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The effectiveness of foreign debt in hedging exchange rate

exposure: Multinational enterprises vs. exporting firms

Soon Sung Kim, Jaiho Chung, Joon Ho Hwang, Ju Hyun Pyun

PII: S0927-538X(20)30667-3
DOI: https://doi.org/10.1016/j.pacfin.2020.101455
Reference: PACFIN 101455

To appear in: Pacific-Basin Finance Journal

Received date: 26 May 2020

Revised date: 21 September 2020
Accepted date: 5 October 2020

Please cite this article as: S.S. Kim, J. Chung, J.H. Hwang, et al., The effectiveness of
foreign debt in hedging exchange rate exposure: Multinational enterprises vs. exporting
firms, Pacific-Basin Finance Journal (2020), https://doi.org/10.1016/
j.pacfin.2020.101455

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© 2020 Published by Elsevier.

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The Effectiveness of Foreign Debt in Hedging Exchange Rate

Exposure: Multinational Enterprises vs. Exporting Firms

Soon Sung Kim†

Korea University

Jaiho Chung‡
Korea University Business School

Joon Ho Hwang¶
Korea University Business School
and

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Ju Hyun Pyun§
Korea University Business School

September 2020
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Abstract
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This study examines the effect of foreign debt use on the reduction in foreign exchange rate risk
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between multinational enterprises (MNEs) and exporting firms. We use manufacturing firms in Korea
and find that the hedging effectiveness of foreign debt of MNEs is more salient than that of exporting
firms. Results are robust after controlling for self-selection effect and alternative measurements for
individual currency exposure. Our findings suggest that the effectiveness of foreign debt in reducing
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FX exposure is influenced by the volatility of foreign cash inflows that depends on different operating
characteristics between two groups of firms.

JEL code: F23, G15

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Keywords: Foreign exchange exposure, Foreign debt, MNEs, Exporting firms

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Acknowledgement: We are thankful to an anonymous referee for helpful comments and suggestions. This study
is (partially) supported by Korea University Business School Research Grant.
†
Korea University, 145 Anam-Ro, Seongbuk-Gu, Seoul 02841, E-mail: nancy15@korea.ac.kr
‡
Corresponding Author: Business School, Korea University, 145 Anam-Ro, Seongbuk-Gu, Seoul 02841, E-
mail: jhochung@korea.ac.kr
¶
Business School, Korea University, 145 Anam-Ro, Seongbuk-Gu, Seoul 02841, E-mail:
joonhwang@korea.ac.kr
§
Business School, Korea University, 145 Anam-Ro, Seongbuk-Gu, Seoul 02841, E-mail: jhpyun@korea.ac.kr
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1. INTRODUCTION

In an increasingly globalized economy, many firms have exposure to foreign exchange (hereafter FX)

rate risk (Jorion, 1990; Bartov and Bodnar, 1994; Bodnar and Gentry, 1993; He and Ng, 1998; Hutson

and Stevenson, 2010). In order to sustain competitiveness and profitability in international markets,

firms engage in FX risk management notably through the use of foreign currency derivatives and/or

foreign debts (Allayannis and Ofek, 2001; Elliot, Huffman and Makar, 2003; Gatopoulos and

Loubergé, 2013; Nydahl, 1999; Pramborg, 2005; Tanha and Dempsey, 2017).

In particular, foreign debt is considered as the most accessible hedging instrument for emerging

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market firms that actively operate in a foreign country because other financial hedging instruments are

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not well-developed or not readily available (e.g., Tanha and Dempsey, 2017). 1 Even firms in
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developed countries such as US firms issue foreign debts not only to avoid information asymmetry

but also to reduce FX exposure (Kedia and Mozumdar, 2003). If a firm‟s revenue occurs in foreign
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currency, the fluctuation of exchange rate increases the variability of income inflows valued in home
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currency, thereby the firm faces higher FX risk. The use of foreign currency-denominated debt offsets

foreign cash inflows generated from firm‟s sales and revenue in a foreign country by way of creating
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foreign cash outflows, which is called matching or natural hedge. Graham and Harvey (2001) report

from their survey that 31% of responding CFOs use foreign debt and its primary motive is to provide
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a natural hedge against foreign currency devaluation.2

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In this study, we argue that the use of foreign debt is more effective in reducing FX exposure for

multinational enterprises (MNEs henceforth) than for exporting firms. The effectiveness of foreign

1
Tanha and Dempsey (2017) note a sizeable difference in the frequency of using financial derivatives
depending on the firm‟s home country due to the level of financial market development of home country.
Pramborg (2005) show that Korean firms use financial derivatives as a hedging instrument at much lower level
(51% of 60 firms) than that of Swedish firms investigated (81% of 103 firms). While Swedish derivatives
markets are well-developed, Korean markets have been heavily regulated and therefore have limited access to
derivative instruments.
2
An example of a firm using foreign debt to reduce FX exposure is Pemex, a Mexican multinational and state-
owned petroleum enterprise. The firm has cash flow structure in which most of revenues are created in US
Dollars but capital expenditure and operating expenses are incurred in Mexican peso (Pemex, 2014, p. 204). As
a result, the appreciation of Mexican peso against US Dollar will deteriorate the firm‟s financial status. If Pemex
issues foreign debt which obligates payment in US Dollar, the payment on the foreign debt will offset the above
mentioned changes in cash flow caused by exchange rate movement. Therefore, Pemex mainly uses foreign debt
instead of other hedging instruments (Pemex, 2014, pp. 204-205).
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debt in reducing FX exposure depends on whether there is relatively constant and predictable amount

of foreign cash inflows over time (Eiteman et al. 2004, p. 254). The stability of foreign cash flow can

be different depending on the firm‟s foreign operational strategy by which the firm can achieve its

goal overseas: foreign direct investment (FDI) vs. exporting. MNEs which set up foreign subsidiaries

by making FDI tend to have more stable foreign cash inflows over time compared to exporting firms

which do not make FDI. This is because MNEs receive dividends, royalties, licensing fees, etc. in

foreign currency from their subsidiaries (Chen, Cheng, He, and Kim., 1997). An influential study by

Errunza and Senbet (1980) notes that MNEs can provide more stability to both consolidated sales and

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costs of production by making FDI, whereas exporting firms can reduce the variability of only

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consolidated sales revenue. Thus, since MNEs and exporting firms have a different level of
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commitment to foreign market, they are likely to have different pattern of foreign cash inflows

(Kirkvliet and Moffet, 1991).

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To test the effectiveness of foreign debt in reducing FX exposure according to firm‟s operational
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characteristics, we use data on Korean manufacturing firms. Korea is an ideal market for our

empirical setting because many Korean firms are actively involved in exporting or FDI activities in
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the international market, and they are exposed to volatile exchange rate since the Asian financial crisis.

We find that the effectiveness of foreign debt in reducing FX exposure of MNEs is more salient than
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that of exporting firms. Since MNEs tend to have more stable foreign cash inflows compared to
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exporting firms, our results provide strong empirical evidence that the effectiveness of foreign debt in

reducing FX risk depends on firm‟s operational characteristics. Our results are robust with alternative

measures of currency exposure and after controlling for the self-selection effect in the decision of

using foreign debt.

This study contributes to previous literature on FX exposure in two major dimensions. First,

while previous studies have focused on the determinants of foreign debt use (e.g., Esho, Sharpe, and

Webster, 2007; Kedia and Mozumdar, 2003; Keloharju and Niskanen, 2001), we focus on the

effectiveness of foreign debt as a hedging instrument. As for the determinants of foreign debt use,

previous studies find mixed evidence on factors such as foreign sales, exports, and foreign operations.
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Keloharju and Niskanen (2001) find that firms in which exports constitute a significant fraction of net

foreign sales are more likely to raise foreign debt. Kedia and Mozumdar (2003) find strong evidence

that firms with greater foreign operations are more likely to use foreign currency debt to hedge their

increased exposure. On the other hand, Allayannis and Ofek (2001) do not find any evidence that

exporters are more likely to issue foreign debt although they do find a significant positive relation

between the ratio of foreign sales to total sales and a firm‟s decision to use foreign debt. Thus, given

such mixed evidence on the relationship between various measure of exposure and the motivation to

use foreign debt as a hedging tool, it is important to ask whether foreign debt is indeed effective as a

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hedging tool for both MNEs and exporters. To the best of our knowledge, we make the first attempt to

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examine the question. By doing so, our research provides an important managerial implication
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regarding the use of foreign debt as a hedging tool for managers of MNEs and exporting firms.

Second, this study takes into account the endogeneity problem in estimating the effect of foreign
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debt on FX exposure. Both MNEs and exporting firms have unobservable characteristics that can
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affect the decision of using foreign debt, and these characteristics can bias the effects of foreign debt

on FX exposure. By controlling for the specification error from omitted variables (Heckman, 1979) in
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determining the firm‟s use of foreign debt, this study controls for the endogeneity in estimating the

effectiveness of foreign debt as a hedging instrument for FX exposure.

