Investment,

Investment,Cash
CashFlow,
Flow,and
and
Corporate
CorporateHedging
Hedging
Deshmukh, S, and S. C. Vogt, 2005, Investment, cash flow,
and corporate hedging, Journal of Corporate Finance 11,
628-644
Group I
Afriyanti H/ M10324057
Aulia Annisa I/
M10324055
Dina Yeni M/ M10324060
Dimas Sumitra D/
Endah Dwi K /

Fiesty Utami /
M10324061
Leni Nurpratiwi /
Randy Heriyanto /
Sugih Sutrisno P /

Introduction

Testable Hypothesis

If firms hedge to reduce both their reliance on

external funds and the volatility of internal cash
flow, then their investment spending should be
less sensitive to internal cash flow in the
presence of hedging.

Parsial

the sensitivity of investment spending to

cash flow is lower when the extent of
hedging is higher.
Simulta

Literature Review
1. Mayers and Smith (1982) and Smith and
Stulz (1985)
hedging can reduce the expected tax liability of
a firm in the presence of a convex tax schedule.

2. Smith and Stulz (1985)

hedging can reduce the costs of financial
distress.
3. Stulz (1984) and Smith and Stulz (1985)
provide a rationale for hedging based on
managerial risk aversion

Literature Reference

4. Breeden and Viswanathan (1996) and

DeMarzo and Duffi (1995)
Focus on asymmetric information between
managers and outside investors and on
managers reputations

5. Stulz (1990), Lessard (1990), and Froot et

al. (1993)
Focus on investment policy to provide a rationale
for corporate hedging. Their models are based on
the premise than external funds are more costly
than internal funds.
,

Literature Reference

4. Tufano (1998) exception

hedging may involve costs if it isolates
managers from the scrutiny of external
capital markets.

Underinvestment Rationale and

Hypothesis Development

Froot et al. (1993) market imperfections

cause external funds to be more costly
than internal funds.

firm is faced with a two-period,

investment-financing decision.

underinvestment results from the random

nature of the first-period wealth w and the
existence of the deadweight costs of
external finance.

Underinvestment Rationale and

Hypothesis Development

The issue of hedging arises because w is random.

The firm wants to maximize its expected profits
(or its net present value).
Froot et al. argue :
that for hedging to be beneficial, the level of
internal wealth w must have a positive impact on
the optimal level of investment chosen by the
firm.
if a firm does not hedge, the variability in the cash
flow from assets in place can cause variability in
both investment spending and/or external funds
raised.

Data and Variables

sample of hedgers/derivative users from

the Database of Users of Derivatives,
published by Swaps Monitor Publications,
New York covers period 1992-1996

Collect annual data from Compustat

Focus on manufacturing firms (SIC 20003999)

Data and Variables

Depedent Variable
Investment spending Ratio of Investment to
beginning of- year gross plant and equipment

Independent Variable
cash flow variable
a proxy for investment or growth opportunities (Q)

Data and Variables

Cash Flow Measures :
1.

CF Mesure 1 =

2.

CF Measure 2 =Sales COGS SGA - NWC

Beginning of year Gross plant & equipment

3.

4.

5.

Operating Income (OI) before deprecition

Beginning of year Gross plant & equipment

CF Measure 3 =Income before Extraordinary item + D&ANWC

Beginning of year Gross plant & equipment
CF Measure 4 =OI before depreciatio income taxes paidNWC
Beginning of year Gross plant & equipment
CF Measure 5 =OI before depreciation - NWC
Beginning of year Gross plant & equipment

Empirical Result

Empirical Result

Empirical Result

Table 3

Empirical Result

Table 4

Empirical Result

Table 5

Summary and Conclusions

1.

The results are consistent with this hypothesis in

that the investment spending of hedgers is less
sensitive to prehedged cash flow than is that of
nonhedgers.

2.

Among hedgers, the sensitivity of investment

spending to cash flow is lower when the extent
of hedging is higher.

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