The determinants of Norwegian exporters’ foreign exchange risk management

Abstract

This paper examines foreign exchange (FX) hedging by Norwegian exporting firms to provide empirical evidence on the determinants of the hedging decision. The paper contributes to prior studies by, first, focusing on exporters to ensure that the companies in the sample have FX exposure, thereby allowing a more rigorous test of the theoretical determinants of hedging, and, secondly, in contrast to most previous studies that have focused on FX external hedging instruments, the use of both internal and external instruments is examined. Univariate, multivariate and multinominal analyses all provide evidence consistent with the firm value maximization hypotheses of underinvestment and risk aversion. Also, the following characteristics of firms—size, extent of internationalization and liquidity—are found to be related to the decision to hedge FX risk. However, the evidence on the links between the firm characteristics and the decision to hedge is not consistent across internal and external FX hedgers, and also varies for individual hedging instruments. Therefore it is argued that the empirical evidence on the theoretical determinants cannot be generalized to cover the full range of FX hedging strategies (which includes internal hedging instruments). Unlike empirical studies for other countries the evidence for Norwegian firms does not support the hypothesis that the avoidance of financial distress and the need to resort to external capital markets is a significant determinant of the hedging decision. Whilst the evidence suggests that country-specific factors may play a role in determining the use of FX hedging, it does not imply that the different policies adopted are necessarily inconsistent with the firm value maximization hypothesis.

Keywords:

• Hedging
• theoretical determinants
• internal and external
• exporters
• firm value

Acknowledgements

We would like to thank the two referees for very useful comments on an earlier draft. We would also like to thank Vice-president of Financial Affairs, Mr Trond Bakke-Nilsen, in Kongsberg Gruppen ASA and Chief Executive Officer, Live Haukvik Aker, in Goodtech ASA for agreeing to be interviewed on their hedging activities. All errors remain our own.

Notes

1. Early US studies were reliant on survey data (Nance et al., 1993) and used a binary classification tests (Geczy et al., 1997) but increased accounting disclosure notes in the USA have meant that that more information is available on the derivative type, the notional amounts and whether the position is long or short. Studies are therefore able to include derivative notional amounts as a continuous variable (Goldberg et al., 1998; Howton and Perfect, 1998) and refine the dependent variables for long and short payoff positions (Graham and Rodgers, 2000).

2. Due to the earlier weak empirical results a number of recent papers have not investigated all of the theoretical risk management hypotheses but rather focus on improving the proxies for one particular theory, see Graham and Smith (2000) on tax incentives, and Rodgers (2000) on managerial incentives.

3. ‘Our international comparison of aggregate equity holdings and ownership concentration both suggest that Norway is an outlier by European standards’ (Bohern and Odegaard, 2001).

4. In 2001 Norway exported 529,966 million Krona with imports at 302,459 million krona. Most exports are to the Euro zone 76.8%, other significant regions are USA 7.9%, and Asia 5.3% (Statistics Norway, 2002). In the same year exports of goods accounted for 35.1% of GDP (OECD Economic Surveys, 2003).

5. Industry-specific studies (Tufano, 1996; Schrand and Unal, 1998) diminish cross-sectional variation in firms’ risk exposures, but they do so at the expense of cross-sectional variation in the potential incentives to hedge.

6. Other studies that restrict their samples with ex ante exposure include Géczy et al. (1997) and Haushalter (2000).

7. During 2001/2002, the Norwegian financial press contained a number of reports that some exporting firms were facing bankruptcy unless there was a weakening of the Krona. For example, the agriculture manufacturer, Kverneland ASA, presented the Norwegian government with an ultimatum stating that if there was no improvement in the strength of the exchange rate they would consider moving their operations abroad.

8. In our analysis a firm could be classified as a non-hedger because they have taken a view on FX rates to enable them to benefit from an unhedged position.

9. None of the following sources provide a segmented list of exchange listed Norwegian exporters: the official Norwegian registration organization (Brønnøysund Registrene), the provider of official Norwegian statistics (Statistisk Sentralbyrå), or the Norwegian export association (Norges Eksportråd).

10. The year 2001 is the first year annual reports are required to report information on hedging, and the availability of this information provided the first opportunity to undertake a study of this nature.

11. Companies registered under the industrial sectors ‘Shipping’ or ‘Financials’ of the Oslo Stock Exchange are omitted as they are the sample. ‘Financials’ are omitted from the sample due to their trading in derivative instruments and ‘shipping’ firms are primarily family owned and have different ownership structures from the typical Norwegian firm.

12. The null hypothesis of no association is rejected for probability p-values less than or equal to 10%. The degrees of freedom following the χ² statistic are in parenthesis.

13. Géczy et al. (1997) measure the managerial wealth by the log of market value of common shares owned by officers and directors as a group. Unfortunately, neither Datastream nor Worldscope provide such data on Norwegian companies. Financial reports provide some data of managerial owned stock or options. However, this data is not consistent enough for empirical analysis.

14. The correlation matrix not presented to conserve space, but is available on request from the authors. We follow Judge et al. (1980) and apply a cut-off of correlation coefficient values of 0.8. This identifies multicollinearity in a number of our independent variables, that is understandable given they are proxies for the same theories. Therefore we exclude GEAR, SALES, MV and OAR independent variables that are highly correlated with the independent variables used in the regression. However, the proxy for the tax hypothesis (TEOL) is removed due to its strong relationship to the size variables and it was necessary to omit the tax proxy from the regression.

15. We thank a reviewer for directing us to this additional test.

16. Norwegian firms typically pay less than one third of their profits to shareholders and the dividend yield in Norway is lower than in most other European stock markets (Oslo Stock Exchange, 1998).