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The remainder of this paper is organized as follows: Section 2 provides the description of data
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and our empirical methodology. In section 3, we report our main empirical findings and discuss the

results. We provide concluding remarks in section 4.

2. EMPIRICAL ANALYSIS

2.1. Data

Our sample consists of 382 Korean manufacturing firms listed on the Korea Stock Exchange during

the sample period of 2002-2006. The number of firms listed as non-financial firms in KISVALUE as

of 2008 is 660. Among these firms, 635 firms are listed in KOSPI, and among those, 459 firms are in

the manufacturing industry. We end up with 382 firms that have information on monthly stock returns
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from KISVALUE, export amount from KISLINE, financial derivatives usage from DART, the

information on the number of foreign subsidiaries and the equity holdings of parent firms on each

foreign subsidiary from KISLINE, DART, and TS2000. The aforementioned firm-level data are

available from 2002, thus the starting point of our sample period. We do not include the global

financial crisis in order to avoid any structural shocks to both foreign revenues and foreign debt. Also,

some Korean firms using Knock In Knock Out (KIKO) derivaties incurred significant loss due to the

huge fluctuation in the Korean Won exchange rate during and shortly after the global financial crisis.

The impact of foreign derivatives on FX exposure and on the effectiveness of foreign debt on FX

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exposure during such period would be very different from normal times.3 In this study, we examine

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the period before the global financial crisis as opposed to the period after the crisis because the
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information on the use of financial derivatives in DART is not readily available from 2009.

To compute FX exposure, monthly stock return and monthly foreign exchange rate returns are
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retrieved from KISVALUE and the Bank of Korea. To measure market return, we collect data on
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Korea Composite Stock Price Index (KOSPI) from KISVALUE. After we compute exchange rate

exposure during the period of 2002-2006, we match this exposure to firm-level characteristics.
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Consistent with Pantzalis et al. (2001), these data on firm-level characteristics are collected for the

midpoint of our sample period, which in our case is 2004.4 Information on firms‟ foreign debt is
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hand-collected from the footnotes of financial statement on KISLINE. The data on the firm‟s use of
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financial derivatives is obtained from annual reports in DART (Data Analysis, Retrieval and Transfer

System). Export amount, debt to equity ratio, book to market ratio and quick ratio are retrieved from

the financial statements in KISLINE. Firm‟s total sales and total assets are obtained from KISVALUE.

The universe of our sample consists of firms that have exports greater than zero. We categorize

firms as MNEs if a firm has at least 20% equity stake in its foreign subsidiary. The remaining firms in

our sample (non-MNE firms) are categorized as exporting firms. This criteria of defining MNEs is

3
Examining the effectiveness of foreign debt during the crisis period will be an interesting area to study in itself
but we think it is a separate topic that requires a new empirical design due to limited time period.
4
Having firm characteristics for every year would enable us to run panel models. However, the data on the
firm‟s use of foreign debt is not consistently available for our entire sample period.
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consistent with previous studies such as Dhanaraj and Beamish (2004), Makino, Chan, Isobe, and

Beamish (2007), and Beamish and Lupton (2009) which show that firms with equal to or more than

20% equity stake of foreign subsidiaries have significant influence and commitment on their foreign

subsidiaries.5 Also from an accounting standpoint, the accounting criteria of 20% equity stake can be

a good indicator for MNEs in that the parent company has relatively constant foreign cash inflows

from their foreign subsidiaries in the form of share of income, dividend, license fees, and rent.6

Previous studies also introduce various other definitions for MNEs to identify the existence of foreign

presence. For example, Choi and Jiang (2009) define MNEs as firms that have at least one foreign

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production facility to examine the effectiveness of operational hedge for FX exposure. Therefore, for

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the robustness of the result, we also introduce an alternative indicator for MNEs which is defined

based on whether the firm has a foreign subsidiary or not.

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Panel A and Panel B of Table 1 shows the descriptive statistics of MNEs and exporting firms.
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Foreign debt ratio is calculated as foreign debt divided by total sales, where foreign debt includes
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foreign borrowing (both short-term and long-term), long-term liquidity foreign debt and accounts

payable in foreign currency.7 The variable of foreign debt level scaled by total sales captures the
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portion of foreign debt relative to the firm‟s source of competitiveness, measured by total sales. In one

of our robustness tests of our main model, we test using the variable of foreign debt divided by total
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asset instead of total sales. We find that MNEs use significantly more foreign debt compared to
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exporting firms. In Panel A, the mean of foreign debt ratio of MNEs and exporting firms are 0.065

and 0.047, respectively. Results in Panel B show that out of 382 firms in our sample (of which 252 are

5
Dhanaraj and Beamish (2004) find that international joint ventures with less than 20% ownership are likely to
have much higher mortality rates, whereas those with higher than 80% equity ownership tend to have similar
mortality rates to wholly owned subsidiaries. Makino, Chan, Isobe, and Beamish (2007) investigate the
continuance and the termination of international venture by defining international ventures as firms with equal
or more than 20% equity stake. Beamish and Lupton (2009) show that local authority tends to regard a parent
company with less than 20% equity stake as not being influential on its foreign subsidiary as an investor.
6
If a parent firm has lower than 20% equity ownership of foreign subsidiary, the accounting cost method is
used in the valuation of the investment of the parent firm. If a firm has a subsidiary with equal to or greater than
20% but less than 50% equity share invested, equity method is applied in translating the portion of subsidiary‟s
income into the income of the parent firm. If a firm has greater than 50% equity share invested in its subsidiary,
the firm uses the consolidation method in which the subsidiary‟s asset, liabilities, income and expenses are
integrated with those of parent firm (White, Sondhi, and Fried, 1997).
7
Because accounts payable exhibits foreign cash outflow on a regular basis, we include it as a part of foreign
debt.
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MNEs and 130 are exporting firms), 310 firms (81.15% of total firms) use foreign debt. Among 310

foreign debt users, 227 firms are MNEs and 83 firms are exporting firms. Among MNEs, the ratio of

firms using foreign debt is 90.08% and among exporting firms, it is 63.85%. In our main analyses, we

employ Heckman two-step method to control for the self-selection of foreign debt usage. Panel B also

reports the number of firms using foreign debt that is denominated in US Dollar, Japanese Yen, and

Euro. The most popular denomination is in US Dollar, followed by Japanese Yen. More than 70

percent of MNEs and 50 percent of exporting firms in our sample have US Dollar and Yen

denominated debts. Accordingly, we suspect that both MNEs and exporting firms are exposed to the

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fluctuations of exchange rate against US Dollar and Yen. Thus, in calculating our FX exposure

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variables, we use not only the exchange rate based on the basket of currencies but also the Won/Dollar
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exchange rate (Dollar return for Won) and the Won/Yen exchange rate (Yen return for Won) to

generate bilateral FX exposure.

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Firm‟s use of financial derivative (Derivativesi) takes the value 1 if the firm uses foreign currency
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derivatives and 0 otherwise. Result in Panel A shows that the mean of financial derivative use of

MNEs is 0.294, which is about three times greater than that of exporting firms. This suggests that
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MNEs use more financial hedging tools to deal with FX risk compared to exporting firms. The mean

of export ratio (export/sales) for MNEs is 0.418 and that for exporting firms is 0.210, respectively.
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The median of export ratio shows even larger difference between MNEs (0.429) and exporting firms
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(0.122). These numbers show that MNEs are also heavily engaged in exporting activities.

As for other firm characteristics, firm size is measured as the log of total assets. Leveragei is

measured as debt to equity ratio. Book-to-market ratio (BMi) is calculated as the book value of equity

divided by market value of equity. Quick ratio (Liquidityi) measures firm‟s liquidity, which is the ratio

of short-term assets (cash, cash equivalents, marketable securities and account receivable) to current

liability. R&Di is measured as R&D expenditure divided by total sales. Credit rating is is retrieved

from KISLINE, and has a smaller number as the evaluation on credit is favorable to a firm. Domestic

debt ratio is measured as domestic debt scaled by total asset. As expected, we find that MNEs tend to

be bigger than exporting firms. Exporting firms have higher quick ratio than MNEs. There is not
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much difference in the book-to-market ratio (BMi), credit rating and domestic debt ratio between

MNEs and exporting firms. As for the firm characteristics of foreign debt users versus non-users,

results in Panel C show that foreign debt users are larger firms and are more likely to use foreign

currency derivatives. We control for the possible effects of different firm characteristics in our

regression.

[Insert Table 1]

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2.2. Empirical specification

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2.2.1. Foreign exchange (FX) exposure
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To measure a firm‟s FX exposure, we use the absolute value of the estimated coefficients of the rate

of return on nominal effective exchange rate on the regression of firm‟s monthly stock returns (e.g.,
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Allayannis and Ofek, 2001 and Pantzalis et al. 2001). Specifically, we regress firm‟s monthly stock
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return on market return and the return of currency basket for the periods 2002-2006 as follows:

Rit  0i  1i Rmt  2i RFXt   it (1)

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where Rit is the monthly rate of return of firm i‟s stock at t, Rmt is the monthly rate of return on the
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market at time t, RFXt is the percentage change in trade-weighted nominal effective exchange rate of

Korea. An increase in nominal effective exchange rate reflects the appreciation of the home currency
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of Korean Won. β2i captures the sensitivity of firm i‟s stock return to the basket exchange rate change

after controlling for the market return. Positive (negative) β2i, i.e., positive (negative) FX exposure

suggests that the appreciation of the Won against other foreign currencies has a positive (negative)

impact on the stock return of firm i. A negative FX exposure is explained by how the home currency

appreciation (depreciation) harms (helps) a firm‟s price competitiveness in the international market.

