FOREIGN CURRENCY DERIVATIES AND CORPORATE VALUE: EVIDENCE FROM CHINA

FOREIGN CURRENCY DERIVATIES AND CORPORATE VALUE: EVIDENCE FROM CHINA Robin Hang Luo ALHOSN University, UAE ABSTRACT Chinese Yuan, also known as Renminbi (RMB), has been appreciating more than 30% against the US dollar since the exchange rate regime reformed in July 2005. Many people view the persistent appreciation and recent inclusion of RMB in the IMF s Special Drawing Rights (SDR) basket as a victory for China because it comes with the stature of a hard reserve currency. Nevertheless, the adverse effects of increased volatility as a freely usable reserve currency began to appear as many multinational companies based in China have no other choices but to hedge foreign exchange risk using derivatives. Greater concerns have been raised on the usage of foreign currency derivatives in hedging the RMB fluctuation and its impact on the corporate value in the aftermath of 2008 Global Financial Crisis. This paper investigates the association between the use of foreign exchange derivatives and the corporate value of Chinese multinational corporations (MNCs) following Allayannis and Weston (2001) and Bartram, Brown, and Conrad (2011). It is found that the use of foreign exchange derivatives brought positive but insignificant hedging premium to the corporate value on average. JEL Classification:F31, G32 Keywords: Corporate Value, Currency Derivatives, Exchange rate, Hedging, Risk Management Corresponding Author s Email Address: h.luo@alhosnu.ae INTRODUCTION In perfect capital markets without information asymmetries, taxes and transaction costs, and agency costs, hedging financial risk should not add value to the firm because shareholders can hedge by themselves according to Modigliani and Miller (1958). In practice, however, imperfections in capital markets create a rationale for corporate hedging activities. Hedging becomes an important tool in managing foreign exchange risk in the multinational corporations (MNCs). According to a derivatives usage survey released by International Swaps and Derivatives Association (ISDA) in 2009, 94 percent of the world s 500 largest companies use derivative instruments to manage and hedge their business and financial risks. A broad array of studies have investigated the relationship between corporate hedging and firm value and some found supportive evidence that hedging enhances firm value. Froot, Scharfstein, and Stein (1993) argue that, when the external financing is more costly than internal financing, hedging activities are value-enhancing because hedging ensures the capability of financing profitable investment, which could alleviate or avoid underinvestment problem. Many empirical studies have found hedging activities increase firm's debt capacity, R & D spending and corporate value. Nain (2004) shows that non-hedger s corporate value is 5% lower than that of hedgers in the industry where foreign exchange derivatives are widely used. Allayannis and Weston (2001) find hedger s corporate value is 5% higher using a sample of 720 U.S. multinational companies. Although the association between use of foreign exchange derivatives effect and corporate value is a hot debated area, very few studies have examined this issue on Chinese MNCs. For instance, Bartram et al. (2011) investigate the determinants of foreign exchange derivatives used by 6888 MNCs from 47 countries. Their sample includes 32 MNCs based in mainland China. Allayannis, Lel, and Miller (2012) study the relationship between corporate governance and hedging premiums using 1605 MNCs cross-listed in the U.S. market, including 12 Chinese MNCs. The empirical results based on such small sample of Chinese MNCs selected in these studies do not truly reflect the value enhancing effect and hedging activities in Chinese MNCs. This might attribute to the short history of floating of RMB, starting from July 2005, and the mandatory requirement of disclosing use of foreign exchange derivatives in the annual report, starting from January 2007. On July 21, 2005, China began the reform of the RMB exchange rate formation mechanism, in addition to a one-time revaluation of 2%. Luo and Jiang (2007) examine the foreign exchange exposure under the new exchange rate 117

