Corporate Derivatives as a Tool for Risk Management: A Comparative Analysis of Pakistan and Malaysia

Abstract

The growing usage of derivatives since the last few decades has increased academic concerns regarding the value relevance of derivatives. Hedging theorists state that considering market imperfections, use of derivatives enhances firm value by minimizing risk. The existing literature has mostly examined the direct effect of derivative usage on firm risk and value, but empirical evidence on ‘how’ and ‘when’ use of derivatives enhances firm value is still missing. Present study primarily adds to the existing literature by identifying ‘how’ and ‘when’ derivative usage increases firm value by using moderated mediation techniques through a bootstrap technique of Hayes (2015). In addition, the current study explores the empirical literature by comparatively analyzing the countries where derivative markets are still in development phase like Pakistan and Malaysia. The sample consists of 167 Pakistani and 266 Malaysian firms for the period of 2004-2010. Findings demonstrate that derivatives play a significant risk management role in both Pakistan and Malaysia, though the effectiveness of the moderating role of derivative usage on the relationship between risk and value is limited in Pakistani non-financial firms. Results on the basis of firm’s types of derivative instruments show no moderating mediating role of a firm’s risk on the relationship of derivative usage and Malaysian firm’s value as they are mostly involved in operational hedging. Whereas, Pakistani firms have high value enhancing benefits of foreign currency derivative usage in case of no ER exposure as firms might have exposed due to imports and other commodity prices. In case of interest rate derivative usage, Malaysian firms use fewer interest rate derivatives in times of low IR exposure as they have more access to external financing at lower costs because of developed capital market.