[Insert Table 2]

Table 2 shows the distribution of FX exposure coefficients, β2i for our sample of firms and for the
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subsample of firms with positive and negative exposures. Results show that more than half of total

firms (220 firms out of 382 firms) have positive exposure, which means that the appreciation of

Korean Won relative to a basket of foreign currencies is positively associated with the firm‟s stock

price. The remaining 162 firms have negative exposure, i.e., the appreciation of Korean Won leads to

lower stock price. Previous studies show that FX exposure is country-specific: while many US MNEs

benefit from strong US Dollar during the period of 1989-1993 (Pantzalis et al., 2001), most Japanese

MNEs gain from Yen deprecation for the period 1979-1993 (He and Ng, 1998). Table 2 also shows

that both the standard deviation and the dispersion of FX exposure (the maximum of positive

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exposure of 9.216 versus the minimum of negative exposure of -6.432) show that there is greater

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variation among the positive FX exposures compared to the negative FX exposures. Table 2 also
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shows that firms with negative exposures are more likely to use financial derivatives than firms with

positive exposures. This result, along with the finding that 75.9% of the negative exposure firms are
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MNEs, compared to 58.6% of the positive exposure firms are MNEs, is consistent with the results in
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Table 1 which show that MNEs are more likely to use financial derivatives compared to exporting

firms.
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2.2.2. A role of foreign debt in reducing FX exposure

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We set up the following cross-sectional regression to investigate the effect of foreign debt use on FX
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exposure using the firm level variables in 2004, which is the middle year of our sample periods8:

ˆ2i =  0 +  1 Foreign debt/salesi +  2 Derivativesi +  3 Export/salesi +  4 Sizei +  5 Leveragei

+  6 BMi +  7 Liquidityi +  8 R&Di +  9 HHI +  i  Industry + 

i
i i (2)

where the dependent variable ˆ2i is the measure of firm i‟s degree of FX exposure as described in

the previous section. A firm‟s foreign debt ratio (Foreign debt/salesi) is the main variable of our

8
Pantzalis et al. (2001) use the information as of 1991 in the sample period of 1989-1993 to examine the effect
of foreign subsidiary network characteristics on reducing FX exposure.
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interest, measured as the foreign debt amount (in Korean Won) divided by total sales. We hypothesize

that the firm‟s use of foreign debt is effective in reducing FX exposure. Specifically, its use of foreign

debt would decrease β2i for firms with positive exposures and increase β2i for firms with negative

exposures, which means the absolute value of β2i decreases regardless of the sign of β2i.

Since all firms in our study has positive amount of export, the use of foreign debt alleviates

the exposure from foreign revenues denominated in that currency. As for firms that also have foreign

currency denominated expenses, they are able to hedge the exposure by using foreign debt in another

currency that has a negative correlation with the exposed currency. This practice is referred to as cross

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hedge and as a result, FX exposure becomes closer to 0 through the use of foreign debt even if the

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firm has only foreign expense. For instance, if a firm pays in Japanese yen for its import, the firm can
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use a foreign debt in US Dollar in order to hedge FX exposure from the costs in Japanese yen when

US Dollar is negatively correlated with Japanese yen. The practice of cross hedging is documented in
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previous studies. Kedia and Mozumdar (2003) find that U.S. firms typically use German mark, British
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pound, and Japanese yen to cross hedge their FX exposure. Especially, they note that U.S. firms

seldom have foreign subsidiaries in Japan but many carry foreign debt in Japanese yen. This suggests
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that the foreign debt in Japanese yen is used to cross hedge other currencies, rather than to straight

hedge their FX exposure to Japanese yen (Kedia and Mozumdar, 2003, p.539). As an actual example
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of cross hedging in our sample, Appendix Table 1 shows the composition of foreign assets and foreign
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liabilities in the balance sheet of Orion, global food company from Korea in 2016. Orion has foreign

debt denominated in Euro even though it has no revenue generated in Euro. Appendix Table 2 shows

the estimated changes in Orion‟s profit due to changes in the exchange rate as provided by the firm‟s

annual report. It shows that the fluctuation of Korean Won with respect to Japanese Yen is partially

offset by the fluctuation of Korean Won with respect to Euro. Thus, firms (whether they are net

exporters or net importers) can bring their FX exposure closer to 0 by keeping a balanced level of

foreign asset and foreign liability. We therefore use the absolute value of beta to measure the

effectiveness of FX exposure and examine whether the effect of foreign debt on the absolute FX

exposure is different between MNEs and exporting firms using subsample analysis.
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The use of foreign currency derivative (Derivativesi) is included as one of the control

variables because foreign currency derivative provides alternative way for a firm to hedge its FX risk.

Other firm characteristics may also influence the firm‟s FX exposure. Export to sales ratio

(Export/salesi) is included as a revenue-related FX exposure factor. He and Ng (1998), Allayannis and

Ofek (2001), Jorion (1990), and Pantzalis et al. (2001) find that the firms with higher export ratio tend

to have higher exposure to FX risk. The effect of firm size (Sizei) on FX exposure is not theoretically

obvious. Nance, Smith, and Smithson (1993) argue that larger firms enjoy greater benefit from

hedging because of informational and transactional economies of scale. In contrast, He and Ng (1998)

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show that because larger firms have lower probability of financial distress, they are not likely to

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actively hedge FX risk. Firms with high financial leverage (Leveragei) are more likely to engage in
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hedging activity because they tend to have higher financial distress costs (He and Ng, 1998). Book-to-

market ratio (BMi) is included as a proxy for firm‟s growth opportunity. Froot, Scharfstein and Stein
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(1993) show that firms with higher growth option (lower book-to-market ratio) try to reduce the
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variance of internal cash flows to avoid underinvestment when external financing is costly. Therefore,

firms with greater growth options are more likely to proactively hedge FX risk. Liquidity measures the
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firm‟s ability to pay its cost in the short term. Nance, Smith and Smithson (1993) argue that firm‟s

high liquidity reduces the expected financial distress cost and thereby leads to lower level of hedging.
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As for the R&D, its effect on FX exposure is ambiguous. On the one hand, firm‟s R&D investment
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often leads to expansion into the foreign market, resulting in more FX risk. On the other hand, if firms

with high R&D expenses invest in unique and proprietary products and services that insulate them

from domestic and foreign competition, these firms can face less FX exposure (Aggarwal and Harper,

2010). The Herfindahl-Hirschman Index (HHI) is calculated by ∑𝑖∈𝑗 𝑠𝑖2 , where 𝑠𝑖 is the market

share of firm i in industry j. This is a proxy for the degree of industry concentration that captures the

level of competition. In models which we do not control for the HHI variable, we include industry

dummy which captures unobserved heterogeneity of the industry that the firm belongs to.

Positive exposure vs negative exposure

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To examine separate effect of foreign debt on FX exposure depending on net economic position

in foreign currency, we categorize firms into firms with positive FX exposure and firms with negative

FX exposure. For firms with net economic long position in foreign currency such as exporters or firms

with foreign operation, they are likely to benefit from the depreciation of domestic currency. On the

other hand, firms that are importers are likely to benefit from the appreciation of domestic currency.

Studies such as Bartov and Bodnar (1994) and Pantzalis et al. (2001) provide empirical support by

showing that the effect of FX movements on firm value or cash flow is determined by the net

economic position (long or short) in foreign currency. In some cases, however, the net position in

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foreign currency is not so clear cut as exporter vs. importers. For example, in the case of a major

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petroleum firm in Korea, the firm imports crude oil, refines it, and sells the processed product both in
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domestic market and foreign market. Even though the firm hedges foreign exchange rate risk, its

financial statements show that the firm goes through gains and losses due to FX movement since
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perfect hedge is not possible. Many other firms in Korea are both importers and exporters because
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they export products after processing imported raw materials and/or intermediate goods. Therefore,

because it can be difficult to categorize firms clearly into exporters or importers, we run another
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regression model in which firms are separated into those with positive exposure and those with

negative exposure. Such a way of separating sample firms into firms with positive exposure and firms
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with negative exposure is also consistent with previous studies such as He and Ng (1998), Pantzalis et
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al. (2001), and Agarwal and Harper(2010). As shown in Equation (3) below, we include a binary

variable D which takes the value of 1 if the firm has positive FX exposure. In this specification, we

include the MNE dummy variable to compare the effect of foreign debt on FX exposure between

MNEs and exporting firms.