regime and association between RMB foreign exchange rate movement and stock market return of Chinese listed firms using the monthly data and augmented market model. They report a positive relationship between RMB appreciation and increase in the average stock market return in the first 20 months after July 21, 2005. According to statistics of the State Administration of Foreign Exchange, the bilateral exchange rate between RMB and the US dollar (monthly central parity) has appreciated over 30% till the end of 2014. Bank for International Settlements data shows that within this period the nominal effective exchange rate of the RMB relative to a basket of trade-weighted currencies appreciated by nearly 15%. 1 As Chinese MNCs accelerate their pace of overseas expansion, exchange rate fluctuations becomes a major concern. Many listed firms started to present the impact of RMB exchange rate fluctuations in their annual reports. On February 2006, Ministry of Finance issued a new "Enterprise Accounting Standards" while the first listed firm reported following the new standard on January 1, 2007. The implementation of new enterprise accounting standards makes the collection of foreign exchange derivatives data from individual listed firms possible. "Accounting Standards for Enterprises No. 22 - Financial Instruments Recognition and Measurement", "Accounting Standards for Enterprises No. 24 - Hedging" and "Enterprise Accounting Standards No. 37 - Financial Instruments" require listed firms disclosing their risk management objectives, policies and processes for risk measurement methods, types of financial instruments used, the carrying value, fair value and changes in fair value gains and other descriptive information and quantitative information. This regulation requirements enable researchers get more detailed information on foreign exchange derivatives and study the relationship between use of foreign exchange derivatives and firm value. Using 810 MNC observations (687 observations after the missing data is excluded) from 2007 to 2013 in China, we find a positive but insignificant relationship between the use of foreign exchange derivatives and corporate value. The results remain robust even if we replace the Tobin Q with adjusted Tobin Q in the fixed effects and random effects regression. Although other types of derivatives may have the similar effect as currency derivatives, in this study, the use of foreign exchange derivatives is chosen to be the proxy for corporate hedging. There are three reasons why currency derivatives are focused on: (1) by considering the research target of this study, exchange rate risks have the premier position for Chinese MNCs. It is practical to isolate it from other common risk factors that may affect firm market value; (2) previous empirical studies have shown mixed results on the effect of using other derivatives, such as commodity or interest rate derivatives. Tufano (1996) argues that the motivation for managers to use commodity derivatives is manager s risk aversion, which hardly adds value to a firm. In contrast, Haushalter (2000) states that the use of commodity derivatives is related to the reduction of expected bankruptcy costs, which may add value to a firm. For hedging with interest rate derivatives; (3) most firms that use other types of derivatives also use foreign exchange derivatives as the latter is considered to be the most widely used derivatives for risk management practitioners. The rest of this study is structured as follows: Section 2 provides a literature review. Section 3 describes the methodology and data. Results of empirical results are reported in Section 4. Section 5 concludes. LITERATURE REVIEW Managerial risk aversion theory believes that the incentive of managers to maximize their personal utility functions is the reason for them to partake in hedging activities Stulz (1984). Mian (1996) and Tufano (1996) also find strong evidence supporting the managerial risk aversion theory, because those managers who hold more stocks or options tend to undertake more hedging activities. Hedging is not likely to affect corporate value according to these studies. Shareholder value maximization theory, however, states that firms undertake hedging activities in order to reduce the various costs caused by high volatility of cash flows. It is widely believed that hedging plays an important role in bringing tax-reduction benefits, avoiding under-investment, reducing costs of financial distress, coordinating company stakeholders, and reducing agency costs. These advantages are likely to create shareholder value (Froot et al., 1993; Smith & Stulz, 1985). Smith and Stulz (1985) argue that hedging might be motivated by tax incentives and it could reduce the volatility of expected corporate earnings and therefore minimize the costs of financial distress. Visvanathan (1998) reports a positive and significant relation between hedging and leverage when investigating the usage of interest rate swaps by S&P 500 non-financial firms. Haushalter (2000) examines the commodity hedging activities of firms in the oil and gas industry and presents supporting evidence of shareholder value maximization theory. Stulz (1996) points out that the main purpose of firm's risk management is to eliminate the deadly consequence of small probability events, which may lead to financial difficulties or make firms unable to perform their investment strategies. Froot et al. (1993) state that hedging would be more valuable if cost of external financing is much greater than the cost of internal financing. 