The Underinvestment Problem and Corporate Derivative Use: Evidence from South African Listed Firms
Keywords:
Underinvestment; hedging policy; Derivatives; Growth opportunitiesAbstract
Research background: Financial innovation, political and economic instability exposed South African firms to
different risks which led to a gradual fall in the investment levels compared to other emerging economies. Derivatives were
invented to manage risks, among other purposes, more than 90% of the world’s largest firms continuously utilise derivatives
to manage their risk. The underinvestment theory hypothesises that firms with more significant growth opportunities make
greater use of derivatives and companies with amplified investment opportunities together with low cash stock levels use
derivatives more. Purpose: This study carefully examines the underinvestment problem as a determining factor of corporate
hedging policy. Research Methodology: The study employed Tobit regression models on a sample of 198 non-financial
Johannesburg Stock Exchange-listed firms over the period 2009-2018. Results: The study found evidence in support of the
hypotheses that firms’ make use of corporate derivatives as an attempt to reduce their exposure to possible underinvestment
problems. Value: The study determines the role of derivatives in alleviating the underinvestment problem crippling firms in
the South African context.
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Smith, C. W. & Stulz, R. M. (1985). The Determinants of Firms’ Hedging Policies. The Journal of Financial and
Quantitative Analysis, 20(4), p. 391. https://doi.org/10.2307/2330757.
Talat, A. & Atia, A. (2011). Determinants of extent of financial derivative usage. African Journal of Business Management,
5(20), pp. 8331–8336. https://doi.org/10.5897/ajbm11.930.
analysis, 41(02), pp. 439-453.
Bartram, S. M.; Brown, G. W. & Fehle, F. R. (2009). International Evidence on Financial Derivatives Usage. Financial
Management, 38(1), pp. 185–206. https://doi.org/10.1111/j.1755-053x.2009.01033.x.
Berkman, H. & Bradbury, M. E. (1996). Empirical Evidence on the Corporate Use of Derivatives. Financial Management,
25(2), 5-13. https://doi.org/10.2307/3665985.
Bessembinder, H. (1991). Forward Contracts and Firm Value: Investment Incentive and Contracting Effects. The Journal of
Financial and Quantitative Analysis, 26(4), p. 519. https://doi.org/10.2307/2331409.
Brooks, C. (2014). Introductory econometrics for finance- 3rd edition. England: ICMA Centre, pp. 579-582.
Fazzari, S. M.; Hubbard, R. G.; Petersen, B. C.; Blinder, A. S. & Poterba, J. M. (1988). Financing Constraints and Corporate
Investment. Brookings Papers on Economic Activity, 1988(1), pp. 141-206. https://doi.org/10.2307/2534426.
Froot, K. A.; Scharfstein, D. S. & Stein, J. C. (1993). Risk Management: Coordinating Corporate Investment and Financing
Policies. The Journal of Finance, 48(5), pp. 1629–1658. https://doi.org/10.1111/j.1540-6261.1993.tb05123.x.
Gay, G. D. & Nam, J. (1998). The Underinvestment Problem and Corporate Derivatives Use. Financial Management, 27(4),
pp. 53-69. https://doi.org/10.2307/3666413.
Geczy, C.; Minton, B. A. & Schrand, C. (1997). Why Firms Use Currency Derivatives. The Journal of Finance, 52(4), pp.
1323–1354. https://doi.org/10.2307/2329438.
Greene, W.H (2002). Econometric analysis, 5th edition, New York University, New York.
Heitzman, S. & Lester, R. (2018). Net Operating Loss Carryforwards and Corporate Financial Policies. SSRN Electronic
Journal. https://doi.org/10.2139/ssrn.3185018.
Hennessy, C. A. & Whited, T. M. (2007). How Costly Is External Financing? Evidence from a Structural Estimation. The
Journal of Finance, 62(4), pp. 1705–1745. https://doi.org/10.1111/j.1540-6261.2007.01255.x.
