Corporate hedging: Currency derivatives and interest rate derivatives use before and after SFAS 133

This study analyzes the relationship between executive compensation and hedging decision of S&P500 firms during 1994--2000, and examines whether this compensation/hedging relationship changes after the implementation of the SFAS 133, a regulation designed to increase transparency of derivative reporting. It is the first panel work that focuses on the effects of SFAS 133 on a firm's decision to use risk management tools.; Results show significant evidence of agency conflict. Hedging decreases with options, and increases with common shares. After the adoption of SFAS 133, managers continue to use hedging to maximize their wealth. Firms whose managers hold more options decrease the use of derivatives; while firms whose managers have higher ownership increase the use of derivatives. The impact of hedging on managerial compensation is also examined. Data significantly demonstrate that hedging lowers compensation, implying that agency conflicts exist because management are not rewarded appropriately for hedging. This leads to reducing risk management activities. My work thus highlights the importance of agency conflicts and disclosure, and shows that SFAS 133 has substantially affected hedging decision.