The Two Sides of Derivatives Usage: Hedging and Speculating with Interest Rate Swaps JEM044 - International Finance
Miriama Tóthová, Josef Záhlava, Jakub Cieslar, Zuzana Rusá
Reasons for derivatives usage •
Hedging interest rate risk
•
Lower tax payments
•
Better matching internal cash flow with financing needs
•
Reduction of the volatility of executive compensation
•
Speculation and earnings management
Previous literature on the topic •
Assessment of the derivatives usage
•
Cross-sectional data
•
Identifying assumption: firms use derivatives for hedging •
•
Interpretation as capturing the C&B of hedging
Other goals possible •
Not clear how to interpret results
Possible reasons for derivatives usage •
Speculation • • • •
Tax deductibility of interest Benefits from successful speculation Managers internalize part of the surplus created through hedging Managers capture some of the benefits but not the costs of speculation
Empirical strategy I •
Data on interest rate swaps (non-financial firms)
•
Firms‘ intentions distinction • •
Panel data (addition of time series dimension) Assumption of time stability of exposure to interest rate risk • •
•
Interest rate hedge ratio constant as well Variation should imply speculative motivation
Cross sectional data results questioned in case of speculations confirmation
Empirical strategy II •
Separating the speculative and hedging components of policies required • •
•
Possible strategy of both hedging and speculating • •
•
“between” specification for optimal hedge ratios “within” specification for speculative activities
having a target hedge ratio Deviation from it in case of speculations
Management of rate exposure of firm‘s debt •
Fixed rate liability vs. floating rate debt security & swaps
The Data Sample •
Nonfinancial firms in Compustat‘s ExecuComp data set (1993 – 2003)
•
Hand-collected data on interest rate swap usage • •
•
The amount of floating-rate long-term debt Amounts and directions of interest rate swaps
More than 11,000 observations
Explanatory variables I. •
Controls for the debt structure of the firm • • •
•
Market leverage Percentage of debt that has more than 5 years of maturity Binary variable (debt vs. commercial paper rating)
Financial condition of the firm • • •
Measures of firm investment (based on CAPEXP and R&D) Natural log of sales Sensitivity of the firm‘s free cash flows to interest rates
Explanatory variables II. •
Macroeconomic indicators • •
•
Term spread – average difference during the fiscal year b/w the 3-year swap rate and 3M LIBOR Measure of the economywide percentage of floating-rate debt
Compensation measures •
Cash, stock and stock option compensation for CEOs and CFOs (Core and Guy, 2002) •
Estimators Delta, Vega
Description of the Resulting Data Sample •
Full Sample •
•
Swap users (number of observations reduced nearly by 45%) •
•
Substantial variation in the direction and amount of swap usage (both, across firms and in time)
Average swap size increases (it corresponds to 25.7% of the outstanding debt)
Cross-sectional vs. time-series variation • •
There is as much time-series variation as there is cross-sectional variation Contrast to the variation in market leverage: •
12.4% cross-sectional and 6.8% time-series
Swap Usage and Floating-Rate Debt – Summary Statistics
Comparison: Entire Sample vs. Swap users •
Swap users are large – access to public debt market, less investment expenditure (as a percentage of assets)
•
Swap users have greater financial sophistication and lower cost of accessing derivatives products
•
Debt usage is similar
Benchmark Multivariate Analysis •
without distinguishing between cross-sectional and time-series variation
•
to provide a benchmark and compare the results with most of the earlier literature (e.g. Faulkender (2005), Chava and Purnanandam (2007))
•
these results are difficult to interpret
•
OLS regression of swap usage and final floatingrate debt percentage
Benchmark Multivariate Analysis •
•
Swap usage is the percentage of outstanding debt that is swapped to a floating interest rate. •
firms with more floating rate debt outstanding are more likely to swap towards fixed
•
most of the baseline covariates are not significant
Final floating rate debt is the percentage of outstanding debt that is floating after accounting for the effect of interest rate swaps. •
the average firm is matching the interest rate exposure of its liabilities to that of its cash flows
•
the level of interest rates, the spread between swap rates and treasury rates, and credit spreads are statistically significant
•
none of the compensation measures are statistically significant
Cross-sectional variation •
the “between” effects and Fama-MacBeth specifications to estimate firms’ interest rate hedging activities are used
•
firms do select their average floating rate debt exposure in a manner consistent with hedging
•
the coefficient on the interest rate sensitivity of operating and investing cash flows is positive and statistically significant
•
larger firms, those with a bond rating, those that engage in more R&D, and those with high leverage ratios have significantly less floating rate debt
Cross-sectional variation •
interacting various measures of investment with the interest rate sensitivity of the firm cash flow and adding these interaction terms to the between specification
•
firms that engage in significant capital expenditures have significantly higher matching of the interest rate exposures of their debt and cash flows
•
the coefficients on the interactions with both advertising and R&D are not statistically significant
•
the results are more consistent with firms hedging to avoid relying on costly external capital (Froot, Scharfstein, and Stein (1993)) than they are with hedging to minimize the costs of financial distress (Smith and Stulz, 1985) or to take advantage of the tax deductibility of interest (Graham and Rogers (2002))
Times series variation •
To distinguish between hedging and speculation – variation around some constant hedge ratio should capture speculating activities
•
Leverage has significantly positive effect on amount of floating debt
•
Spreads affect the floating debt •
Increase of spread between 3-year swap and 3 month libor -> average +3,1% floating debt
Time series variation •
High-powered compensation structures for CFOs results in more speculation (consistent with surveys (Geczy et al., 2007)) as well as in the use of floating-rate swap usage, not in more hedging
•
Firms use interest rate risk management to manage earnigs •
If firm could reach its earnigns forecast by full floating-rate debt, 1% increase in yield spread leads to approx. 10% more floating-rate debt
Conclusion •
Motivations of interest rate risk management • •
•
Cross-section to identify which vars affect hedging, time-series to identify speculation •
•
Hedging Speculation
Assuming constant optimal hedge ratio
Previous findings suggesting hedging more consistent with speculation
Conclusion
•
In contrast with pooled benchmark separate analysis find some variables statistically significant – panel data needed for true identification of derivatives usage
Conclusion •
Motivation of hedging • •
•
Access external capital for investment ? To decrease financial distress costs
Motivation of speculation •
Altering derivatives with movements in term structure, particularly: • •
When executives have high powered incentives Adjustment can fullfil earnings forecast
Thank you for your attention!
