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The Management of Foreign Exchange Risk in US Multinational Enterprises: An Empirical Investigation
Abstract
This study examines how US multinational enterprises manage foreign exchange risks by exploring the concepts applied by management, the objectives followed, and how management has organised this important function of multinational financial management. Despite the change in generally accepted accounting principles from SFAS8 to SFAS52 and the fact that translation exposure is not real exposure, 19 of the 22 surveyed companies closely monitored accounting exposure and would take action under certain circumstances. Further, transaction exposure management still plays a significant role in foreign exchange risk management. Economic exposure management, which focuses on foreign exchange-induced changes in future cash flows, was also perceived as essential, although the degree of sophistication varies. The majority of the participating companies are risk averse and have centralised their foreign exchange risk management.
... Test results are reported and discussed in section 5 with conclusions presented in section 6. Allayannis & Ofek (2001) Smith & Stultz (1985), Nance, Smith & Smithson (1993) and Pramborg (2004) claim that, in practice, most companies indeed hedge their currency exposures. Duangploy, Bakay &Belk (1997) andPrevost, Rose &Miller (2000) find that transaction exposures are often dealt with using money market hedges, among which, currency forward contract is the most popular instrument. ...
... Test results are reported and discussed in section 5 with conclusions presented in section 6. Allayannis & Ofek (2001) Smith & Stultz (1985), Nance, Smith & Smithson (1993) and Pramborg (2004) claim that, in practice, most companies indeed hedge their currency exposures. Duangploy, Bakay &Belk (1997) andPrevost, Rose &Miller (2000) find that transaction exposures are often dealt with using money market hedges, among which, currency forward contract is the most popular instrument. ...
Empirical studies observe that currency exchange rates often deviate from PPP theoretical values. The literature recognized that cumulative exchange rate deviations are often corrected over subsequent periods, indicating that cumulative PPP deviations can provide reliable information for predicting future directions of exchange rate movements. Also established in the literature is the exchange market regularity that exchange rates often move to the opposite directions as implied in forward rate premiums or discounts. Based on these empirical findings, a selective forward hedging strategy is proposed for managing transaction exposures of long foreign currency positions. Intuition of the strategy is to avoid predictable depreciations of over-valued currencies and capturing benefits of forward premiums. The strategy calls for hedging when a foreign currency is over-valued and the forward contract is trading at a premium. Exposures are left uncovered otherwise. Examined on daily data of eight free-floating currencies for the period between 1986 and 2004, the strategy has increased domestic cash flow returns and reduced return volatilities compared to unhedged strategy. Superior performance of the proposed strategy is confirmed by analysis of the second order stochastic dominance which finds 44 out of 56 dominance of the proposed strategy over un-hedged strategy. Both components of exchange rate corrections to PPP and the forward premiums contribute to the success of the strategy. The proposed strategy is applicable by international corporations facing long-term exposures to foreign currency transactions.
... With regards to risk management strategies employed, although firms use some internal measures, financial instruments are a more popular choice. Amongst these, forward contracts dominate due to their relatively low costs, inherent flexibility and ease of organisation ( Duangploy et al., 1997). Innovative instruments such as option contracts, although used, are less common since senior management are hesitant with such instruments in the light of their speculative nature, high up-front premiums and resource intensity (Belk and Glaum, 1992). ...
... Forward contracts, for reasons described in prior research (Belk and Glaum, 1992;Duangploy et al., 1997), are the preferred choice of instruments. Moreover, in many instances there is little scope to use other instruments: option contracts are not available in many countries and swap transactions manage risk on a long term basis rather than the 12 month periods that concern the firm. ...
Using a case study approach, this paper reviews the corporate exchange risk management practices of a single large UK multinational company. The research results shed new light on the management of economic exchange rate risk and also have implications for the effects of movements in exchange rates in the context of the translation process. More generally, these results indicate that, instances in which corporate practices deviate from normative prescriptions do not necessarily imply sub-optimal behaviour, although some companies may benefit from the re-consideration of their exchange risk management policies. Finally, they highlight new areas of research and also emphasise the role of qualitative research in accounting and finance.
... This can also be seen as an indication of corporate risk avoidance (though, on balance, the prevailing trend has been for GUFs to initiate many of the IFAs). More broadly, a range of MNEs have demonstrated risk aversion through hedging behaviours such as foreign exchange risk management practices (Duangploy, Bakay and Belk, 1997;Mian, 1996;Tufano, 1996). ...
