THE USE OF DERIVATIVES AND FIRM MARKET VALUE: FINNISH EVIDENCE

Abstract

The current economic crisis has increased the market volatility of asset prices, making firms highly exposed to price risk. As a result firms have increasingly devoted more resources to risk management in order to protect firm’s profitability by using derivatives for hedging. As the importance of corporate risk management has increased the use of derivatives has expanded, making the derivatives market volumes increase rapidly. Due to an increased interest towards derivatives usage at the firm level, this thesis examines the potential impact of financial derivatives usage on firm value by testing the hypothesis that derivatives users are rewarded with higher firm value than non-users.

The firm value effect related to derivatives usage arises from positive risk management theory. According to the positive risk management theory by using derivatives, firms can increase their value by reducing cash flow volatility and enhance firm’s competences which will lead to higher firm value. The firm value relation is measured by conducting a series of empirical studies which link Tobin’s Q as a measure of firm value with derivatives usage in order to determine whether there exists positive firm value effect. Further analyses are conducted by examining the effects of the use of different types of derivatives and additionally investigating the value effect especially during the recent financial crisis.

After a series of analyses the overall results showed that no higher firm value was found, indicating that derivatives usage does not increase firm value. In fact, while no relationship was found for general derivatives usage, some results suggested that especially interest rate derivatives user experienced a statistically significant decrease in firm value. The only derivatives type that was found positively related with firm value in some of the tests was foreign exchange derivatives users. However the results were not statistically significant. Furthermore, analyses on the financial crisis demonstrated that derivatives had little or no impact on firm value, suggesting that derivative users did not fare better during the financial downturn when compared to non-users.