Firm value and hedging: Evidence from United States oil and gas producers

This paper studies hedging activities of 124 U.S. oil and gas producers in 1999, and evaluates their impact on firm value. Theories of hedging based on market imperfections imply that hedging should increase the firm's market value. We first verify that hedging reduces the firm's stock price sensitivity to oil and gas prices and that the effect is economically significant. Contrary to previous studies, however, we find that hedging does not seem to affect a firm's market value. Our result is robust to many control variables that theory or empirical findings have shown to have an effect on a firm's value. The list includes size, profitability, investment growth, leverage, and earnings volatility, among others. Our result also persists in the subgroup of large firms and firms with potentially higher cost of financial distress, which we find are the determinants of oil and gas firms decision to hedge. One interpretation of our result is that there is no hedging premium in this industry because the exposure to these commodity price risks is transparent and can be easily hedged by investors.; This study contributes to the current literature on hedging by showing that the value of hedging depends on the types of risks a firm is exposed to. As a firm moves closer to the environment described by Modigliani-Miller conditions, the rationale behind hedging diminishes. In particular, we show that in the oil and gas industry, when market risk exposure is clear and hedging instruments are easily accessible to investors, we no longer observe a hedging premium.