Hedging, Financing, and Investment Decisions: A Simultaneous Equations Framework

Chen-Miao Lin and Stephen D. Smith
Working Paper 2005-5
March 2005

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The purpose of this paper is to empirically investigate the interaction between hedging, financing, and investment decisions. This work is relevant in that theoretical predictions are not necessarily identical to those in the case where only two decisions are being made. We argue that the way in which hedging affects the firms’ financing and investing decisions differs for firms with different growth opportunities. We empirically find that high-growth firms increase their investment, but not their leverage, by hedging. However, we also find that firms with few investment opportunities use derivatives to increase their leverage.

JEL classification: G31, G32

Key words: investment, financing, hedging

The views expressed here are the authors’ and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors’ responsibility.

Please address questions regarding content to Chen-Miao Lin, Department of Finance, School of Business Administration, Clark Atlanta University, 223 James P. Brawley Drive, SW, Atlanta, Georgia 30314, 404-880-8461, clin@cau.edu, or Stephen D. Smith, Department of Finance, J. Mack Robinson College of Business, Georgia State University, 35 Broad Street, NW, Atlanta, Georgia 30303, 404-651-1236, sdsmith@gsu.edu.