How Does Information Asymmetry Affect Corporate Hedging?

56 Pages Posted: 26 Apr 2021 Last revised: 3 May 2022

See all articles by Praveen Kumar

Praveen Kumar

University of Houston - Department of Finance

Kit Pong Wong

University of Hong Kong

Shijie Yang

The Chinese University of Hong Kong, Shenzhen

Margaret Zhu

affiliation not provided to SSRN

Hong Zou

The University of Hong Kong - Faculty of Business and Economics

Date Written: May 18, 2020

Abstract

We test three prominent risk management theories related to information asymmetry that have differing predictions. Exploiting mergers or closures of brokerage firms as plausibly exogenous events that increase information asymmetry, we find that treatment firms significantly reduce derivative-based hedging, compared with matched control firms. Lower hedging is concentrated in firms that are ex ante subject to lower collateral, more financial constraints, and better growth opportunities. Our results are consistent with the view that hedging is constrained by available collateral and, therefore, collateral and financial constraints exacerbated by increasing information asymmetry restrict hedging in affected firms, especially those with attractive investment opportunities. We also find some evidence that treatment firms that have a high-quality CEO and are not subject to collateral constraints respond to the increase in information asymmetry by increasing hedging, consistent with the hypothesis that hedging helps signal superior managerial quality (DeMarzo and Duffie (1991; 1995)).

Keywords: Information asymmetry, collateral, risk management, hedging, analysts

JEL Classification: G30, G32, K22

Suggested Citation

Kumar, Praveen and Wong, Keith Kit Pong and Yang, Shijie and Zhu, Margaret and Zou, Hong, How Does Information Asymmetry Affect Corporate Hedging? (May 18, 2020). Available at SSRN: https://ssrn.com/abstract=3833733 or http://dx.doi.org/10.2139/ssrn.3833733

Praveen Kumar (Contact Author)

University of Houston - Department of Finance ( email )

Houston, TX 77204
United States
713-743-4770 (Phone)
713-743-4789 (Fax)

Keith Kit Pong Wong

University of Hong Kong ( email )

Faculty of Business and Economics
University of Hong Kong
Hong Kong, Nil Nil
Hong Kong
(852) 2859-1044 (Phone)
(852) 2548-1152 (Fax)

Shijie Yang

The Chinese University of Hong Kong, Shenzhen ( email )

Zhiren 606
2001 Longxiang Road, Longgang District
Shenzhen, Guangdong 518172
China

Margaret Zhu

affiliation not provided to SSRN

Hong Zou

The University of Hong Kong - Faculty of Business and Economics ( email )

China

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