Date of Award
Doctor of Philosophy (PhD)
John A. Doukas
The derivative hedging research has looked at why firms and how firms hedge and if it increases value for their shareholders. In this dissertation we investigate the relation between CEO risk preferences and ability and whether if affects their hedging decisions and firm value.
In our first essay, we challenge the theory and previous empirical evidence that showed CEO risk preferences affects hedging. Using a sample of Fortune 500 firms and 5 years of panel data, and using inside debt (i.e., CEO pension and deferred compensation) and the CEO Vega and CEO Delta, as proxies of CEO risk preferences, we document that neither risk-averse (i.e., debt like compensation) nor risk-seeking (i.e., convex compensation) inducing CEO compensation packages influence corporate hedging. Moreover, we find CEOs who have more previous work experience and high job tenure to be positively related to hedging.
Essay 2 examines the hedging intensity and market value sensitivity of firms run by CEOs with different risk preferences. We find derivatives hedging intensities of risk-seeking and risk-averse CEOs to be fairly similar, suggesting that compensation contracts designed to motivate risk-seeking (less hedging) behavior do not succeed to alter CEOs’ inherent risk-aversion. We also find, that if the underline asset prices change by three standard deviations the average firm’s derivatives portfolio creates only modest gains for both types of CEOs. These results seem consistent with the view that hedging is just an insurance policy and not a firm value increasing strategy.
In Essay 3, we investigate whether high-ability managers are more likely to engage in hedging to reduce the level of information asymmetry with the aim of protecting their reputation capital in a competitive executive labor market, as predicted by the theory of managerial responses to asymmetric information. We find that high-ability managers do not engage in greater hedging than their low-ability counterparts as the theory of managerial responses to asymmetric information predicts. Specifically, the results show that high-ability managers significantly increase firm value, but they do not undertake more hedging than low-ability managers who fail to increase firm value. Our findings suggest that high-ability managers safeguard their reputation capital through effective implementation of value increasing strategies than through hedging implying that they view hedging as an insurance policy against exogenous uncertainties.
Overall, this dissertation investigates how CEO risk preferences and ability, affects their hedging decisions and if they increase firm value. Given the widespread use of derivatives for risk management purposes, the findings of this dissertation that hedging is not the main risk management strategy by CEOs (only 10-11% of total assets) and similar hedging intensities of risk seeking and risk averse CEOs questions the validity of the convex compensation contracts designed to make CEOs take more risk and suggests that hedging is more of an insurance policy rather than a value maximizing strategy.
"Three Essays on CEO Risk Preferences, and Ability, Corporate Hedging Decisions, and Investor Sentiment"
(2018). Doctor of Philosophy (PhD), Dissertation, , Old Dominion University, DOI: 10.25777/7d6r-ta24