Commodity Derivative Usage in U.S. Non-Financial Firms

Abstract

Financial derivatives have been studied and scrutinized in depth since the financial crises in 2007-2009. Derivatives’ effect on firms, in particular firm value, have been studied prior to, during, and post global recession, with no definitive answer as to whether this relationship is positive or negative. The global oil price shock that occurred in 2014 drove our interest in how this commodity, along with other commodities are hedged by companies to mitigate risk, and whether or not this action has a particular effect on firm value. We focus our research on U.S. nonfinancial firms from the Standard and Poor’s 500 Index (S&P 500 Index), and evaluate firm value using Pooled Ordinary Least Squares (Pooled OLS) regressions and fixed effect between 2006-2017. This time period allows us to see the relationship between commodity derivative usage and firms during periods of an economic downturn, as well as during a commodity price shock. By looking at S&P500 Index companies it gives us a better idea of commodity derivative usage on a larger and broader scale. We find that, firstly with the univariate test the firm value of the users are significantly lower than the firm value of the non-users, proxy by the Tobin’s Q. Secondly, with the multivariate test, we use the Fixed Effect estimator to deal the problem because of the biased Pooled OLS estimator. We also found that the distribution of the firms’ value with commodity derivatives are less peaked than the distribution of the firms’ value without commodity derivatives. It implies that using commodity serves the firm as the insurance. For the Tobin’s Q and the firm size, as the proxies of the firm values, the mean and the median of the user Tobin’s Q are statistically significant different to the mean of the non-users.