ˆ2i =  0 D+  1 D×Foreign debt/salesi+  2 D×Derivativesi+  3 D×Export/salesi+  4 D× Sizei

+  5 D×Leveragei+  6 D×BMi+  7 D×Liquidityi+  8 D×R&Di+  9 D×HHI+ 10 D×MNE Dummy

+ 11 D× Foreign debt/salesi×MNE_Dummy i +  0 d (1-D)+ 1 d (1-D)× Foreign debt/salesi

+  2 d (1-D)×Derivativesi+  3 d (1-D)×Export/salesi+  4 d (1-D)× Sizei

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+  5 d (1-D)×Leveragei+  6 d (1-D)×BMi+  7 d (1-D)×Liquidityi+  8 d (1-D)×R&Di+  9d (1-D)×HHI

+ 10d (1-D)×MNE Dummy+ 11d (1-D)×Foreign debt/salesi×MNE Dummy i + ui (3)

Since various firm characteristics can affect both the firm‟s decision to use foreign debt and the

effectiveness of foreign debt towards reducing FX exposure, we control for the endogeneity of foreign

debt use drawing on Heckman‟s (1979) selection model. This two-step approach can better identify

the effectiveness of foreign debt in reducing FX exposure by controlling for the firm‟s self-selection

effect.

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3. EMPIRICAL RESULTS

3.1. Baseline results

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Table 3 shows the results of the regression of the absolute value of FX exposure as shown in Equation
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(2). Panel A reports the results for MNEs and Panel B shows the results for exporting firms. In
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columns (1) and (4), we include the Herfindahl-Hirschman Index (HHI) of the industry that the firm

belongs to. In columns (2) and (5), we include industry dummy in the regression instead of the HHI
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variable. In columns (3) and (6), we exclude firms that use financial derivatives from our sample. This

exclusion is done because the use of financial derivatives is alternative way to hedge foreign exchange
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rate risk and thus the use of financial derivatives can impact the effect of debt on reducing FX
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exposure. For all specifications, the estimated coefficients of both the foreign debt use and the

financial derivative use are significantly negative at the 1% level for MNEs, whereas statistically

insignificant for exporting firms. We also conduct the test for the difference in the foreign debt

coefficient between MNEs and exporting firms and find that the difference is statistically significant.

These results imply that the use of foreign debt reduces the absolute FX exposure more for MNEs

compared to exporting firms.

[Insert Table 3]

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As for the control variables, leverage has significantly positive effect on the FX exposure for

MNEs but has insignificant effect for exporting firms. Firm‟s book-to-market ratio is positively

associated with the absolute FX exposure for both MNEs and exporting firms. This is consistent with

previous studies such as Froot et al. (1993) and Nance et al. (1993) in that firms having high growth

opportunity (low book-to-market ratio) are more likely to engage in hedging activities to reduce the

variability of the internal cash flow. The coefficient of R&D shows significant and positive sign for

MNEs in column (2), which implies that MNEs with higher R&D intensity are likely to have higher

levels of international transactions for MNEs, so they face higher FX exposure. We do not find any

of
support for the theoretical prediction on the relationship between firm‟s export ratio and FX exposure

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(i.e., He and Ng, 1998; Bodnar and Wong, 2003) and the argument that large firms can enjoy the
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economies of scale in hedging cost (He and Ng, 1998; Nance et al., 1993). The R-squares in models

are similar to those reported in studies such as Pantzalis et al. (2001, p.805) and Nguen and Faff (2006,
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p.195).
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As an alternative specification, we use the indicator of positive and negative exposures as shown

in Equation (3). Results in Table 4 show that the coefficient of the triple interaction term of negative
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FX exposure dummy (1-D), foreign debt, and the MNE dummy is negative and statistically significant.

This implies that there is significant effect of foreign debt use in reducing FX exposure for MNEs
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with negative FX exposure. Considering our investigation period of 2002-2006 when Korean Won
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showed an appreciating trend, MNEs with negative exposure (which are likely to be firms with long

position on foreign currency) can offset the loss in foreign cash inflow by using foreign debt.

[Insert Table 4]

3.2. Bilateral exchange rate

Previous studies such as Allayannis and Ofek (2001), Dominguez and Tesar (2006), Glaum, Brunner,

and Himmel (2000), and Nydahl (1999) use bilateral nominal exchange rate to compute FX exposure.

Glaum, Brunner, and Himmel (2000) argue that the use of exchange rate indices could underestimate
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the effect of a specific currency and thus bilateral exchange rate is better suited to capture the firm

sensitivity to a specific currency movement. If the firm issues foreign debt, the currency by which the

foreign debt is denominated will have greater impact on the firm‟s FX exposure.

Table 5 shows the results of examining FX exposure with respect to individual currency. When

comparing the results of MNEs and exporting firms, foreign debt of MNEs shows significantly

negative effects on absolute US Dollar and Japanese Yen FX exposure at the 1% and 5% levels

respectively. Because MNEs have foreign debt in US Dollar more than other currencies, the negative

relationship between absolute US Dollar FX exposure and foreign debt is predictable. By contrast, in

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columns (4)-(6), the estimated coefficients of foreign debt use by exporting firms are not statistically

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significant at all.9
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[Insert Table 5]
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3.3. Controlling for endogeneity: Self-selection
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It is possible that MNEs and exporting firms systematically prefer one hedging tool, either foreign

debt or financial derivatives, over the other. To address this concern, we test for the preference of
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MNEs and exporting firms for using foreign debt or financial derivatives.
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[Insert Table 6]
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Results in Table 6 show that „MNE dummy‟, „foreign subsidiaries/total subsidiaries‟, „export

dummy‟, „export/sales‟ are not statistically significant. Therefore, neither MNEs nor exporting firms

show any significant preference for either the use of foreign debt or the use of financial derivatives. In

addition to examining the preference for foreign debt or financial derivatives separately, we consider

the case where firms use either foreign debt or financial derivatives. The results show that MNEs are

9
Another observation in Table 5 is that even though none of the variables are significant in column (4), the
stronger explanatory power of the industry dummy makes R-square of exporting firms greater than the R-square
of MNEs. When we check the regression excluding industry dummy (result not reported for brevity), we find
that the R-square is higher for MNEs compared to exporting firms.

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more likely to use foreign debt or financial derivatives than exporting firms. Since the use of foreign

debt or financial derivatives also has speculative aspect in addition to hedging purpose, examining the

effectiveness of foreign debt in reducing FX risk between MNE and exporting firms warrants further

attention. Of course, we have to control for the use of financial derivatives in examining the firms‟

choice of using foreign debt as well as in analyzing the effectivess of foreign debt in reducing FX

exposure.

We control for the self-selection of foreign debt use by employing the two-step model of

Heckman (1979). In the first stage regression, we use the probit model in which the foreign debt use

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dummy variable is the dependent variable. We include all the controls used in our baseline analysis

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except for the leverage variable and instead add two more controls of credit rating and domestic debt
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to asset ratio to satisfy the exclusion restriction. Firm‟s credit rating is retrieved from KISLINE, and

has a smaller number as the evaluation on credit is favorable to a firm. In the second stage, we use its
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predicted value to compute the inverse Mill‟s ratio.
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Pr(Foreign debt=1) = α0 + α1 Derivativesi + α2 Sizei + α3 Export/salesi + α4BMi + α5Liquidityi

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+ α6R&Di + α7Ratingi + α8Debt/assetsi + wi (4)

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In Appendix Table 3, we report the results of the first stage regression of (4) that show the
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determinants of foreign debt use by MNEs and exporting firms. Results show that firm size is

positively related to the use of foreign debt for both MNEs and exporting firms. This result is

consistent with that of Kedia and Mozumdar (2003), Keloharju and Niskanen (2001), and Allayannis

and Ofek (2001). The positive and significant coefficient of export ratio implies that firms with higher

exposure are more likely to use foreign debt (e.g., Keloharju and Niskanen 2001), while Allayannis

and Ofek (2001) do not find a significant linkage between exporters and foreign debt issuance. The

positive coefficient of credit rating indicates that the firms with better credit rating (lower credit rating

number in the regression) are less likely to use foreign debt. This result is contrary to the result of

Kedia and Mozumdar (2003), which show that good credit rating is positively related to the
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probability of issuing foreign debt. The estimated coefficients of Liquidity and R&D intensity are

significant for exporting firms but not for MNEs. Exporting firms with lower level of liquidity are

more likely to use foreign debt. This is consistent with the findings of Kedia and Mozumdar (2003).

Also, consistent with the results of Kedia and Mozumdar (2003) and Allayannis and Ofek (2001), we

find that R&D intensity positively affects the usage of foreign debt for exporting firms. This suggests

that firms with higher R&D intensity may have better excess to external financing via foreign debt

due to their expected competitiveness in the world market.

