Hedging, Contract Enforceability and Competition
Authors:
Erasmo Giambona, Syracuse University
Anil Kumar, Aarhus University
Gordon Phillips, Dartmouth College
Journal (Year):
Review of Financial Studies (2024)
One sentence summarizing the essence (findings or implications) of your paper:
Managing risk through hedging allows firms to price their products more competitively and gain market share, indicating that policies to encourage hedging benefit consumers.
Research Questions:
How does hedging impact product market competition?
What We Know:
We know that hedging impacts payout policies, M&A activities, and other corporate policies, but no previous studies has shown that hedging can be used to make products cheaper and, therefore, more easily accessible to consumers.
Novel Findings:
We show that firms that are likely to face costly external finance increase hedging and reduce the probability of receivership following a reform that lowers the bankruptcy cost of hedging. These firms also lower prices and increase their market share following the reform.
Implications for Practice:
Firms can use hedging to price their products more competitively and gain market share.
Implications for Policy:
Hedging can benefit consumers. Therefore, policy concerns about the potential destabilizing effects of using derivatives for hedging need to take into account how derivatives can also benefit consumers.
Implications for Society:
Finance can improve the welfare of households.
Implications for Research (How might this research affect future research?):
Future research should consider the effect of corporate financial policies on consumers.
Full Citation:
Hedging, Contract Enforceability, and Competition (E. Giambona, A. Kumar and G. Phillips), (Forthcoming) Review of Financial Studies.
Abstract:
We study how risk management through hedging impacts firms and competition among firms in the life insurance industry - an industry with over 7 Trillion in assets and over 1,000 private and public firms. We examine firms after a staggered state-level reform that reduces the costs of hedging by granting derivatives superpriority in case of insolvency. We show that firms that are likely to face costly external finance increase hedging and reduce risk and the probability of receivership. Firms that are likely to face costly external finance, also lower prices, increase policy sales, and increase their market share post reform.
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