Determinants of Corporate Hedging Policy: The Use of Interest Rate Derivatives by Non-Financial Firms of Pakistan

Abstract

Usually, firms use interest rate derivatives to hedge interest rate risk. Similarly, some non-financial firms in Pakistan are also engaged in the use of interest rate derivatives to hedge their exposure to interest rate risk.

Purpose: The purpose of this study is to identify determinants of interest rate derivatives used by non-financial firms in Pakistan and to identify any differences between non-financial firms using interest rate derivatives and non-interest rate derivatives.

Methodology: Since interest rate derivatives are taken as dependent binary variables, binary digits 1 and 0 are assigned to firm and non-user interest rate derivatives.  As a result, the Logit model is used to identify the determinants of interest rate derivative use. Besides, users and non-users of interest rate derivatives are two groups independent of each, and therefore the Mann Whitney U test is used to identify the difference between them.

Results: In line with the literature, the non-parametric Mann Whitney U test resulted in significant differences between interest rate derivative users and non-users. While using the Logit model, there was a significant positive relationship between financial distress costs, asset growth, cash flow, firm size, and interest rate derivatives use. However, there was a negative relationship between profitability (ROA) and interest rate derivatives.

Limitation: Since most financial firms use derivatives for trading rather than hedge purposes, the scope of the study is limited to non-financial firms that use derivatives for hedge purposes. Also, the study was launched in 2013-14, so the data collected and used for the period 2006-12 will be used.

Implication: The findings suggest that large, financially distressed firms can hedge their interest rate risk and benefit from the optimal utilization of interest rate derivatives.

Originality: The study was the first attempt to explore interest rate derivatives in non-financial firms in Pakistan and pave the way for further exploration of the subject matter. Besides, the original data were extracted from the annual reports of the sampled firms.