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[Insert Table 7]

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-p
Table 7 shows the effect of foreign debt use by MNEs and exporting firms on absolute FX

exposure after the self-selection effect is controlled for.10 Results are similar to the baseline model. In
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columns (1)-(4), the effects of foreign debt on FX exposure for MNEs are consistently negative and
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significant for all FX exposure measurements except for exposure against Euro. On the other hand,

results in columns (5)-(8) show that foreign debt does not have significant effect on reducing FX
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exposures among exporting firms. The effect of financial derivative usage is also same as the

basenline model in that financial derivative use reduces the FX exposure for MNEs but not for
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exporting firms. Our results still show that the use of foreign debt is statistically significant in
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reducing FX exposure for MNEs after the effect of financial derivatives use is controlled for.

3.4. Other robustness check

10
While we control for important firm characteristics in the first stage of the equation, the effect of foreign debt
use on FX exposure can be confounded with the effect of unobserved firm characteristics that can affect firms‟
use of foreign debt. If such omitted variables are positively correlated with the likelihood of using foreign debt,
the coefficient of the foreign debt in the main regression would be biased toward zero. The coefficient of the
inverse Mills ratio in Heckman selection model conveys the sign of the correlation between the error terms
(which would account for the unobserved factors) in the first-stage regression of foreign debt use and the error
terms in the second-stage regression of FX exposure. In Table 7, we find that the coefficient of the inverse Mills
ratio is mostly insignificant for 6 out of 8 model specifications. Thus, the unobserved factors that make the firm
more likely to use foreign debt are generally not correlated with magnitude of FX exposure. The exceptions are
MNEs with respect to Euro and exporting firms with respect to a basket of foreign currencies. The positive
coefficient of the inverse Mills ratio for exporting firms implies that the unobserved factors that make exporting
firms more likely to use foreign debt are associated with greater FX exposure.
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The universe of our sample consists of firms that have exports greater than zero. We also try different

cutoff point for firms to be included in our sample by using the export/sales hurdles of 5%, 20%, and

50%. Table 8 shows the result of the main model from using this alternative definition of exporting

firms. The results confirm the main results: MNEs show greater effect of foreign debt use in reducing

FX exposure compared to exporting firms. In the 50% export ratio cutoff sample, MNEs also become

active in using financial derivatives for their hedging purpose.

[Insert Table 8]

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As an alternative measure to scale our main variable of foreign debt, we conduct a robustness
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check using foreign debt to total asset. Previous studies such as Galindo, Panizza and Schiantarelli

(2003) and Kim (2016) examine the competitive effect and balance sheet effect of FX movements on
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the firm‟s performance. If domestic currency is depreciated, it affects firm‟s performance through
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either increased foreign sales (competitive effect) or increased the foreign debt burden (balance sheet

effect). Because the foreign sales data is not available in Korea, we used total sales instead of foreign
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sales to measure the firm‟s competitive effect. Results in Table 9 show that our main results do not

change when we scale foreign debt by total asset instead of total sales.
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Jo

[Insert Table 9]

In another way to reinforce the robustness of our results, we repeat our estimation controlling for

self-selection effect using an alternative FX exposure. Because taking the absolute value can cause

truncation bias which results in non-normal error terms, we follow Dominguez and Tesar (2006),

Hutson and Stevenson (2010) and Hutson and Liang (2014) and transform the absolute FX exposure

by taking its square root. Results are reported in columns (1) and (2) of Table 10. We also use an

alternative foreign debt measurement, which excludes the account payable in foreign currency from

our baseline foreign debt measure. Results are shown in columns (3) and (4). Lastly, we use an
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alternative classification for MNEs and exporting firms, in which MNEs are defined as firms that

have a foreign subsidiary (instead of the previous definition with regard to the level of equity

ownership). Results are reported in columns (5) and (6). If we use this alternative definition of MNEs,

there are 265 firms that satisfy the requirement of having at least one foreign subsidiary, as opposed to

the previous definition of MNEs in which case there were 252 firms that have at least 20% equity

stake in its foreign subsidiary. The results of Table 10 again support our main message about hedging

effectiveness of foreign debt for MNEs. Our results show that the effectiveness of foreign debt use in

reducing the FX exposure is more prominent for MNEs than for exporting firms.

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[Insert Table 10]
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4. CONCLUSION
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This study highlights the usefulness of foreign debt as a hedging instrument against foreign exchange
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rate (FX) risk using Korean manufacturing firm-level data for the period of 2002-2006. In particular,

this study shows that the effect of foreign debt uses in reducing FX exposure is different between
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MNEs and exporting firms due to their distinct characteristics of foreign operation. MNEs, due to

their equity stake in their foreign subsidiary, is likely to have a higher stability of foreign cash inflow
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than exporting firms. We find strong evidence that the use of foreign debt is more effective in
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reducing FX exposure for MNEs than for exporting firms. Our results are robust in a variety of

alternative specifications including one which controls for the endogenous nature of foreign debt

usage.

As foreign debt has been considered as an important hedging tool for emerging market firms

relying on the relatively less developed financial market, the findings from this study merit attention.

In particular, this study sheds light on the interaction between firm‟s operational characteristics and

financial hedge. For instance, a seminal research by Panzalis et al. (2011) emphasizes that firm‟s

multinational operations help reduce FX exposure. This study further suggests that firm operational

strategy such as FDI plays an important role in reinforcing the effectiveness of foreign debt in
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reducing FX exposure.

This study also provides important managerial implications which are applicable to firm‟s

foreign business operation where the stability of foreign cash inflow can affect the effectiveness of

foreign debt in reducing FX exposure. This study suggests that the stability of foreign cash inflows is

an important precondition to improve the effectiveness of foreign debt in reducing FX exposure.

Therefore, a firm considering hedging FX exposure using foreign debt as a hedging instrument needs

to consider the stability of foreign cash inflow.

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na
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Table1. Descriptive statistics

Panel A. Firm characteristics between MNEs and exporting firms

Difference Difference
MNEs Exporting firms
in mean in median
H0: no difference
Mean S.D. Median Mean S.D. Median
(p-value is reported)
Absolute FX
1.213 1.266 0.912 1.096 1.107 0.776 0.3725 0.450
exposure
Foreign
0.065 0.074 0.041 0.047 0.075 0.013 0.027** 0.000***
debt/sale
Financial
0.294 0.456 0 0.085 0.279 0 0.000*** 0.000***
derivatives
Export/sales 0.418 0.307 0.429 0.210 0.231 0.122 0.000*** 0.000***

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Firm size 12.505 1.545 12.199 11.642 1.009 11.565 0.000*** 0.002***

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Leverage (D/E) 1.144 1.166 1.43 0.878 0.749 0.662 0.0186** 0.040**
BM (Book-to-
0.677 0.743 0.425 0.693 0.647 0.461 0.8361 0.450
Market)
-p
Liquidity
1.264 1.219 0.935 1.569 1.325 1.082 0.0251** 0.450
(Quick ratio)
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R&D 1.559 2.227 0.755 1.191 1.822 0.45 0.1056 0.040**
Rating (Credit
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5.071 1.817 5 4.962 1.898 5 0.5816 0.584

rating)
Domestic
0.393 0.193 0.397 0.369 0.203 0.337 0.2598 0.331
debt/Total asset
Total number of
na

252 130
firms
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Panel B. The number of firms using foreign debt by currency between MNEs and exporting firms
Difference in percentage
Denomination of MNEs Exporting firms
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p-value of
foreign debt (% of total firms) (% of total firms)
H0: no difference
U.S. dollar
127 (50.40) 46 (35.38) 0.0052***
Japanese yen 0.3526
61 (24.21) 26 (20.00)
Euro 0.1137
33 (13.10) 10 (7.70)
Other currency 0.3503
13 (5.16) 4 (3.08)
Number of firms
227 (90.08) 83 (63.85) 0.000***
using foreign debt
Total number of
252 130
firms

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Panel C. Firm characteristics between foreign debt users vs non-users

Difference Difference
Foreign debt users Foreign debt non-users
in mean in median
H0: no difference
Mean S.D. Median Mean S.D. Median
(p-value is reported)
Absolute FX 0.230 0.191
1.136 1.211 0.815 1.327 1.222 1.106
exposure
Foreign 0.000*** 0.000***
0.072 0.077 0.046 0 0 0
debt/sale
Financial 0.000*** 0.000***
0.261 0.440 0 0.055 0.230 0
derivatives
0.000*** 0.000***

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Export/sales 0.389 0.304 0.334 0.162 0.192 0.080

Firm size 12.399 1.460 12.114 11.400 1.038 11.334 0.000*** 0.002***

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Leverage (D/E) 1.080 1.099 0.829 0.938 0.798 0.621 0.303 0.067*

BM (Book-to- 0.343 0.601

Market)
0.665 0.712 0.433
-p
0.753 0.707 0.454
Liquidity 0.016** 0.067*
1.292 1.238 0.931 1.689 1.322 1.269
(Quick ratio)
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R&D 1.426 2.060 0.635 1.467 2.290 0.69 0.881 0.794

Rating (Credit 0.417 0.993

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5.070 1.857 5 4.875 1.783 5

rating)
Domestic 0.284 0.794
0.379 0.196 0.378 0.406 0.197 0.383
debt/Total asset
na

Total number of
310 72
firms
Note: Panel A presents a comparison of firm characteristics between MNEs and exporting firms. Firms are
classified as MNEs if a firm has more than one foreign subsidiary with equal or more than 20% equity stake in
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the subsidiary. Otherwise, firms are classified as exporting firms.

