Microsoft Word 2007 ichrie conference Proceedings Final-Final 06-06-07. doc

Keywords
: derivatives, exposure, hedging, notional value, interest rate 
INTRODUCTION 
Firms in the lodging industry face significant risks from fluctuations in interest rates. Exposure to interest 
rate risk is costly because it induces volatility in cash flows and earnings, which can lead to financial distress (Smith 
& Stulz, 1985). If exposure to risk is costly to firms, then lodging firms have incentives to reduce their exposure to 
interest rate risk. Evidence from lodging firm market risk disclosures suggest that the majority of lodging firms are 
concerned about volatility of their earnings and cash flows, and borrowing costs to changes in interest rates. For 
example, LaSalle Hotel Properties, a lodging real estate investment trust (REIT) disclosed that its interest rate risk 
management objective was to limit the impact of interest rate changes on its earnings and cash flows and to lower its 
overall borrowing costs. Interstate Hotels and Resorts also disclosed that it mitigates exposure of its earnings and 
cash flows by identifying and monitoring changes in interest rate exposures that could adversely impact its expected 
future cash flows, and by evaluating hedging opportunities.
Lodging, casino, and REITs, typically rely on high amounts of debt to finance fixed assets. Given the 
substantial operating and financial leverage held by lodging firms, these firms are expected to face higher exposure 
and have more volatile cash flows. For example, a PKF Hospitality Research (2003) examination of over 3,900 
hotel financial statements found a significant increase in the number of hotels that failed to cover interest payments 
from 7% in 1996 to 20% in 2002 compared to 24% in 1992, a time period after the first Gulf war that was 
characterized by widespread hotel foreclosures and bankruptcies.
Thus far, there is limited research investigating the interest rate exposure of nonfinancial firms. The 
majority of exposure studies have examined on foreign exchange exposure while a limited number of studies on 
interest rate exposure have focused mainly on financial institutions. In this study I investigate the level of interest 
rate exposure of publicly traded lodging firms and determine whether the use of interest rate derivatives reduces the 
exposure in a sample of REITs, lodging and casino firms for the period from 2000-2004. 
My study differs from prior studies in a number of ways. First, I use more recent data and I focus on 
interest rate exposure in the lodging industry to test the stability in time of previous findings. Most current studies 
on exposure and derivatives have used pre-2000 data under previous accounting guidelines to perform the empirical 
analysis (Triki, 2005). Second, unlike prior research, I use the current accounting guidelines and firm disclosures to 
separate derivatives into those used for hedging and those that are speculative or that fail to qualify for hedge 
accounting treatment. In this regard, I measure interest rate derivatives that qualify for hedge accounting treatment 
(excluding foreign currency and speculative derivatives). Third, I control for interest rate exposure from debt and 
foreign currency exposure to isolate the effect of derivatives on exposure. Most prior studies that examine foreign 
currency exposure (interest exposure) fail to control for interest exposure (foreign currency exposure) in the 
analysis. Finally, I analyze explicit market risk disclosures to determine how firms are managing their interest rate 
risk. My paper contributes to the literature on interest rate exposure and hedging by providing a comprehensive 
investigation of exposure of publicly traded non-financial firms in the lodging industry. Researchers, industry 
practitioners, and financial statement users will find this information relevant and informative in understanding the 
exposures faced by lodging firms and the factors that drive lodging firm choice of risk exposures. 

---