1 Please refer to the Bank for International Settlements (http://www.bis.org/statistics/eer/index.htm) for the relevant statistical data of RMB effective exchange rate. 118

They believe that hedging could better match the cash outlays and inflows so that firms using hedging strategy should have sufficient internal funds invested in the projects with positive NPV. The problem of insufficient investment could be reduced or eliminated. Leland (1998) also argues that reducing income volatility can increase firm's debt capacity and thus achieve great benefit from tax shield. A broad array of empirical studies on hedging practice examine which school of corporate hedging theory could better explain the firm s hedging behavior. Triki (2005) compares the identification method of hedgers, measurement of corporate hedging, and variable selection and possible determinants considered in the test by reviewing empirical studies in nearly two decades from 1985 to 2005. Allayannis and Ofek (2001) and Graham and Rogers (2002) report a positive relationship between the employment of foreign exchange derivatives and corporate investment opportunities, which supports that hedging could mitigate the under investment problems in many firms. Graham and Rogers (2002) also find that hedging improves firms debt capacity, with increased tax benefits averaging 1.1 percent of firm value. Haushalter (2000) and Lin et al. (2008) predict a positive linear relationship between firm s leverage level and hedging, which is consistent with the argument that firms hedge to reduce the expected cost of financial distress. Campello et al. (2011) argue that, compared with non-hedgers, hedgers using exchange rate or interest rate derivatives are likely to borrow at lower lending rates and face less capital spending restrictions in the loan agreement. Average hedging benefits are equivalent to 4.7 percent of net income. Other studies, such as Knopf, Nam, and Thornton Jr (2002) and Rogers (2002), show management risktaking incentives represented by stock and option portfolios are negatively related to derivative holdings, which is consistent with derivatives being used for hedging purposes. Findings derived from a broad array of empirical studies on the association between hedging and corporate value do not reach the same conclusion. Allayannis and Weston (2001) report an average 5% premium on the firm value for those using currency derivatives in a sample of 720 U.S. multinationals. Clark and Judge (2009) analyze the value-enhancing effect of the adoption of various types of hedging instruments, such as forwards, futures, and options, and show that the effect is varying from 11 percent to 34 percent. Nain (2004) find a 5 percent discount on corporate value for those firms not using derivatives in the industry which foreign currency derivatives are widely used. Kim, Mathur, and Nam (2006) argue that the value-enhancing effect of operational hedging would be five times higher than that of financial hedging though both have positive impact on corporate value. Allayannis et al. (2012) investigate the impact of foreign currency derivatives on firm value using a broad sample of firms from thirty-nine countries and report strong evidence that the employment of currency derivatives for firms that have strong internal or external governance is associated with a significant value premium. Bartram et al. (2011) find that the effect of derivative use on corporate value is positive but more sensitive to endogeneity and omitted variable concerns. Nevertheless, value-enhancing effect has been challenged by some researchers. Tufano (1996) reports little empirical support for the predictive power of theories that view risk management as a channel to maximize shareholder value. Guay and Kothari (2003) analyze the economic effects of derivatives positions for a sample of 243 large non-financial derivative users. They conclude that potential gains