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Influence of financial distress on foreign exchange exposure

Influence of financial distress on foreign exchange exposure Purpose – The purpose of this paper is to investigate whether a non-monotonic relationship may exist between financial distress and foreign exchange (FX) exposure. The authors hypothesize that firms with higher FX exposures are those with the lowest levels of financial distress because the costs of hedging exceed the benefits and those with highest levels of financial distress due to the conflict of interest between shareholders and bondholders. Design/methodology/approach – The methodology allows for the possibility of a non-monotonic relation between financial distress and FX exposure for firms known to have ex-ante exposures. The approach is to include a Black-Scholes-Merton financial distress measure and standard accounting-based financial distress measures. Findings – The results support the hypothesis of a non-monotonic relationship between financial distress and exposure; companies with the lowest and highest levels of financial distress are willing to bear greater FX exposures. Originality/value – The authors examine whether a non-monotonic relationship may exist between distress and FX exposure. Intuition for this non-monotonic relationship is provided by Stulz (1996) as he describes the risk management practices of firms with low, medium, and high default probabilities. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png American Journal of Business Emerald Publishing

Influence of financial distress on foreign exchange exposure

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Publisher
Emerald Publishing
Copyright
Copyright © Emerald Group Publishing Limited
ISSN
1935-5181
DOI
10.1108/AJB-07-2013-0054
Publisher site
See Article on Publisher Site

Abstract

Purpose – The purpose of this paper is to investigate whether a non-monotonic relationship may exist between financial distress and foreign exchange (FX) exposure. The authors hypothesize that firms with higher FX exposures are those with the lowest levels of financial distress because the costs of hedging exceed the benefits and those with highest levels of financial distress due to the conflict of interest between shareholders and bondholders. Design/methodology/approach – The methodology allows for the possibility of a non-monotonic relation between financial distress and FX exposure for firms known to have ex-ante exposures. The approach is to include a Black-Scholes-Merton financial distress measure and standard accounting-based financial distress measures. Findings – The results support the hypothesis of a non-monotonic relationship between financial distress and exposure; companies with the lowest and highest levels of financial distress are willing to bear greater FX exposures. Originality/value – The authors examine whether a non-monotonic relationship may exist between distress and FX exposure. Intuition for this non-monotonic relationship is provided by Stulz (1996) as he describes the risk management practices of firms with low, medium, and high default probabilities.

Journal

American Journal of Business – Emerald Publishing

Published: Sep 30, 2014

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