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Taking a View: Corporate Speculation, Governance and Compensation

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  • Geczy, Christopher C.

    (U of Pennsylvania)

  • Minton, Bernadette

    (Ohio State U)

  • Schrand, Catherine

    (U of Pennsylvania)

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    Abstract

    Using a unique dataset from a well-known survey on derivatives use, this paper examines several questions about the use of derivatives to “take a view” on interest-rate and currency movements. Tests of what motivates firms to take a view suggest that firms view speculation as a profitable NPV activity. The data do not support other theories of “rational” speculation such as Campbell and Kracaw (1999). Firms “specialize” in taking a view on either interest rates or currency rates and specialization in FX contracts is positively related to the extent of the firm’s foreign operations. We also examine the associations between speculation and compensation arrangements, governance structures, and internal control mechanisms. Compensation-related incentives of the CFO, but not the CEO, are associated with the likelihood that a firm actively takes derivatives positions. CFO portfolio deltas (vegas) positively (negatively) impact the probability of these activities. Moreover, firms with governance structures that allow for greater managerial power and indicate fewer shareholder rights are more likely to take a view. However, internal controls related specifically to derivatives use are more extensive for the firms that take a view, which suggests that transaction-specific controls are demand driven. Finally, we examine whether investors using publicly available information in corporate disclosures could identify firms that openly admit to speculation in the confidential survey. The answer is that they cannot.

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    File URL: http://www.cob.ohio-state.edu/fin/dice/papers/2004/2004-11.pdf
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    Bibliographic Info

    Paper provided by Ohio State University, Charles A. Dice Center for Research in Financial Economics in its series Working Paper Series with number 2004-11.

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    Date of creation: Jun 2004
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    Handle: RePEc:ecl:ohidic:2004-11

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    References

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    1. Core, John & Guay, Wayne, 1999. "The use of equity grants to manage optimal equity incentive levels," Journal of Accounting and Economics, Elsevier, vol. 28(2), pages 151-184, December.
    2. Paul A. Gompers & Joy L. Ishii & Andrew Metrick, 2001. "Corporate Governance and Equity Prices," NBER Working Papers 8449, National Bureau of Economic Research, Inc.
    3. Smith, Clifford W. & Stulz, René M., 1985. "The Determinants of Firms' Hedging Policies," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 20(04), pages 391-405, December.
    4. Tufano, Peter, 1996. " Who Manages Risk? An Empirical Examination of Risk Management Practices in the Gold Mining Industry," Journal of Finance, American Finance Association, vol. 51(4), pages 1097-1137, September.
    5. Geczy, Christopher & Minton, Bernadette A & Schrand, Catherine, 1997. " Why Firms Use Currency Derivatives," Journal of Finance, American Finance Association, vol. 52(4), pages 1323-54, September.
    6. Graham, John R. & Harvey, Campbell R., 2001. "The theory and practice of corporate finance: evidence from the field," Journal of Financial Economics, Elsevier, vol. 60(2-3), pages 187-243, May.
    7. Grossman, Sanford J, 1981. "The Informational Role of Warranties and Private Disclosure about Product Quality," Journal of Law and Economics, University of Chicago Press, vol. 24(3), pages 461-83, December.
    8. Paul R. Milgrom, 1979. "Good Nevs and Bad News: Representation Theorems and Applications," Discussion Papers 407R, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    9. Gordon M. Bodnar & Gregory S. Hayt & Richard C. Marston, 1998. "1998 Wharton Survey of Financial Risk Management by US Non-Financial Firms," Financial Management, Financial Management Association, vol. 27(4), Winter.
    10. Mian, Shehzad L., 1996. "Evidence on Corporate Hedging Policy," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 31(03), pages 419-439, September.
    11. Robert C. Merton, 1973. "Theory of Rational Option Pricing," Bell Journal of Economics, The RAND Corporation, vol. 4(1), pages 141-183, Spring.
    12. Ljungqvist Lars, 1994. "Asymmetric Information: A Rationale for Corporate Speculation," Journal of Financial Intermediation, Elsevier, vol. 3(2), pages 188-203, March.
    13. Catherine Schrand & Haluk Unal, 1998. "Hedging and Coordinated Risk Management: Evidence from Thrift Conversions," Journal of Finance, American Finance Association, vol. 53(3), pages 979-1013, 06.
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    Cited by:
    1. Purnanandam, Amiyatosh, 2007. "Interest rate derivatives at commercial banks: An empirical investigation," Journal of Monetary Economics, Elsevier, vol. 54(6), pages 1769-1808, September.

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