Corporate Risk Management Under Information Asymmetry
50 Pages Posted: 26 Apr 2014 Last revised: 31 Dec 2016
Date Written: April 11, 2014
This paper examines the financial and operational hedging activities of U.S. pharmaceutical and biotech firms that are subject to high level of information asymmetry stemming from R&D investments during 2001-2006. We find evidence in support of the information asymmetry hypothesis à la Froot, Scharfstein and Stein (1993) that hedging helps mitigate the under-investment problem. Specifically, we find that the use of financial derivatives is associated with greater firm value and that the value enhancement is larger for firms subject to greater information asymmetry and better growth opportunities. There is a synergy between financial hedging and operational hedging where the latter is used to counter product development risk. The results are robust with respect to alternative performance measures, industry-specific growth measures, and the endogeneity problem. Our work is differentiated from existing studies that examined commodity-based industries without addressing information asymmetry.
Keywords: corporate risk management, R&D, financial hedging, operational hedging, information asymmetry, pharmaceutical or biotech firms
JEL Classification: G32, D82
Suggested Citation: Suggested Citation