Three essays on risk management and corporate finance

Abstract

In the third essay, we focus on the topic of managerial ability and its impact on the value of firm through cash holdings. We compare firm value and cash policy of firms with high managerial ability with those with relatively low managerial ability. The finding indicates that superior managers can significantly increase cash value: a dollar of cash is worth 0.289 dollars more for firms with high-ability managers. We also find that high-ability managers tend to spend less cash and accumulate more. High-ability managers are able to reserve the bad firm performance due to cash dissipation, which confirm our hypothesis that managers with high ability tend to make correct investment decisions, maintain low costs and have a more accurate vision of industry and market.

In this dissertation, I mainly investigate two topics in corporate finance, risk management and managerial ability. The first essay investigates how non-financial firm headquarters locations impact managers' decision on risk management policy, and how significant the impact would be by comparing the hedging behaviors of firms located in metropolitan areas and other areas. In the second essay, I study the role of firms' risk management activities in maintaining financial flexibility, by testing the substitute relation between derivative usage and transitory debt preserving. The third essay discusses what kind of role managerial ability plays in assessing value of firms by cash holdings, and how cash policy and firm performance would be impacted by managerial ability.

Risk management is a very important topic in the field of corporate finance, and has not yet been explored well by researchers due to lack of data. Majority of existing literature in risk management focuses on explaining the rationales of firms' risk management activities, specifically on the derivative usage of non-financial firms. Different from previous paper, my dissertation explores extra factors that impact managers' decision making on risk management, as well as how the implementation of hedging strategy works on other firm activities and firm value.

Managerial ability is a relative new concept in corporate finance and has been identified as an important determinant of firm performance and strategy making. It is a measure of manager's general ability (or talent) in managing firms. Previous researchers have emphasized the impact of individual managers on various aspects of firm operation. My work explores this topic from the aspect of the value of cash holdings.

The first essay of my dissertation examines the impact of firm headquarters locations on corporate risk management activities. This essay provides empirical evidence that a firm's hedging probability is monotonically increasing with distance from metropolitan areas. Compared with firms located in big cities, remotely located firms are 5.91% - 7.26% more likely to use derivatives as tools for risk management purpose. The tendency of interest rate (foreign currency) hedging of remotely located firms is around 4.42% - 6.74% (5.26% - 6.06%) higher than that of centrally located firms. I also find that the propensity of hedging is around 1.10% higher per mile away from top 10 metropolitan areas. The results confirm our hypothesis that unique environment of rural areas motives firms to hedge more than urban counterparties due to information barrier, agency conflict issues and extra borrowing costs. This essay complements and extends the existing literature on the rationales for corporate hedging, by providing new evidence on the impact of geography on firms' hedging activities.

The second essay of my dissertation investigates the relation between firm financial flexibility and risk management strategy. Using transitory debt as an "intermediary", we find that risk management is another important channel for firms to provide themselves financial flexibility. Specifically, hedging lowers tendency to preserve borrowing capacity among firms with positive transitory debt, and increases financial flexibility for over-leveraged firms by reducing excessively high debt ratio. The reverse causality also exists. The causal effect is more significant for interest risk management, compared with foreign currency and commodity risk management.