Panel B presents a comparison of foreign debt usage between MNEs and exporting firms. The number in
parenthesis is the percentage of firms with foreign debt. Because some firms use multiple currencies of foreign
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debt, the number of firms in a specific currency of foreign debt does not add up to the total number of firms that
use foreign debt.
Panel C presents a comparison of firm characteristics between foreign debt users and foreign debt non-users.
***, **, and * denotes statistical significance at the 1%, 5%, and 10% levels respectively.

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Table 2. The distribution of FX exposure

Positive exposure Negative exposure

Full (N=382)
(N=220) (N=162)
Beta
Minimum -6.432 0.000 -6.432
25% quantile -0.548 0.447 -1.187
Median 0.235 1.040 -0.712
75% quantile 1.222 1.743 -0.321
Maximum 9.216 9.216 -0.001
Mean 0.412 1.376 -0.897
S.D. 1.638 1.402 0.827

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MNEs (%) 0.660 0.586 0.759

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Difference in proportion of MNEs
between positive and negative -p 0.0004****
exposures(p-value)
Difference in mean between
positive and negative exposures 0.0004***
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(p-value)
Foreign debt/sales 0.059 0.053 0.066
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Difference in mean (p-value) 0.1004

Use of financial derivatives (%) 0.223 0.186 0.272
Difference in mean (p-value) 0.0479**
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Note: The table 2 presents the distribution of FX exposure coefficients 𝛽̂2𝑖 for 382 firms obtained from
Equation (1). Positive exposure means a situation where the firm‟s stock price increases in response to the
appreciation of Korean Won, whereas negative exposure means a situation where the firm‟s stock price
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decreases in response to the appreciation of Korean Won. Firms are classified as MNEs if a firm has more than
one foreign subsidiary with equal or more than 20% equity stake in the subsidiary. Otherwise, firms are
classified as exporting firms. ***, **, and * denotes statistical significance at the 1%, 5%, and 10% levels
Jo

respectively.

26
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Table 3. Main results on FX exposure: MNEs vs. exporting firms

Dependent variable Absolute Beta (FX exposure)

Panel A: MNEs Panel B: Exporting firms
w/ Firms w/o w/ Firms w/o
w/ HHI Industry financial w/ HHI Industry financial
dummy derivative dummy derivative
(1) (2) (3) (4) (5) (6)

Foreign debt/sales -1.640** -2.344** -2.705** -0.823 -0.433 -0.642

(0.717) (0.851) (1.219)

of
(1.357) (1.569) (1.855)
Financial derivative -0.181*** -0.215*** -- -0.030 -0.011 --
(0.062) (0.054) (0.203) (0.246)

ro
Export/sales -0.077 0.153 0.192 -0.123 0.056 0.072
(0.264) (0.404) (0.510) (0.316) (0.276) (0.363)
Firm size -0.096 -0.094
-p
-0.172* -0.280** -0.278 -0.302*
(0.074) (0.088) (0.095) (0.129) (0.170) (0.165)
re
Leverage 0.126* 0.143** 0.156*** -0.078 0.030 0.060
(0.069) (0.068) (0.050) (0.127) (0.134) (0.168)
lP

BM 0.194 0.265*** 0.289** 0.417* 0.534** 0.558*

(0.124) (0.093) (0.121) (0.205) (0.243) (0.260)
Liquidity -0.085* -0.069 -0.094** -0.147** -0.088 -0.065
na

(0.042) (0.051) (0.045) (0.061) (0.071) (0.079)

R&D 0.041 0.050** 0.061 -0.011 -0.040 -0.046
(0.029) (0.023) (0.049) (0.076) (0.102) (0.101)
ur

HHI 0.022 0.399

(0.253) (0.552)
Differences in
Jo

H0: β(Foreign debt for MNEs) = β(Foreign debt for exporting firms)
coefficient between
MNEs and
exporting firms 0.00 0.00 0.00
(p-value)
Industry dummy No Yes Yes No Yes Yes
Observations 252 252 178 130 130 119
R-squared 0.094 0.147 0.168 0.219 0.317 0.316
Note: Table 3 presents the estimates of linear regression models for MNEs and exporting firms in Panel A and
panel B, respectively. The dependent variable is absolute FX exposure measured as the absolute value of
coefficient on currency basket against Korean Won. The FX exposure coefficient is obtained through regressing
firm‟s stock return on market return and currency basket index (nominal effective exchange rate) at a time. The
independent variable is foreign debt ratio: foreign debt amount divided by total sale in Korean Won. Control
variables are specified in previous literatures: Financial derivative is a dummy variable which takes value of 1
when firms use currency derivatives (and 0 otherwise). Export/sale is a proxy for firm‟s degree of foreign
related activity. Firm size (natural log of total asset), Leverage (debt to equity ratio), BM (book to market ratio),
Liquidity (quick ratio), R&D intensity (R&D expenditure divided by total sale) are also included. A constant
term is included, but not reported. In the parentheses, clustered robust standard errors by industry level are

27
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reported and ***, **, and * denotes statistical significance at the 1%, 5%, and 10% levels respectively.

Table 4. Positive and Negative exposures: MNEs vs. Exporting firms

Dependent variable Abs.beta

Firms w/ financial derivatives Firms w/o financial derivative
D 4.545*** 5.738***
(1.042) (1.343)
D× Foreign debt/sales -1.176 -0.536
(1.624) (2.200)
D×Financial derivative -0.083 --
(0.143)

of
D×Export/sales -0.540 -0.757
(0.565) (0.755)

ro
D×Firm size -0.284*** -0.385***
(0.065) (0.086)
D×Leverage 0.086
-p 0.139*
(0.083) (0.079)
D×BM 0.399** 0.387*
(0.166) (0.209)
re
D×Liquidity -0.159** -0.198***
(0.076) (0.060)
D×R&D 0.025 0.017
lP

(0.037) (0.037)
D×HHI -0.006 0.081
(0.358) (0.461)
D×MNE dummy 0.295 0.381
na

(0.240) (0.256)
(1-D) -0.215 -0.229
(0.330) (0.307)
ur

(1-D)× Foreign debt/sale 2.228 2.342

(1.662) (1.944)
(1-D)×Financial derivative -0.150 --
Jo

(0.127)
(1-D)×Export/sales 0.078 -0.062
(0.121) (0.173)
(1-D)×Firm size 0.050 0.053*
(0.034) (0.027)
(1-D)×Leverage 0.127* 0.122*
(0.065) (0.066)
(1-D)×BM -0.074 -0.126**
(0.046) (0.049)
(1-D)×Liquidity -0.020 -0.030
(0.058) (0.069)
(1-D)×R&D 0.037* 0.061**
(0.020) (0.023)
(1-D)×HHI 0.257 0.350
(0.201) (0.274)
(1-D)×MNE dummy 0.480*** 0.493***
(0.114) (0.147)
D×Foreign debt/sales×MNE dummy 2.143 1.539
(2.810) (3.585)
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 Journal Pre-proof

(1-D) ×Foreign debt/sales×MNE -3.086** -2.894*

dummy (1.211) (1.696)
Observations 382 297
R-squared 0.594 0.590
Note: Table 4 presents the results with positive and negative exposures using the methodology of He and Ng
(1998). A constant term is suppressed. Clustered robust standard errors by industry level are reported in
parentheses, and ***, **, and * denotes statistical significance at the 1%, 5%, and 10% levels respectively.
Table 5. Foreign debt use and FX exposure for MNEs and exporting firms: Individual currency
Dependent
Absolute Beta (FX exposure)
variable
Panel A: MNEs Panel B: Exporting firms
US dollar Yen Euro US dollar Yen Euro
(1) (2) (3) (4) (5) (6)

of
Foreign -2.231*** -1.937** -1.057 -1.926 -0.297 1.172
debt/sales (0.623) (0.717) (0.704) (1.268) (1.088) (0.733)

ro
Financial -0.057 -0.119 0.033 0.016 -0.396 -0.103
derivative (0.058) (0.072) (0.091)
-p (0.205) (0.423) (0.161)
Export/sales 0.305 0.144 0.169 -0.171 -0.264 -0.074
(0.361) (0.220) (0.157) (0.495) (0.321) (0.251)
0.002 -0.043 -0.072** 0.116 -0.022 -0.168
re
Firm size
(0.066) (0.047) (0.029) (0.196) (0.166) (0.156)
Leverage 0.089 0.176 0.242* 0.044 0.113 -0.051
lP

(0.061) (0.139) (0.130) (0.110) (0.109) (0.085)

BM 0.196** 0.375*** 0.144*** 0.332 0.541*** 0.242
(0.094) (0.075) (0.041) (0.285) (0.160) (0.174)
na

Liquidity -0.069*** -0.045 -0.014 0.054 -0.023 -0.096**

(0.015) (0.060) (0.030) (0.171) (0.055) (0.038)
R&D -0.026*** 0.028* 0.084*** 0.027 -0.069 0.037
ur

