The Effects of Financial and Operational Hedging on Company Value: The Case of Malaysian Multinationals

Fluctuations in foreign currency (FC) always have been a source of concern for multinational companies exoposed to higher FC risk compared to domestic companies. These companies employ different hedging strategies to reduce FC risk exposure. This study examines the value effects of financial hedging (i.e., derivatives and FC debt) and operational hedging in a managed floating exchange rate regime with strict limitations on the trading of Malaysian Ringgit and control for the value effects of non-operational income (loss) measured by foreign exchange profits (losses), and its two components: transaction and translation profits (losses). The results of two-step system generalized method of moments (GMM) estimation for a sample of 109 Malaysian multinationals over the 2004−2018 period show that, on average, derivatives hedging creates a value premium range of 7.88−8.21 % in the short-run, and 18.81−19.80 % in the long-run, with respect to company value approximated by Tobin’s Q. In contrast, foreign debt hedging, on average, creates a value discount range of 8.19−8.54 % in the short-run and 12.70−13.12 % in the long-run. Operational hedging strategies do not affect company value, though different proxies represented operational hedging. Although all the Malaysian multinationals in this study face significant FC risk exposure, less than half of Malaysian companies do not use any financial hedging strategies whereby hedgers reduce their FC risk exposure through forward contracts in the over-the-counter market and employ FC swaps occasionally. The positive value effect of derivatives hedging should motivate managers of Malaysian multinationals to involve in hedging more actively and encourage policymakers to take steps in developing derivatives market and products. However, the negative effect of foreign debt hedging on company value may stem from two potential causes; higher company risk due to FC borrowing, and improper hedging practices including high cost of hedging in the underdeveloped derivatives market. These potential causes need further empirical evaluations. Keywords: Financial hedging; operational hedging; company value; foreign currency derivatives; foreign currency debt; Malaysia.