Global union federations (GUFs) and multinational enterprises (MNEs) have been concluding “international framework agreements” (IFAs) to protect their interests amidst the globalizing economic landscape. By modelling the underlying bargaining processes, the authors show that IFAs can be expected when both sides exhibit risk aversion, although the agreement will favour the less risk-averse side. Since globalization has created fewer vulnerabilities for MNEs than for GUFs, IFAs have so far typically delivered only minimal benefits for labour. But this should change in the future if strengthened transnational union capacities and abilities to threaten MNEs with reputational costs bring greater equalization of attitudes towards risk.
... UK Based MNCs are covered in a series of studies with Belk taking a significant part in each of them (Belk, 1990;Belk, 2002;Belk and Glaum, 1990). US based MNCs are studied by different authors (Choi, 1995;Duangploy et al, 1997;Jorion, 1990). Marshal compared the practices of the MNCs based in the US, UK and the Far East (Marsahl, 2000). ...
More and more Indian firms are becoming global in their operations - through exports and imports, by setting up manufacturing plants abroad and through joint-ventures and tie-ups. In this process most of them are dealing with multiple currencies. This has increased the overall exposure of Indian firms to foreign exchange-rate fluctuations. How have they been coping with the risk associated with the exchange-rate fluctuations? In order to explore this, the authors have engaged the case-research method. The authors studied 64 cases for this purpose. Of these 27, firms have been handling forex exposure and/or have had at least one near-crisis situation in the past. The remaining 37 cases are Indian firms from sectors like Textiles, IT, Gems and Jewelry, Pharma, Engineering, FMCG and Energy. The study focused on the context of these firms, their business model, the sources of forex exposure and the policies and practices of managing forex exposure risk. The authors have tried to identify the basic factors underlying the forex exposure and to identify patterns, if any, in the coping-strategy. They conclude that the insights would help formulate a generic strategy.
... Joseph and Hewins (1991) show that MNCs in the United Kingdom place greater emphasis on transaction exposure and aim to minimise it at the same time. Duangploy et al. (1997) also find that US firms place greater emphasis on transaction exposure. Belk and Edelshain (1997) show that the reason why this exposure is emphasised is the ease of measuring and managing it, and the ease of measuring performance and reward. ...
In this paper, we examine the performance of different hedging strategies for a domestic firm in the GCC that is exposed to foreign currencies, such as the GBP, CHF, and JPY. These strategies are always to hedge, to hedge or not to hedge, and always not to hedge. Our results show that, on average, there is no difference in performance and risk under these hedging strategies for all of the GCC currencies considered against foreign currencies. The results also show that in terms of risk, no strategy outperforms the other. Hypothesis-testing results suggest that firms do not have to worry about foreign-exchange risk, at least in the long run. Different reasons were suggested to verify such results.
... Since transaction exposure has direct cash flow and market value implications on a firm, it should be actively managed (Srinivasulus, 1983). Besides the use of internal hedging methods such as cash flow netting to manage transaction exposure; amongst a basket of external hedging tools, firms overwhelmingly make use of forward contracts because they are cheap, and flexible (Duangploy et al., 1997). Belk and Glaum (1990) found that a handful of firms engage in profit making when trying to hedge their foreign exchange transactions. ...
... Smith & Stultz (1985), Nance, Smith & Smithson (1993) and Pramborg (2004) claim that, in practice, most companies indeed hedge their currency exposures. Duangploy, Bakay & Belk (1997) and Prevost, Rose & Miller (2000) find that transaction exposures are often dealt with using money market hedges, among which, currency forward contract is the most popular instrument. The literature, however, provide little evidence on forward hedging efficiencies in terms of cash flow impact in the context of managing transaction exposures. ...
... Scheirer (1994) in a case study of 18 US companies that have strong international commitment, shows that 47 per cent of the respondents emphasise establishing a natural hedge, that is, matching currency cash flow, and the other 37 per cent were adjusting operation decisions to manage operating exposure. Another study in the US by Duangploy, Bakay and Belk (1997) of 22 industrial companies indicates that 17 companies based management of operating exposure on cash flow forecasts with the degree of sophistication and time horizon varying greatly. Of the 17 companies, 7 companies used operational policies such as sourcing, production location, pricing and foreign direct investment; three companies used financial means such as forward contract and options, and seven used both operational and financial techniques. ...
This paper uses a large Australian multinational corporation as a case study examining foreign exchange operating exposure. We firstly review the importance of operating exposure for a business and then examine in detail the company’s exposure and policies to manage the exposure. A sensitivity analysis is also conducted to examine how movements in the value of exchange rates affect the company. We conclude with some suggestions as to how the company could further protect itself from adverse movements.
