Effect of corporate risk management on dividend policy: Evidence from US oil and gas firms

This paper tests the real effect of corporate risk management on dividend policy within a signaling theory framework. According to this theory, in the presence of information asymmetry, managers use dividends as a costly signal to convey private information to investors. This prediction has been extensively examined in the empirical literature (Baker et al., 2016). The risk management literature generally argues that firms facing high earnings volatility are more likely to hedge to stabilize their cash flows (Chay & Suh, 2009), allowing them to send more credible signals through dividend payments. We suggest that these policies are complementary and should therefore be positively related. Actual empirical results diverge regarding the sign and significance of this relationship. One potential explanation for this mixed evidence is reverse causality between dividend payments and hedging intensity. We extend the theoretical framework of Bhattacharya (1979) by allowing firms to hedge future cash flows. The theoretical results suggest that dividend policy and corporate hedging are positively related, confirming that they operate as complementary rather than substitute mechanisms. In the empirical section, we test the joint effect of hedging intensity and dividend payments on firm value. Using an instrumental variable approach, we show that once the endogeneity between both policies is adequately addressed, corporate hedging emerges as a positive and significant determinant of dividend policy. Joint dividend and risk management decisions increase firm value.