The Effects of Corporate Derivatives Use on the Cost of Equity: Evidence from Finland

Abstract

This study examines the effects of corporate derivatives use on the firms’ cost of equity capital. Furthermore, the economic factors that drive changes in the firms’ cost of equity are under scrutiny. Also, the effect of firm size in the cost of equity is examined. Prior research focused specifically on the relationship between corporate derivatives use and the cost equity has been somewhat lacking. However, it can possibly offer a potential reconciliation on the previous mixed results on derivatives use and its value implications and offer a more sophisticated risk management strategy.

The study is conducted using a sample of Finnish non-financial companies listed in NASDAQ OMX Helsinki in years 2007 – 2013. Firms’ cost of equity is estimated within the context of Fama and French three-factor model (1993). The relation between derivatives use and the cost of equity is examined with univariate mean and median tests and with multivariate regressions including pooled regression and fixed effects regression.

Mean and median tests indicate that the cost of equity is higher but statistically insignificant among derivative users and that this increase is relatively attributed mostly to SMB and market beta. However, when control variables are included in the model, multivariate regressions indicate that derivatives use lowers the cost of equity of firms. The reduction in the cost of equity among derivatives users is statistically significant in the pooled regression specification. Cost of equity is found to be higher but statistically insignificant among larger firms.