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

Hedging, Exposure and Debt Structure 
Within the broad context of hedging, there are many studies that investigate the incentives to hedge and the 
impact of derivatives on interest exposure. Guay (1998) examined the change in risk level for large firms that began 
using derivatives. Measuring risk in several different ways, his results were consistent with firms using derivatives 
to lower risk exposure. On the other hand, Hentschel and Kothari (2001) examined the risk characteristics of a panel 
of 425 financial and nonfinancial firms and find no significant exposure or risk reduction due to derivative use. A 
number of empirical studies have also investigated the relation between interest rate derivatives and choice of debt 
structure. The findings of these studies are generally consistent with the theoretical arguments for hedging. Fenn et 
al (1996) find strong evidence that firms use derivatives (swaps) to hedge interest rate risk arising from their short-
term variable debt obligations but no evidence that they hedge interest rate exposure arising from operating income.
In a more recent study, Covitz and Sharpe (2005) report that smaller and lower rated firms face greater exposure 
from their liabilities than larger firms. These firms are consequently more likely to use derivatives to offset this 
exposure while larger firms mitigate their interest exposure through long-term debt financing.