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Do firms hedge in order to avoid financial distress costs? New empirical evidence using bank data

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  • Lutz Hahnenstein
  • Gerrit Köchling
  • Peter N. Posch

Abstract

We present a new approach to test empirically the financial distress costs theory of corporate hedging. We estimate the ex‐ante expected financial distress costs, which serve as a starting point to construct further explanatory variables in an equilibrium setting, as a fraction of the value of an asset‐or‐nothing put option on the firm's assets. Using single‐contract data of the derivatives' use of 189 German middle‐market companies that stems from a major bank as well as Basel II default probabilities and historical accounting information, we are able to explain a significant share of the observed cross‐sectional differences in hedge ratios. Hence, our analysis adds further support for the financial distress costs theory of corporate hedging from the perspective of a financial intermediary.

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  • Lutz Hahnenstein & Gerrit Köchling & Peter N. Posch, 2021. "Do firms hedge in order to avoid financial distress costs? New empirical evidence using bank data," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 48(3-4), pages 718-741, March.
    • Handle: RePEc:bla:jbfnac:v:48:y:2021:i:3-4:p:718-741
    DOI: 10.1111/jbfa.12489
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