in the literature, our framework is based on less restrictive distributional assumptions and allows a closed-form analytical solution to the joint optimization problem. Using anecdotal evidence of greater benefits of risk management for firms selling “credence goods” or products that involve long-term relationships, we prove that those optimally leveraged firms, which face more convex indirect bankruptcy cost functions, will choose higher hedge ratios. Moreover, we suggest a new approach to test this relationship empirically. Copyright Springer Science+Business Media, LLC 2007

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  • Lutz Hahnenstein & Klaus Röder, 2007. "Who hedges more when leverage is endogenous? A testable theory of corporate risk management under general distributional conditions," Review of Quantitative Finance and Accounting, Springer, vol. 28(4), pages 353-391, May.
    • Handle: RePEc:kap:rqfnac:v:28:y:2007:i:4:p:353-391
    DOI: 10.1007/s11156-007-0017-z
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    More about this item

    Keywords

    Corporate hedging; Risk management; Leverage; Capital structure; Bankruptcy; Financial distress; G32; G39;
    All these keywords.

    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G39 - Financial Economics - - Corporate Finance and Governance - - - Other

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