Foreign Debt Usage in Non‐Financial Firms: a Horse Race between Operating and Accounting Exposure Hedging

Published date01 June 2015
Date01 June 2015
Foreign Debt Usage in NonFinancial
Firms: a Horse Race between
Operating and Accounting
Exposure Hedging
Tom Aabo
Aarhus University, Fuglesangs Allé 4, DK 8210, Aarhus V, Denmark
Marianna Andryeyeva Hansen
Novozymes A/S, Krogshoejvej 36, DK 2880, Bagsvaerd, Denmark
Yaz Gulnur Muradoglu
Queen Mary, University of London, School of Business and Management, Mile End, Francis Bancroft
Building, Room 4.01, E1 4NS, UK
Previous studies show that foreign exchange exposure from international sales can
be hedged by foreign debt. We go beyond the foreign sales measure by using a
unique database with detailed exposure information on Danish nonnancial rms
with international operations. Our results indicate that foreign debt is used to hedge
foreign assets and subsidiaries (accounting exposure) as opposed to foreign sales
(operating exposure). The paper adds to the literature on corporate hedging by
highlighting the importance of accounting exposure in the hedging behavior of
corporate managers and the perceived need to reduce risks due to currency
mismatches between assets and liabilities.
Keywords: exchange rate exposure management, foreign debt, foreign assets,
foreign subsidiaries, accounting exposure
JEL classification: F23, G32
The authors would like to thank an anonymous referee, John Doukas (the editor), Kim
H. Frederiksen, Jonatan Groba, Alain Krapl, Thomas OBrien, Berkay Ozcan, Christos
Pantzalis, Frank Thingaard, and participants at the 2010 Behavioral Finance Working Group
Conference, the 2011 European Financial Management Association Annual Meeting, and the
2012 Financial Management Association European Conference for helpful comments and
suggestions to earlier versions of this paper. Tom Aabo acknowledges financial support from
the Danish Council for Independent Research | SocialSciences. Correspondence: Tom Aabo.
European Financial Management, Vol. 21, No. 3, 2015, 590611
doi: 10.1111/j.1468-036X.2013.12032.x
© 2013 John Wiley & Sons Ltd
1. Introduction
Shapiro (1975) shows that one of the major factors affecting a multinational rms
exchange rate risk is sales in export markets. The foreign sales ratio is the standard proxy
for openness. It has been used in a number of studies on the management of exchange rate
exposure by nonnancial rms. A rm that receives revenue in foreign currency has two
ways of eliminating such positive (long) foreign exchange exposure by nancial means.
The rst is the use of nancial derivatives, such as forward contracts, futures, swaps, and
options. The second is the use of debt denominated in foreign currency (foreign debt);
this can involve either raising new debt or changing the currency denomination of existing
The use of the foreign sales ratio as the sole proxy for openness assumes the
rm to be a simple exporter. However, many rms are also multinational producers.
Proxies for openness for such rms also include foreign costs,
foreign assets, and foreign
We use a unique database with detailed exchange rate exposure information on Danish
nonnancial rms to determine whether foreign debt hedges against exposure from
foreign revenues or against exposure from physical presence abroad (foreign assets and
subsidiaries). Our database enables us to investigate the issue by differentiating the effects
of not only revenues and operating costs, but also foreign operating assets and foreign
subsidiaries. We nd that foreign debt usage among internationally involved, medium
sized rms is primarily related to foreign operating assets and foreign subsidiaries. Thus,
the results of our study indicate that, in its practical hedging application, foreign debt is
used predominantly to hedge accounting exposure, as opposed to operating exposure.
Yet, it is also possible that foreign debt is used to hedge the ow of expected future
revenues and that foreign assets and foreign subsidiaries provide better proxies for the
present value of future foreign revenues than the annual foreign revenue reported in last
years annual report. The foreign debt measure we use ignores domestic debt swapped
into foreign currency but we address this issue and show that the results are robust.
In spite of the academic focus on operating exposure over accounting exposure
example, the focus on cash ows in terms of reducing the risk of nancial distress (Smith
and Stulz, 1985) or improving the ability to make valueadding investments (Froot et al.,
1993) empirical studies show that accounting concerns do matter in actual managerial
decision making (e.g., Lins et al., 2011). A rm that has foreign assets (e.g., in the form of
In exposure terms it makes no difference whether, say, a German rm chooses to hedge a
positive cash ow of US$1 million that it expects to receive in three months based on a sales
contract by 1) selling forward today with a settlement of US$1 million against the euro (EUR)
in three months or 2) borrowing an amount in US dollars (instead of borrowing in EUR) today
that, together with accrued interest, is settled by paying back exactly US$1 million in three
months. Géczy et al. (1997) note that foreign debt can displace the need to hedge with
derivatives by acting as a hedge of foreign revenues.
Foreign debt cannot be used as a hedge against costs in foreign currency because this would
create two negative and thus nonoffsetting cash ows in that particular currency. Thus,
foreign costs cannot explain foreign debt usage but are generally correlated with openness.
Foreign exchange exposure is traditionally grouped in three categories: transaction exposure,
translation exposure also called accounting exposure and economic exposure also called
operating exposure, strategic exposure, or competitive exposure (e.g., Eiteman et al., 2010).
© 2013 John Wiley & Sons Ltd
Foreign Debt Usage in NonFinancial Firms 591

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