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Master Thesis the Use of Interest Rate Derivatives and Firm Market Value an Empirical Study on European and Russian Non-Financial Firms

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Master Thesis the Use of Interest Rate Derivatives and Firm Market Value an Empirical Study on European and Russian Non-Financial Firms Master Thesis The use of Interest Rate Derivatives and Firm Market Value An empirical study on European and Russian non-financial firms Tilburg, October 5, 2014 Mark van Dijck, 937367 Tilburg University, Finance department Supervisor: Drs. J.H. Gieskens AC CCM QT Master Thesis The use of Interest Rate Derivatives and Firm Market Value An empirical study on European and Russian non-financial firms Tilburg, October 5, 2014 Mark van Dijck, 937367 Supervisor: Drs. J.H. Gieskens AC CCM QT 2 Preface In the winter of 2010 I found myself in the heart of a company where the credit crisis took place at that moment. During a treasury internship for Heijmans NV in Rosmalen, I experienced why it is sometimes unescapable to use interest rate derivatives. Due to difficult financial times, banks strengthen their requirements and the treasury department had to use different mechanism including derivatives to restructure their loans to the appropriate level. It was a fascinating time. One year later I wrote a bachelor thesis about risk management within energy trading for consultancy firm Tensor. Interested in treasury and risk management I have always wanted to finish my finance study period in this field. During the master thesis period I started to work as junior commodity trader at Kühne & Heitz. I want to thank Kühne & Heitz for the opportunity to work in the trading environment and to learn what the use of derivatives is all about. A word of gratitude to my supervisor Drs. J.H. Gieskens for his quick reply, well experienced feedback that kept me sharp to different levels of the subject, and his availability even in the late hours after I finished work. At last I want to thank my family for the unconditional support they have given me during my study period: Without your support it was impossible for me to be who I am and where I am at the moment. Thank you, Mark. 3 Contents List of tables and figures ............................................................................................................................. 5 Glossary ............................................................................................................................................................. 6 Abstract .............................................................................................................................................................. 7 1. Introduction ................................................................................................................................................ 8 1.1 Background .......................................................................................................................................... 8 1.2 Research question ............................................................................................................................. 9 1.3 Thesis outline .................................................................................................................................... 11 2. Literature review ..................................................................................................................................... 12 2.1 The universe of risk ........................................................................................................................ 12 2.2 Derivatives .......................................................................................................................................... 14 2.3 Risk management and firm value .............................................................................................. 17 3. Theoretical model ................................................................................................................................... 21 3.1 Definition of measurement .......................................................................................................... 21 3.2 Hypotheses ......................................................................................................................................... 22 3.3 Research model ................................................................................................................................ 23 4. Methodology .............................................................................................................................................. 24 4.1 Sample selection ............................................................................................................................... 24 4.2 Research methods ........................................................................................................................... 26 4.3 Control variables on Firm Value ................................................................................................ 28 5. Empirical results ...................................................................................................................................... 32 5.1 Univariate test ................................................................................................................................... 33 5.2 Multivariate tests ............................................................................................................................. 35 5.3 Robustness tests ............................................................................................................................... 37 6. Conclusions ................................................................................................................................................ 38 7. References .................................................................................................................................................. 40 Appendix A ..................................................................................................................................................... 44 4 List of tables and figures Table Content Page Table I Notional amount outstanding derivatives Page 14 Table II Notional amount outstanding derivatives Page 14 Table III Descriptive statistics Page 25 Table IV Hedge activity per country Page 32 Table V Hedge activity over time Page 33 Table VI Firm value between derivative users vs non-users Page 34 Table VII Interest rate derivatives use and firm value Page 36 Table VIII Multivariate test: difference before after crisis Page 37 Figure I Research model Page 23 5 Glossary Derivatives: Financial instruments whose value depends on an underlying. E.g. interest rates, currency or commodity prices. Euribor interest: Mean variable interest rates between European banks. Firm market value: Price stock * number of shares outstanding Forward/Futures: A Forward or future agreement between two parties obligates one party to buy and one party to sell a particular commodity at the contract price at a certain date in the future. Futures are listed and forwards are over-the-counter contracts. Free Cash Flow: EBIT (1-Tax Rate) + Depreciation & Amortization - Change in Net Working Capital - Capital Expenditure Hedging: Eliminates all exposure to a particular risk. E.g. price risk. Het Financieele Dagblad: Dutch financial newspaper. Interest rate swap: Can be used to swap variable interest rates into fixed interest rates on loans. Metallgesellschaft AG: Large German Corporation who faces large financial problems due to the use of commodity derivatives. Option: An option gives the holder (the buyer of the option) the right, not the obligations, to buy or sell an underlying at a certain date at a specific price (exercise prize). Tobin’s Q: Ratio between the market value of a firm and the replacement cost of their assets (book value). Variable interest rates: Interest rates whose value depends on a fixed rate + Euribor. 6 Abstract This study is focused on hedging, and in particular the use of interest rate derivatives to reduce the risk of interest rate sensitivity, which is a small, but important part of the firm’s risk management. Firms use interest rate derivatives for example to mitigate the volatility of the Financial Cash Flow. In order to investigate a potential value enhancing effect of the use of interest rate derivatives univariate and multivariate regressions are used. This study examines the use of interest rate derivatives in a sample of 282 largest listed European nonfinancial firms in the year 2007 and in the year of 2012 and its impact on firm value as measured by Tobin’s Q. The results show that the use of interest rate derivatives is rewarded by investors with lower firm valuation. The negative hedging premium is statistically significant and is on average - 13.1 percent of firm value. This could be explained by the short research period. Most interest rate derivatives are used by firms to create value in the long run and firms suffer value decreasing effects on their cash flow on the short term due to the premium they have to pay (insurance). This effect is stronger (more negative) when looking at data before the credit crisis in 2007, suggesting that in the conception of investors derivatives could affect the European economy positive during financial turmoil. The results are not significant when firm fixed effects are added to the sample. This indicates a potential endogeinity problem. Keywords: Interest rate derivatives, risk management, firm value, hedging. Data availability: Orbis Database and manually collected mainly from annual reports. 7 1. Introduction 1.1 Background On April 17, 2014 Het Financieele Dagblad headed “Holland Casino loses €16 million on interest
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