on derivatives are no more than $15 million in cash and $31 million in value, and they believe it cannot possibly have an effect of the magnitude claimed with such a small hedging premium. Li, Visaltanachoti, and Luo (2014) examine the benefits of foreign currency derivatives usage in 134 non-financial firms listed in the New Zealand Stock Exchange and find no evidence supporting the value-enhancing effect of employment of foreign currency derivatives. Most of the previous literature investigating the association between hedging and corporate value are based on U.S. or European multinationals. Evidence from other economies are emerging in recent years and studies using Chinese data are rarely found. Luo and Jiang (2007) analyze the effect of foreign exchange exposure on Chinese listed firms market return and find the appreciation of RMB drove up the average stock market return after the foreign exchange regime reform in 2005. However, hedging activities and use of foreign currency derivatives were not considered in their study. PBOC (2006) investigate the foreign exchange risk management using data obtained from 323 enterprises and report that foreign currency derivatives, particularly forward, has become one of the major approaches to manage foreign exchange risk. METHODOLOGY AND DATA Our sample consists of 30 largest listed firms in Shanghai Stock Exchange and Shenzhen Stock Exchange between the first quarter of 2007 and the third quarter of 2013. We obtain a total of 810 firm-quarter observations in the sample period. Financial firms are not excluded from our sample because most of the Chinese financial institutions are market participants rather than market makers in trading foreign exchange derivatives in the international financial markets. Final sample excludes following three categories of corporations: 1) Special Treatment corporations, or ST firms for short. These firms are normally in financial distress and have much greater risk than other firms; 2) Firms with mergers & acquisitions or major asset 119

restructuring taking place; 3) Corporations with missing data. After the missing data are removed, 687 firmquarter observations left in our sample. FCD is a dummy variable with value 1 if firm uses derivatives, and 0 otherwise (Allayannis et al. (2012); Bartram et al. (2011)). Chinese listed firms normally disclose their foreign exchange derivatives usage information in the notes of financial reports. But almost all financial data providers do not include the financial statement notes of listed companies in their databases. Therefore FCD data is not available in the CSMAR database. Triki (2005) summarizes three approaches to identify hedgers, namely the survey approach, the keyword search approach, and the private data approach. In the present study, I use the keyword search approach to obtain FCD data by manually searching the keywords, such as foreign exchange forwards, foreign exchange futures, currency options, currency swaps, and Non-deliverable forwards (NDFs), in the sample corporations annual reports. If a listed company s annual financial statement notes report foreign exchange derivatives have been used to hedge or management exchange rate risk, and disclose the fair value or the nominal value of the derivatives, and recognize the profit or loss of using derivatives as financial expenses or investment income in the relevant items of income statement, this firm is identified as a hedger even though it does not hold long or short positions at the end of the financial period. FCDs data are manually collected from annual report of Shanghai and Shenzhen listed firms while other financial and operational data are obtained from CSMAR database. Tobin s Q, which is used to capture firm market value in the present study, compares the value of a company given by financial markets with the value of a company s assets. It is calculated by dividing the market value of a company by the replacement value of its assets (Blose & Shieh, 1997). When it is computed for new investment only, then it is referred to as the marginal Q. When it is calculated for all of a firm s assets it s referred to the average Q (also known as simple Q). If the market value of a firm is solely reflected by its recorded assets. Q equals to 1. If Q is greater than 1, the market value of a firm is greater than the cost to replace a firm s assets and implies that this firm s stock is overvalued. If Q locates between 0 and 1, the market value of a firm is less than its asset replacement cost, which suggests that the stock is undervalued. High Q values