(0.005) (0.014) (0.025) (0.062) (0.064) (0.070)

Jo

Industry dummy Yes Yes Yes Yes Yes Yes

Observations 252 252 252 130 130 130
R-squared 0.152 0.323 0.311 0.264 0.261 0.34
Note: Table 5 presents the estimates of linear regression models for MNEs and exporting firms in Panel A and
panel B respectively. The dependent variable is individual currency FX exposure measured as the absolute value
of the coefficient on US dollar, Japanese Yen and Euro against Korean Won respectively. These FX exposure
coefficients are obtained through regressing firm‟s stock return on market return and return of individual
currency exchange rate at a time. The independent variable is foreign debt ratio: foreign debt amount divided by
total sale in Korean Won. Control variables are specified in previous literatures: Financial derivative is a dummy
variable which takes value of 1 when firms use currency derivatives (and 0 otherwise). Export/sales is a proxy
for firm‟s degree of foreign related activity. Firm size (natural log of total asset), Leverage (debt to equity ratio),
BM (book to market ratio), Liquidity (quick ratio) and R&D intensity (R&D expenditure divided by total sale)
are also included. A constant term is included, but not reported. In the parentheses, clustered robust standard
errors by industry level are reported and ***, **, and * denotes statistical significance at the 1%, 5%, and 10%
levels respectively.

29
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of
ro
-p
re
lP
na
ur
Jo

30
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Table 6. Preference for the use of foreign debt and financial derivatives by MNEs and Exporting firms
Use foreign debt=1, otherwise=0 Use financial derivatives=1, otherwise=0 Use foreign debt
or financial derivatives=1, otherwise=0
MNE dummy 0.217 0.754 0.600***
(0.155) (0.461) (0.211)
Foreign subs/ 0.240 -0.131 0.807**

f
Total subsidiaries (0.245) (0.429) (0.325)

o
Export dummy -0.217 -0.754 -0.600***

o
(0.155) (0.461) (0.211)
Export/sales 0.107
(0.220)
0.126
(0.251)
0.107
(0.220)
0.263
(0.456)
0.576
(0.487)
p r 0.263
(0.456)
1.674***
(0.453)
1.702***
(0.415)
1.674***
(0.453)
Firm size -0.063* -0.056* -0.063* 0.026 0.075

e - 0.026 0.386*** 0.410*** 0.386***

Rating
(0.034)
0.021
(0.033)
0.019
(0.034)
0.021
(0.154)
-0.176***

P r (0.159)
-0.220***
(0.154)
-0.176***
(0.067)
0.084*
(0.068)
0.082*
(0.067)
0.084*

R&D
(0.034)
-0.029
(0.035)
-0.028
(0.034)
-0.029

a l
(0.063)
-4.542***
(0.075)
-4.213***
(0.063)
-4.542***
(0.047)
0.834
(0.046)
1.249
(0.047)
0.834

Quick ratio
(0.019)
-0.018
(0.021)
-0.018
(0.019)

r
-0.018
n (0.896)
-0.765**
(0.696)
-0.809**
(0.896)
-0.765**
(4.007)
-0.082
(3.707)
-0.084
(4.007)
-0.082

Leverage
(0.073)
-0.126
(0.076)
-0.121
o u
(0.073)
-0.126
(0.375)
-0.454
(0.317)
-0.336
(0.375)
-0.454
(0.079)
-0.153***
(0.075)
-0.142**
(0.079)
-0.153***

Book to market
(0.090)
0.043
(0.107)
(0.090)
0.039
(0.106)
J (0.090)
0.043
(0.107)
(0.328)
0.227
(0.296)
(0.266)
0.291
(0.271)
(0.328)
0.227
(0.296)
(0.055)
-0.050
(0.130)
(0.058)
-0.071
(0.129)
(0.055)
-0.050
(0.130)
HHI -0.002 -0.003 -0.002 0.062** 0.058*** 0.062** -0.004 -0.007 -0.004
(0.005) (0.005) (0.005) (0.027) (0.020) (0.027) (0.007) (0.008) (0.007)
Pseudo R2 0.013 0.012 0.013 0.387 0.357 0.387 0.246 0.241 0.246
Observations 382 382 382 382 382 382 382 382 382
Note: Table 6 presents the preference for the use of foreign debt and financial derivatives by MNEs and Exporting firms. In the parentheses, clustered robust standard errors
by industry level are reported and ***, **, and * denotes statistical significance at the 1%, 5%, and 10% levels respectively.

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Table 7. Correcting for self-selection effect

Dependent
Absolute beta (FX exposure)
variable
Panel A: MNEs Panel B: Exporting firms
FX
Basket USD Yen Euro Basket USD Yen Euro
exposure
(1) (2) (3) (4) (5) (6) (7) (8)

Foreign -2.311** -2.245*** -2.044** -1.217* 0.469 -1.414 -0.665 1.14

debt/sales (0.869) (0.672) (0.797) (0.702) (1.325) (1.307) (1.323) (0.749)
Financial -0.213*** -0.058 -0.126* 0.023 0.143 0.103 -0.459 -0.109
derivative (0.055) (0.061) (0.070) (0.088) (0.202) (0.211) (0.436) (0.150)
0.193 0.287 0.01 -0.031 0.465 0.061 -0.431 -0.088
Export/sales

of
(0.459) (0.380) (0.207) (0.223) (0.286) (0.487) (0.364) (0.258)
-0.09 -0.001 -0.058 -0.094*** -0.186 0.168 -0.06 -0.171
Firm size

ro
(0.081) (0.066) (0.044) (0.025) (0.214) (0.185) (0.169) (0.176)
0.142** 0.09 0.182 0.250* -0.08 -0.019 0.158 -0.047
Leverage
(0.066) (0.060) (0.135) (0.128) (0.139) (0.153) (0.132) (0.106)
0.266*** 0.196**
-p
0.374*** 0.143*** 0.512** 0.32 0.550*** 0.243
BM
(0.093) (0.094) (0.073) (0.039) (0.238) (0.291) (0.162) (0.171)
re
-0.074 -0.067*** -0.029 0.009 -0.116 0.038 -0.012 -0.095**
Liquidity
(0.053) (0.021) (0.058) (0.034) (0.075) (0.186) (0.052) (0.040)
lP

0.049** -0.026*** 0.029** 0.086*** -0.011 0.044 -0.081 0.036

R&D
(0.023) (0.005) (0.014) (0.023) (0.093) (0.047) (0.072) (0.076)
Inverse 0.102 -0.045 -0.339 -0.507* 0.707** 0.401 -0.288 -0.025
na

Mills Ratio (0.335) (0.394) (0.291) (0.255) (0.307) (0.325) (0.337) (0.224)

Industry
Yes Yes Yes Yes Yes Yes Yes Yes
dummy
ur

Observations 252 252 252 252 130 130 130 130

R-squared 0.147 0.152 0.325 0.315 0.329 0.268 0.264 0.34
Jo

Note: Table 7 presents sample selection models for MNEs and exporting firms in panel A and panel B
respectively. The dependent variable is FX exposure measured as the absolute value of the coefficient on Korean
nominal effective exchange rate and those of the coefficients on US dollar, Japanese Yen and Euro against
Korean Won respectively. These FX exposure coefficients are obtained through regressing firm‟s stock return on
market return and return of individual currency exchange rate at a time. The independent variable is foreign debt
ratio: foreign debt amount divided by total sale in Korean Won. Control variables are specified in previous
literatures: Financial derivative is a dummy variable which takes value of 1 when firms use currency derivatives
(and 0 otherwise). Export/sale is a proxy for firm‟s degree of foreign related activity. Firm size (natural log of
total asset), Leverage (debt to equity ratio), BM (book to market ratio), Liquidity (quick ratio) and R&D
intensity (R&D expenditure divided by total sale) are also included. To control for self-selection, this study
includes inverse Mills ratios which are obtained from a bivariate probit model that determines the choice of
foreign debt use. A constant term is included, but not reported. In the parentheses, clustered robust standard
errors by industry level are reported and ***, **, and * denotes statistical significance at the 1%, 5%, and 10%
levels respectively.

