Derivative Cash Flows and Corporate Investment

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Abstract

According to an influential argument, corporate hedging supports corporate investment when internal cash flows are volatile and external financing is costly (Froot, Scharfstein and Stein, 1993). Despite its vast influence, the predictions of this theory have not yet been directly tested using actual derivative cash flows. This study uses hand-collected data on cash flows from derivative positions in the oil and gas industry between 2000 and 2015. Strikingly, on average, an extra dollar in derivative cash flow translates into one more dollar in capital expenditure. During industry recessions, the median ratio of derivative cash flow to capital expenditure rises to 20% for hedging firms, suggesting that derivatives play a crucial role in sustaining investment when the cost of external financing rises abruptly.

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  • Business Administration
Original languageEnglish
Article number105916
JournalJournal of Banking & Finance
Volume119
Publication statusPublished - 2020
Publication categoryResearch
Peer-reviewedYes