encourage firms to invest more in capital because they are worth more than the price they paid. There are three different methods to construct Tobin s Q in the literature. It can be measured by the ratio of market value of the firm to the book value of the assets (Allayannis & Weston, 2001); or an approximate ratio proposed by Chung and Pruitt (1994) using the product of share price and common stock shares outstanding, liquidating value of outstanding preferred stock, value of short-term liabilities net of short-term assets plus the book value of longterm debt, and book value of total assets; or the more complex Lindenberg and Ross (1981) procedure. Allayannis et al. (2012) compare the above three measures and find different measurement of Tobin s Q has very little impact on the result examining the relationship between the use of foreign currency derivatives and corporate value. Simple method proposed by Allayannis and Weston (2001) is used in the present study to approximate Tobin s Q. The market value of Chinese MNCs consists of the total capitalization and total interest-bearing liabilities. Total interest-bearing liabilities include short-term loans payable, short-term bonds, long-term debt and long-term liabilities due within one year, excluding accrued liabilities and deferred income tax liabilities. Book value of Chinese MNCs equals to the book value of total assets minus the book value of non-interest bearing liabilities. Control Variables In order to accurately investigate the association between hedging with FCDs and corporate value of Chinese MNCs, following control variables are used to alleviate the effect that these variables in the multivariate regressions following Allayannis et al. (2012), Bartram et al. (2011), and Li et al. (2014). The first control variable is Firm Size. A large number of literature suggests that the managerial decision of using derivatives is positively related to the firm size (Graham & Rogers, 2002; Haushalter, 2000; Mian, 1996). Large firms are more likely to hedge proactively because they often launch a larger amount of initial investment for any project compared those with small firms. Meanwhile, larger firms benefit from both economic of scale and economic of scope, which give them more credit on project success compared with their small size competitors. Smirlock, Gilligan, and Marshall (1986) provide arguments for the fact that size does lead to higher efficiency. Total assets (item A001000000) is obtained from quarter report from CSMAR database. Natural logarithm of total assets is used to reduce the size effect. The second control variable is Profitability. Firms ability to generate profit is one of the most important considerations when investors are making their investment decision. Risk-averse investors would prefer to pay more for profitable firms than firms with operating loss. Therefore, firms with higher profitability are likely to have higher Tobin s Q. Thus, the ratio of return on assets is used, which is represented by the net income after tax and dividend divided by the average of total assets. Return on assets ratio is item T40301 in the CSMAR database. 120

Leverage is the third control variable. It is widely believed that capital structure affects the corporate value through its impact on the magnitude of discount factor when discounting its future expected cash flow by its cost of capital. Mayers (1998) argues that debt financing has one important advantage, which is that interest the firm pays is a tax-deductible expense but equity income is subject to corporate tax. It implies that firms with debt financing may have higher Tobin s Q. However, a firm faces greater risk of financial distress when it is overly financed by debt and therefore, controlling leverage is necessary. The leverage control variable is presented by the ratio of total liability to total assets. Debt to assets ratio is item T30100 in the CSMAR database. Investment Opportunities. Géczy, Minton, and Schrand (1997) provide empirical evidence that hedgers have a better chance to obtain better investment opportunities. It is worth controlling firms investment opportunities in the present study. According to Yermack (1996), the ratio of capital expenditures over total sales is used to control investment growth effect. Morck and Yeung (1991) use R&D expenditure as a proxy for investment growth. R&D creates great potential for firms future growth, but how much a firm will spend on R&D is largely dependent on its industry orientation and firm size. However, many Chinese listed firms do not present the ratio of