Why and How UK Firms Hedge


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    This paper was previously entitled “Hedging and the Use of Derivatives: Evidence from UK Non-Financial Firms”. I wish to thank Philip Arestis, Ephraim Clark, Paul Dunne, Brian Eales, Alex Rebmann, Nick Robinson, Duncan Watson, seminar participants at the 2002 MMF/UEM meeting, 2003 MFS meeting, Middlesex University and an anonymous referee for their helpful comments and suggestions. I am solely responsible for any remaining errors.


This paper attempts to differentiate among the theories of hedging by using disclosures in the annual reports of 400 UK companies and data collected via a survey. I find, unlike many previous US studies, strong evidence linking the decision to hedge and the expected costs of financial distress. The tests show that this is mainly because my definition of hedging includes all hedgers and not just derivative users. However, when the tests employ the same hedging definition as previous US studies, financial distress cost factors still appear to be more important for this sample than samples of US firms. Therefore, a secondary explanation for the strong financial distress results might be due to differences in the bankruptcy codes in the two countries, which result in higher expected costs of financial distress for UK firms. The paper also examines the determinants of the choice of hedging method distinguishing between non-derivative and derivatives hedging. My evidence shows that larger firms, firms with more cash, firms with a greater probability of financial distress, firms with exports or imports and firms with more short-term debt are more likely to hedge with derivatives. Thus, differences in opportunities, in incentives for reducing risk and in the types of financial price exposure play an important role in how firms hedge their risks.