Debt Financing and Risk Management

57 Pages Posted: 15 Jan 2021

See all articles by Ilona Babenko

Ilona Babenko

Arizona State University

Hendrik Bessembinder

Arizona State University; W.P. Carey School of Business

Yuri Tserlukevich

Arizona State University (ASU)

Date Written: August 17, 2020

Abstract

We obtain detailed data on bank lending agreements and derivative positions of U.S. oil and gas producers during the 1999-2019 period to study interactions between financing and hedging decisions. Using the emergence of fracking technology as an exogenous shock to firms' financing needs, we document sharp increases in debt financing accompanied by increased hedge ratios and longer hedge maturities. We document that bank lending contracts often include covenants that require hedging, with the majority specifying an explicit minimum. Our results support the interpretation that these hedge covenants are binding, and are structured to mitigate potential agency conflicts originating from the priority of derivatives in default and incentives for firms to speculate with derivatives. We also show that firms with bank-imposed hedging requirements perform better during the COVID-19 pandemic. Our results support the interpretation that firms' hedging decisions should be viewed as outcomes from constrained optimization shaped in part by prior financing choices.

Keywords: hedging, risk management, debt, covenants, credit boom

JEL Classification: G30, G32, G21

Suggested Citation

Babenko, Ilona and Bessembinder, Hendrik (Hank) and Tserlukevich, Yuri, Debt Financing and Risk Management (August 17, 2020). Available at SSRN: https://ssrn.com/abstract=3675898 or http://dx.doi.org/10.2139/ssrn.3675898

Ilona Babenko

Arizona State University ( email )

Department of Finance
W.P. Carey School of Business
Tempe, AZ 85287
United States

Hendrik (Hank) Bessembinder

Arizona State University ( email )

PO Box 873906
Tempe, AZ 85207
United States

W.P. Carey School of Business ( email )

W. P. Carey School of Business
PO Box 873906
Tempe, AZ 85287-3906
United States

HOME PAGE: http://https://wpcarey.asu.edu/people/profile/2717225

Yuri Tserlukevich (Contact Author)

Arizona State University (ASU) ( email )

Farmer Building 440G PO Box 872011
Tempe, AZ 85287
United States

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