R&D expenditure over total assets properly in their annual reports. Thus, revenue growth (item T81101) is used as a control variable to proxy the investment opportunities in the current study. Capital Constraints. The economical way of funding a project is from the inside source. If a firm pays out dividend, there will be fewer funds retained in the firm for future investing. As a result, firms have to finance the proposed project through the financial market, which costs firms a lot more in resources. It is not only more costly in terms of interest expenses, but also in the time consumed in regards to dealing with financing the proposed project from outsiders. By considering the cost to finance a project from outsourcing, firms may have to forgo a number of good investment opportunities. Thus, if a firm has dividend payable (item A00211500), it has more of a chance to outsource its project fund, and in turn it is expected to have lower Q (Servaes, 1996). A dividend dummy is used as a proxy for capital constraints. It is equal to 1 if the firm paid dividend in the sample period and equals 0 otherwise. International Diversification. Previous studies in examining the association between international diversification and corporate value did not reach the same conclusion. Morck and Yeung (1991) proclaim that multi-nationality is positively associated with firm value although agency problems exist. Kim et al. (2006) compare operationally hedged firms (firms with foreign sales) with non-operationally hedged firms (firms with export sales) and find that non-operationally hedged firms use more financial hedging relative to their levels of foreign currency exposure. Operational hedging is more effective in creating firm value though both operational and non-operational hedging are positive associated with corporate value. Choi and Jiang (2009) report evidence that operational hedging decreases a firm s exchange risk exposure and increase its stock returns. Nevertheless, Allayannis and Ofek (2001) argue that multinational operations increase exchange rate risk exposure and therefore reduce the company's value. The proportion of overseas revenue from foreign subsidiaries has been used to measure international diversification in the existing literature. However, this ratio is very low for most Chinese MNCs as their history of overseas expansion is rather short. In this occasion, a dummy variable (MNC) is used as the proxy of international diversification. If the balance sheet items in foreign currency translation (item B00130300) amount is not zero, MNC equals to 1, and 0 otherwise. EMPIRICAL ANALYSIS Statistics summary is presented in Table 1. Total number of observation is 687, including quarterly data of 30 listed MNCs from 2007Q1 to 2013Q3. Table 1 reports summary statistics of the main variables used in the present study. It shows that 58% of selected Chinese MNCs use foreign exchange derivatives. This percentage is very similar to those reported in the related studies using samples from other countries. Allayannis and Weston (2001) state that over 60% of U.S. MNCs use foreign currency derivatives and Bartram et al. (2011) report a similar result of 61% in their transnational study. It is noteworthy that some Chinese MNCs have very high Tobin Q and adjusted Tobin Q though the mean and median value of Tobin Q are 1.28 and 1.03, and those of adjusted Tobin are 1.53 and 1.08, respectively. It reflects that some Chinese MNCs have prominent investment opportunities. The selected Chinese MNCs demonstrate normal level of profitability as Table 1 reports an average of 4% of return on assets. International diversification level is illustrated by the control variable MNC which indicating that around 63% of sample firms confirm the foreign currency exchange differences in their balance sheet. TABLE 1. SUMMARY STATISTICS Variable Observation Mean Median St.Dev Min Max Dependent Variable TQ 687 1.28 1.03 1.04 0.73 9.51 121

