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Forward Contracts and Firm Value: Investment Incentive and Contracting Effects

Published online by Cambridge University Press:  06 April 2009

Hendrik Bessembinder
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Abstract

Corporate risk hedging with forward contracts increases value by reducing incentives to underinvest. This occurs because the hedge decreases the sensitivity of senior claim value to incremental investment, allowing equity holders to capture a larger portion of the incremental benefit from new investment. Hedging also allows the firm to credibly commit to meet obligations in states where it otherwise could not, which improves contract terms the firm can negotiate with customers, creditors, and managers. These benefits cannot be duplicated by individual hedging, and each result holds independent of agents' risk preferences.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 26 , Issue 4 , December 1991 , pp. 519 - 532
Copyright
Copyright © School of Business Administration, University of Washington 1991

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