Judge, A. (2003). Hedging and the Use of Derivatives: Evidence from UK Non-Financial Firms. SSRN Electronic Journal.
https://doi.org/10.2139/ssrn.394990.
Larry, Z.; Jack, B.; Ryan, Q.; Aftab. B. & Erik, V. Z. (2018). South Africa’s foreign direct investment has been in steady
decline. www.consultancy.co.za. https://www.consultancy.co.za/news/1077/south-africas-foreign-direct-investment-hasbeen-
in-steady-decline.
Lewellen, W. G. & Badrinath, S. G. (1997). On the measurement of Tobin’s q. Journal of Financial Economics, 44(1), pp.
77–122. https://doi.org/10.1016/s0304-405x(96)00013-x.
Lin, C.; Phillips, R. & Smith, S. (2008). Hedging, financing, and investment decisions: Theory and empirical tests. Journal of
Banking & Finance, 32(8), pp. 1566-1582.
Mian, S. L. (1996). Evidence on Corporate Hedging Policy. The Journal of Financial and Quantitative Analysis, 31(3), pp.
419-439. https://doi.org/10.2307/2331399.
Modigliani, F. & Miller, M. H. (1958). The Cost of Capital, Corporation Finance and the Theory of Investment. Am. Econ.
Rev., 48(3), pp. 261-297.
Myers, S. C. (1984). The Capital Structure Puzzle. The Journal of Finance, 39(3), pp. 574–592.
https://doi.org/10.1111/j.1540-6261.1984.tb03646.x.
Myers, S. C. (1993). Still Searching For Optimal Capital Structure. Journal of Applied Corporate Finance, 6(1), pp. 4–14.
https://doi.org/10.1111/j.1745-6622.1993.tb00369.x.
Myers, S. C. (1977). Determinants of corporate borrowing. Journal of Financial Economics, 5(2), pp. 147–175.
https://doi.org/10.1016/0304-405x(77)90015-0.
Nance, D. R.; Smith, C. W. & Smithson, C. W. (1993). On the Determinants of Corporate Hedging. The Journal of Finance,
48(1), pp. 267–284. https://doi.org/10.1111/j.1540-6261.1993.tb04709.x.
Pyeman, J.; Zakaria, S. & Idris, N.M.An Empirical Analysis on the Application of Financial Derivatives as a Hedging
Strategy among Malaysian Firms. Contemporary Economics, 13(3), pp. 305-316.
Schwegler‘s, (2011). Empirical results on the use of derivatives in South Africa. COVER Magazine.
https://www.cover.co.za/empirical-results-on-the-use-of-derivatives-in-south-africa/.
Shapiro, A.C. & S. Titman, S. (1986). An Integrated Approach to Corporate Risk Management. In: Stern, J.M. & Chew, D.
H. (eds.). The Revolution in Corporate Finance. Basil Blackwell, New York, NY, 215-229.
Smith, C. (2019, August 21). Using the Tobin Q Ratio as a Relative Value Metric - CFA Level 3. Investing for Beginners
101. https://einvestingforbeginners.com/tobin-q-ratio-cfa-level-3/.
Smith, C. W. & Stulz, R. M. (1985). The Determinants of Firms’ Hedging Policies. The Journal of Financial and
Quantitative Analysis, 20(4), p. 391. https://doi.org/10.2307/2330757.
Talat, A. & Atia, A. (2011). Determinants of extent of financial derivative usage. African Journal of Business Management,
5(20), pp. 8331–8336. https://doi.org/10.5897/ajbm11.930.
Published
2020-10-07
How to Cite
Vengesai, E., Reddy, J., Govender, J., Alison, A. M., Nkontwane, M., & Govender, T. (2020). The Underinvestment Problem and Corporate Derivative Use: Evidence from South African Listed Firms: Array. The Journal of Accounting and Management, 10(3). Retrieved from https://dj.univ-danubius.ro/index.php/JAM/article/view/596
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