ADQ 687 1.53 1.08 1.62 0.76 20.82 Independent Variable FCD 687 0.58 1.00 0.49 0.00 1.00 Control Variables SIZE 687 27.00 27.20 1.88 21.66 30.56 ROA 687 0.04 0.01 0.06-0.01 0.43 GINC 687 0.08 0.04 0.37-1.52 3.97 CAPX 687 0.40 0.00 0.49 0.00 1.00 DEBT 687 1.28 0.83 2.84 0.12 17.42 MNC 687 0.63 1.00 0.48 0.00 1.00 Multivariate regression method is used to investigate the impact of hedging on firm value. It is well believed that unobserved heterogeneity is a fundamental challenge in empirical study. The factors that are related with variables of interest can lead to biased estimated parameters. For example, unobserved factors- like corporate governance is common cross firms and affect firm value. Failing to control such factors can cause spurious relationship between firm value and hedging. Therefore, to consider the unobservable firm factors that may affect firm value, a firm-fixed effect model is used. For each firm, the unobservable factors are assumed to be time-invariant. Table 2 present the results of a pooled OLS regression. The main variable concerned is the FCD dummy that equals 1 if a firm uses foreign exchange derivatives and 0 otherwise. Consistent with value-enhancing theory that firms with currency exposure that use derivatives are rewarded by investors with higher valuation. We find a positive and significant relationship between the use of derivatives and Tobin Q. The coefficient demonstrates that hedgers have a higher Tobin Q than non-hedgers by 38% of corporate value. Some of the control variables are statistically significant at 1% level. For instance, like Allayannis and Weston (2001) we find that size has a negative sign; firms with high ROA have higher Tobin Qs; and the extent of multinationality is positively related to corporate value. Coefficient of debt to assets ratio is significant at 5% level and with a positive sign, indicating that firms with more leverage have higher corporate value. Other control variables, such as investment opportunity and capital constraint, however, are not statistically significant. TABLE 2. RESULT OF POOLED OLS REGRESSION Source SS df MS Number of obs = 687 F( 7, 679) = 131.48 Model 438.562067 7 62.6517238 Prob > F = 0.0000 Residual 323.558981 679.4765228 R-squared = 0.5754 Adj R-squared = 0.5711 Total 762.121048 686 1.11096363 Root MSE =.69031 tq Coef. Std. Err. t P> t [95% Conf. Interval] fcd.3831534.0710214 5.39 0.000.2437053.5226014 size -.0755488.0212318-3.56 0.000 -.1172367 -.0338609 ginc -.0458802.0725938-0.63 0.528 -.1884156.0966552 roa 13.57264.5529431 24.55 0.000 12.48695 14.65832 debt.0213724.0100213 2.13 0.033.0016959.0410489 capx.0160414.0670933 0.24 0.811 -.1156939.1477767 mnc -.2840158.0590437-4.81 0.000 -.3999459 -.1680857 _cons 2.730043.5686029 4.80 0.000 1.613612 3.846474 122

The estimated results of the fixed effects model (Mundlak, 1961; Wallace and Hussain, 1969) and the random effects model (Balestra and Nerlove, 1966) are reported in Table 3 and Table 4, to control for unobservable firm characteristics that may affect value and to tackle the problem of too many parameters and the loss of degress of freedom in the fixed effects model, respectively. Table 3 presents the results of the fixedeffect model. Unlike to the results reported in the pooled OLS regression, we find a positive but insignificant relationship between derivatives use and corporate value for firms with foreign exchange exposure. The magnitude of the hedging premium (0.1065) is higher than that in the pooled OLS regression, and suggests that users of derivatives have on average 10.65% higher corporate value than non-users. The signs and significance level of the coefficients of control variables are similar to those in the pooled regression, except in the fixedeffect model, both leverage and multinationality are statistically insignificant. Table 4 reports the results of the random-effect model. Similar to the results reported in the fixed-effect, the relationship between derivatives use the firm value is found positive but insignificant. The magnitude of the hedging premium (0.0937) is slightly lower than that in the fixed-effect regression, and suggests that users of derivatives have on average 9.37% higher corporate value than non-users. The signs and significance level of the coefficients of control variables are similar to those in the fixed-effect regression. Both Wald test and Likelihood-ratio test suggest that the pooled OLS regression results are biased the therefore not appropriate. TABLE 3. RESULT OF FIXED-EFFECT REGRESSION Fixed-effects (within) regression Number of obs = 687 Group variable: id Number of groups = 30 R-sq: within = 0.0692 Obs per group: min = 6 between = 0.3467 avg = 22.9 overall = 0.3272 max = 27 F(7,650) = 6.90 corr(u_i, Xb) = 0.2539 Prob > F = 0.0000 tq Coef. Std. Err. t P> t [95% Conf. Interval] fcd.1065382.1515832 0.70 0.482 -.1911137.4041901 size -.1764934.0391179-4.51 0.000 -.2533062 -.0996806 ginc.0145879.0392073 0.37 0.710 -.0624004.0915761 roa 2.4866.4934788 5.04 0.000 1.517595 3.455605 debt.0053144.0813929 0.07 0.948 -.1545105.1651392 capx.0386498.0676919 0.57 0.568 -.0942714.171571 mnc -.0132857.0717904-0.19 0.853 -.1542548.1276834 _cons 5.88392 1.032986 5.70 0.000 3.855528 7.912312 