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Table 8. Robustness check: FX exposure for MNEs vs. Exporting firms using different cutoff
points for exporting firms

Dependent variable Absolute Beta (FX exposure)

Export/sales > 0.05 Export/sales > 0.20 Export/sales > 0.50
MNEs Exporting MNEs Exporting MNEs Exporting
(1) (2) (3) (4) (5) (6)

Foreign debt/sales -2.205* 1.812 -2.490** 2.295 -3.635* 1.600

(1.139) (1.871) (1.180) (3.204) (1.783) (4.034)

of
Financial derivative -0.118 0.124 -0.048 0.003 -0.410* 0.021
(0.108) (0.307) (0.154) (0.548) (0.228) (1.127)

ro
Export/sales 0.104 -0.128 0.803 -0.900 0.400 -1.550
(0.599) (0.529) (0.596) (0.890) (2.227) (4.545)
Firm size -0.093 -0.290** -0.067 -0.416* -0.028 0.353
-p
(0.070) (0.127) (0.082) (0.200) (0.107) (0.525)
Leverage 0.145* -0.059 0.143* -0.204 0.140** -0.532
re
(0.074) (0.190) (0.078) (0.237) (0.062) (0.744)
BM 0.298*** 0.578** 0.200** 0.421 0.192 1.016
lP

(0.086) (0.260) (0.078) (0.246) (0.203) (1.187)

Liquidity -0.045 -0.146 -0.059 -0.362* -0.114 -0.130
(0.043) (0.114) (0.037) (0.180) (0.068) (0.444)
na

R&D 8.844 -5.797 4.354 8.126 2.674 13.760

(6.045) (14.147) (6.800) (19.674) (9.306) (13.803)
Industry dummy Yes Yes Yes Yes Yes Yes
ur

# of firms 218/250 81/130 163/250 53/130 108/250 20/130

R-squared 0.149 0.396 0.122 0.422 0.150 0.787
Jo

Note: Table 8 is a robustness test of Table 3. In Table 3, the universe of our sample consists of firms that have
exports greater than zero. In Table 8, the cutoff point for firms to be included in our sample is where export/sales
ratio is 5%, 20%, and 50%, respectively.

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Table 9. Robustness check: FX exposure for MNEs vs. Exporting firms using ‘Foreign debt/total
asset’ instead of ‘Foreign debt/sales’

Dependent variable Absolute Beta (FX exposure)

Panel A: MNEs Panel B: Exporting firms
(1) (2) (3) (4)

Foreign debt/total asset -0.851** -0.815* -1.034 -1.054

(0.366) (0.435) (1.942) (1.886)
Financial derivative -0.193*** 0.026
(0.061) (0.244)
Firm size -0.123 -0.112 -0.272 -0.274
(0.087) (0.090) (0.175) (0.175)

of
Leverage .1454 0.1488 0.034 0.032
(0.087) (0.080) (0.128) (0.132)

ro
BM 0.227** 0.222* 0.530** 0.529*
(0.108) -p(0.112) (0.248) (0.251)
Liquidity -0.058 -0.0615 -0.096 -0.096
(0.051) (0.055) (0.069) (0.071)
re
R&D 5.031 4.994* -4.282 -4.278
(3.030) (2.890) (10.193) (10.251)
lP

Industry dummy Yes Yes Yes Yes

Observations 252 252 130 130
na

R-squared 0.132 0.136 0.318 0.319

Note: Table 9 is a robustness test of Table 3. In Table 9, foreign debt is scaled by total assets instead of total
sales.
ur
Jo

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Table 10. Robustness checks: Alternative measures controlling for self-selection

Dependent Square root of absolute

Absolute FX exposure
variable FX exposure
Alternative category:
Alternative debt MNEs and Exporting
measurement firms (Exporting firms if
no foreign subsidiary)
Exporting Exporting Exporting
MNEs MNEs MNEs
firms firms firms
(1) (2) (3) (4) (5) (6)
Foreign debt/sales -0.715*** 0.091 -2.926** -0.060 -1.630** -0.715
(0.241) (0.622) (1.094) (1.716) (0.596) (0.693)
Financial -0.035 0.063 -0.212*** 0.090 -0.186*** 0.167

of
derivative (0.026) (0.090) (0.059) (0.247) (0.054) (0.262)
Export/sales 0.037 0.188* -0.028 0.028 0.175 0.667

ro
(0.126) (0.107) (0.416) (0.219) (0.400) (0.379)
Firm size -0.029 -0.061 -0.111
-p -0.243 -0.099 -0.152
(0.032) (0.082) (0.067) (0.193) (0.083) (0.261)
Leverage 0.062** -0.025 0.150** 0.029 0.142** -0.060
(0.025) (0.040) (0.056) (0.132) (0.063) (0.150)
re
BM 0.074* 0.254** 0.241*** 0.527** 0.237** 0.593**
(0.037) (0.088) (0.071) (0.245) (0.103) (0.263)
lP

Liquidity -0.029 -0.039 -0.039 -0.102 -0.092 -0.069

(0.023) (0.034) (0.101) (0.074) (0.055) (0.078)
R&D 0.020*** -0.012 0.048* -0.075 0.051** -0.039
na

(0.006) (0.038) (0.027) (0.093) (0.022) (0.089)

Inverse Mills Ratio 0.094 0.276** -0.161 0.251 0.197 0.616
(0.131) (0.114) (0.315) (0.205) (0.236) (0.376)
ur

Industry dummy Yes Yes Yes Yes Yes Yes

Observations 252 130 252 130 265 117
Jo

R-squared 0.151 0.318 0.146 0.321 0.143 0.337

Note: Table 10 presents the estimates of linear regression models for MNEs and exporting firms using
alternative measure of foreign debt and alternative category of MNEs and exporting firms respectively. In
columns (1) and (2), we transform the absolute FX exposure by taking its square root. Alternative categorization
of MNEs and exporting firms is based on whether the firm has a foreign subsidiary of not, instead of
considering the minimum level of equity ownership. The dependent variable is FX exposure measured as the
absolute value of coefficient on currency basket against Korean Won. The FX exposure coefficient is obtained
through regressing firm‟s stock return on market return and currency basket index (nominal effective exchange
rate) at a time. The independent variable is foreign debt ratio: foreign debt amount, which is composed of short-
term foreign debt, long-term foreign debt and current maturities of long-term foreign debt excluding the account
payable in foreign currency, is divided by total sale in Korean Won. Control variables are specified in previous
literatures: Financial derivative is a dummy variable which takes value of 1 when firms use currency derivatives
(and 0 otherwise). Export/sale is a proxy for firm‟s degree of foreign related activity. Firm size (natural log of
total asset), Leverage (debt to equity ratio), BM (book to market ratio), Liquidity (quick ratio) and R&D
intensity (R&D expenditure divided by total sale) are also included. To control for self-selection, this study
includes inverse Mills ratios which are obtained from a bivariate probit model that determines the choice of
foreign debt use. A constant term is included, but not reported. In the parentheses, clustered robust standard
errors by firm level are reported and ***, **, and * denotes statistical significance at the 1%, 5%, and 10%
levels respectively.

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-p
re
lP
na
ur
Jo

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Appendix Table 1. The composition of foreign assets and liabilities by currency (million of
KRW) of Orion in 2016

Assets Liabilities
Cash & Cash Accounts Accounts Payable Short term
equivalents Receivable borrowing
USD 2,202 750 77
JPY 372 2,451 261
EUR 748 638

Appendix Table 2. Changes in profit and loss of Orion in response to the exchange rate change

of
(estimated value by the firm, million KRW)

ro
2016 2015
Currency 10% increase in 10% decrease in
-p 10% increase in 10% decrease in
KRW KRW KRW KRW
USD 53 (53) 141 (141)
re
JPY 256 (256) 63 (63)
EUR (139) 139 (43) 43
lP
na
ur
Jo

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Appendix Table 3. First stage of probit model: likelihood of using foreign debt
Dependent variable Foreign debt use (binary variable)
MNEs Exporting Firms
(1) (2)

Financial derivative 0.149 1.038

(0.172) (0.637)
Firm size 0.391*** 0.334***
(0.138) (0.083)
Export/sales 1.778*** 1.375*
(0.530) (0.808)
BM -0.095 -0.244

of
(0.179) (0.236)
Liquidity -0.254 -0.188**

ro
(0.154) (0.090)
R&D -p -0.01 0.154*
(0.037) (0.081)
Rating 0.285*** 0.248**
(0.073) (0.097)
re
Debt/Asset -2.992*** -3.494***
(0.462) (1.311)
lP

Constant -3.773** -3.424***

(1.533) (1.205)
na

Observations 252 130

Note: Dependent variable is a dummy coded as 1 if a firm uses foreign debt, and otherwise 0. Independent
variables include variables that affect firm‟s decision on foreign debt use specified in previous literature.
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Financial derivative, Firm size (natural log of total asset), Export/Sales, BM (book to market ratio), Liquidity
(quick ratio) and R&D intensity (R&D expenditure divided by total sale) are used as controls. Additional
regressors are as follows: Rating is an integer. Domestic debt/Asset is domestic debt divided by total asset. In
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the parentheses, clustered robust standard errors by firm level are reported and ***, **, and * denotes statistical
significance at the 1%, 5%, and 10% levels respectively.

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Highlights
 Foreign debt is effective in reducing foreign exchange exposure.

 Foreign debt is more effective for MNEs than for exporting firm.

 Our results are robust after controlling for the self-selection effects.

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 Journal Pre-proof

Soon Sung Kim: Conceptualization, Software, Formal Analysis, Investigation, Writing-

Original Draft
Jaiho Chung: Conceptualization, Methodology, Writing-Review & Editing, Funding
acquisition
Joon Ho Hwang: Writing-Review & Editing, Visualization, Supervision, Project
administration
Ju Hyun Pyun: Writing-Review & Editing, Validation, Resources, Data Curation

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