This literature review surveys some of the main topics regarding foreign-exchange risk exposure managment. The basic goal is to conduct literature surveys on some of the major studies in the field that focus on foreign-exchange risk managment. The primary focus is to undersand when the firm must hedge and to differentiate between financial and operational hedging techniques. This is done by summarising some of the existing literature in these areas in order to synthesize this topic and understand the impact of hedging techniques on corporate foreign-exchange risk.
Resumen
Las federaciones sindicales internacionales y las empresas multinacionales están concluyendo acuerdos marco internacionales para proteger sus intereses en el entorno económico de la globalización. Los autores modelizan las negociaciones al respecto y muestran que puede esperarse la conclusión de estos acuerdos cuando ambas partes son reacias al riesgo, pero el acuerdo favorecerá a la que menos lo sea. Como la globalización ha afectado más a los sindicatos que a las empresas, los acuerdos marco hasta ahora firmados ofrecen mínimas ventajas a los trabajadores; ello debería cambiar gracias a las capacidades sindicales transnacionales reforzadas y a la posibilidad de atacar la imagen de las EMN, lo cual igualará las actitudes frente al riesgo.
Résumé
Face à la mondialisation, les fédérations syndicales internationales et les entreprises multinationales ont cherché à protéger leurs intérêts par des «accords‐cadres internationaux», ou ACI. En modélisant les processus de négociation sous‐jacents, les auteurs montrent que ces accords n'aboutissent que si les deux partenaires présentent une aversion pour le risque et qu'ils tendent à favoriser celle des parties chez qui cette aversion est moins prononcée, les multinationales en l'occurrence, aux dépens des travailleurs. Les choses pourraient évoluer cependant si les syndicats parviennent, par une action transnationale, à déstabiliser les multinationales en menaçant leur réputation, rapprochant le niveau d'aversion pour le risque des deux interlocuteurs.
This article provides a selective, critical survey of the academic literature on the financial management policy of multinational enterprises (MNEs). The focus of much current research interest can be captured in two major themes which also dominate this analysis. The first is financial management policy in relation to the increasing volatility of real and financial asset prices in the international financial environment within which MNEs operate. This dictates one theme of this article: the impact of financial risk, in particular market risk, on MNEs and an appraisal of evolving financial risk management practices. The second theme is international market segmentation. The globalization of international business activity has evolved along with a trend towards increasing financial market integration, particularly in capital markets.
According to academics, the translation form of exchange rate risk does not affect the market value of a firm and as a result should not be managed by corporate managers. Research to date, however, suggests that many multinational companies (MNCs) actively monitor and manage their translation exchange risk. Thus, either corporate management fail to understand the irrelevant nature of this risk or there are other factors that need to be considered. This paper extends the current literature by examining these issues; in particular, it examines whether MNCs continue to manage their translation exchange rate risk and if so what their reasons are for the specific practices. Results suggest that the gearing ratio, itself a measure of risk, is largely responsible for the management of the translation process. Further, some companies seek to manage their ‘profit and loss translation exchange risk,’ a ‘risk’ resulting from the impact of the translation process on the profit and loss account. Preferred management strategies include the currency denomination of debt and use of financial instruments such as forward contracts. Capital market imperfections reflected in binding loan covenants, agency theory problems and the assumption of inefficient market behaviour explain the observed corporate management behaviour.
The objective of this paper is to simultaneously survey the foreign exchange risk practices of large UK, USA and Asia Pacific multinational companies (MNCs). It investigated whether foreign exchange risk management practices vary internationally, including for the first time a large sample Asia Pacific MNCs. From 179 (30%) usable responses it is shown that there are statistically significant regional differences in the importance and objectives of foreign exchange risk management, the emphasis on translation and economic exposures, the internal/external techniques used in managing foreign exchange risk and the policies in dealing with economic exposures. In general, UK and USA MNCs have similar policies, with a few notable exceptions, however, Asian Pacific MNCs display significant differences. To control for regional variations in the characteristics of respondents the results are also compared by size, percentage of overseas business and industry sector. It was found that either the size of the respondent or the industry sector could also explain the emphasis on translation and economic exposure and use of external hedging instruments.
Highly volatile foreign exchange markets have forced corporate managers and academics alike to pay more attention to the management of foreign exchange risk. However, with only a few exceptions, both business practice and the relevant academic literature concentrate solely on the short term, tactical aspects of foreign exchange risk management. This article emphasizes the strategic nature of foreign exchange risk. The concept of economic exposure is accepted as the appropriate basis for corporate exchange risk management. From this concept, the author argues that it follows conclusively that exchange risk is a strategic factor in a company's competitive environment. As such it requires a strategic management approach: exchange risk management should be incorporated into the long range, strategic planning system of the corporation, and it should be integrated with all areas of corporate decision making.