sigma_u.77190654 sigma_e.36823438 rho.81461603 (fraction of variance due to u_i) F test that all u_i=0: F(29, 650) = 59.87 Prob > F = 0.0000 TABLE 4. RESULT OF RANDOM-EFFECT REGRESSION Random-effects GLS regression Number of obs = 687 Group variable: id Number of groups = 30 R-sq: within = 0.0675 Obs per group: min = 6 between = 0.4145 avg = 22.9 overall = 0.3829 max = 27 Random effects u_i ~ Gaussian Wald chi2(7) = 84.94 corr(u_i, X) = 0 (assumed) Prob > chi2 = 0.0000 tq Coef. Std. Err. z P> z [95% Conf. Interval] fcd.0936972.1231843 0.76 0.447 -.1477397.3351341 size -.1743763.0336806-5.18 0.000 -.2403891 -.1083635 ginc.0089359.0407249 0.22 0.826 -.0708834.0887551 roa 3.275365.4924979 6.65 0.000 2.310087 4.240643 debt.021219.0305505 0.69 0.487 -.0386589.0810969 capx.0266213.0662709 0.40 0.688 -.1032673.1565099 mnc -.0596019.0699367-0.85 0.394 -.1966754.0774716 _cons 5.791383.8832937 6.56 0.000 4.060159 7.522606 sigma_u.43863436 sigma_e.36823438 rho.58659165 (fraction of variance due to u_i) 123

ROBUSTNESS CHECK Proceedings of the Australia-Middle East Conference on Business and Social Sciences 2016, Dubai In this section we explore the robustness of our results to alternative measures of corporate value. Tobin Q used in the previous section is replaced by the adjusted Tobin Q to conduct pooled OLS regression, fixed-effect regression, and random-effect regression. Adjusted Tobin Q differs from the Tobin Q in that the former uses the market value the circulating shares to proxy the value of non-circulating shares while the latter uses the book value instead. Table 5 present the results of a pooled OLS regression using adjusted Tobin Q. The signs and significance level of the coefficients are similar to those reported in Table 2, except the magnitude of the hedging premium is now much higher, nearly 40%. The estimated results of fixed effects model and random effects model are shown in Table 6 and Table 7, respectively. Hedging premiums are 36% and 42% but insignificant. TABLE 5. RESULT OF POOLED OLS REGRESSION USING ADJUSTED TOBIN Q Source SS df MS Number of obs = 687 F( 7, 679) = 107.20 Model 967.574513 7 138.22493 Prob > F = 0.0000 Residual 875.53612 679 1.28944937 R-squared = 0.5250 Adj R-squared = 0.5201 Total 1843.11063 686 2.68675019 Root MSE = 1.1355 atq Coef. Std. Err. t P> t [95% Conf. Interval] fcd.3970895.1168288 3.40 0.001.1677004.6264786 size -.1475479.0349259-4.22 0.000 -.2161237 -.0789722 ginc -.0713246.1194153-0.60 0.551 -.3057923.1631431 roa 18.91312.9095796 20.79 0.000 17.12719 20.69905 debt.035582.0164848 2.16 0.031.0032146.0679494 capx.0186121.1103671 0.17 0.866 -.1980896.2353139 mnc -.430627.0971256-4.43 0.000 -.6213295 -.2399244 _cons 4.767762.9353397 5.10 0.000 2.931256 6.604267 TABLE 6. RESULT OF FIXED-EFFECT REGRESSION USING ADJUSTED TOBIN Q Fixed-effects (within) regression Number of obs = 687 Group variable: id Number of groups = 30 R-sq: within = 0.1907 Obs per group: min = 6 between = 0.2496 avg = 22.9 overall = 0.2225 max = 27 F(7,650) = 21.87 corr(u_i, Xb) = -0.7169 Prob > F = 0.0000 atq Coef. Std. Err. t P> t [95% Conf. Interval] fcd.3572988.3342419 1.07 0.285 -.2990253 1.013623 size -.9383431.0862553-10.88 0.000-1.107716 -.7689705 ginc.0260716.0864523 0.30 0.763 -.1436879.1958312 roa 4.460877 1.088123 4.10 0.000 2.324216 6.597538 debt -.0712759.1794719-0.40 0.691 -.4236905.2811387 capx.412124.149261 2.76 0.006.119032.7052159 mnc -.0698703.1582982-0.44 0.659 -.3807079.2409674 _cons 26.4583 2.277739 11.62 0.000 21.98568 30.93091 sigma_u 1.7186014 sigma_e.81195882 rho.81751973 (fraction of variance due to u_i) F test that all u_i=0: F(29, 650) = 23.38 Prob > F = 0.0000 TABLE 7. RESULT OF RANDOM-EFFECT REGRESSION USING ADJUSTED TOBIN Q Random-effects GLS regression Number of obs = 687 Group variable: id Number of groups = 30 R-sq: within = 0.1446 Obs per group: min = 6 between = 0.4216 avg = 22.9 overall = 0.3526 max = 27 Random effects u_i ~ Gaussian Wald chi2(7) = 159.81 corr(u_i, X) = 0 (assumed) Prob > chi2 = 0.0000 atq Coef. Std. Err. z P> z [95% Conf. Interval] fcd.4250359.211777 2.01 0.045.0099606.8401111 size -.4831051.0602375-8.02 0.000 -.6011683 -.3650418 ginc.0100309.0933869 0.11 0.914 -.1730041.1930658 roa 6.763133 1.064795 6.35 0.000 4.676172 8.850093 debt.0778661.0402058 1.94 0.053 -.0009359.1566681 capx.1380074.1397494 0.99 0.323 -.1358963.4119112 mnc -.2993822.1418824-2.11 0.035 -.5774666 -.0212978 _cons 14.08066 1.577694 8.92 0.000 10.98844 17.17289 sigma_u.50072787 sigma_e.81195882 rho.27552404 (fraction of variance due to u_i) 124

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