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Time-inconsistent investment, financial constraints, and cash flow hedging

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  • Lien, Donald
  • Yu, Chia-Feng (Jeffrey)

Abstract

This paper studies the interplay between firm investment and cash flow hedging decisions when the decision-maker has time-inconsistent preferences. We show that cash flow hedging acts as a double-edged sword. In some cases, cash flow hedging enhances firm value because the firm can thus invest at the firm-value-maximizing timing. In other cases, however, cash flow hedging may adversely affect firm value because it loosens the financial constraint that works as a commitment device to mitigate premature investment. Our results thus highlight one unexplored potential dark side of hedging and suggest that the optimal hedging decision is the result of a trade-off between flexibility and commitment.

Suggested Citation

  • Lien, Donald & Yu, Chia-Feng (Jeffrey), 2014. "Time-inconsistent investment, financial constraints, and cash flow hedging," International Review of Financial Analysis, Elsevier, vol. 35(C), pages 72-79.
    • Handle: RePEc:eee:finana:v:35:y:2014:i:c:p:72-79
    DOI: 10.1016/j.irfa.2014.07.009
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    Cited by:

    1. Liu, Bo & Niu, Yingjie & Zhang, Yuhua, 2019. "Corporate liquidity and risk management with time-inconsistent preferences," Economic Modelling, Elsevier, vol. 81(C), pages 295-307.
    2. Niu, Yingjie & He, Linfeng & Wu, Wei, 2021. "Managerial compensation with hyperbolic discounting," Finance Research Letters, Elsevier, vol. 38(C).
    3. Yehong Yang & Guohua Cao, 2019. "Optimal Financing and Dividend Strategies with Time Inconsistency in a Regime Switching Economy," Complexity, Hindawi, vol. 2019, pages 1-11, April.
    4. Lien, Donald & Yu, Chia-Feng (Jeffrey), 2017. "Production and hedging with optimism and pessimism under ambiguity," International Review of Economics & Finance, Elsevier, vol. 50(C), pages 122-135.
    5. Luo, Pengfei & Tian, Yuan & Yang, Zhaojun, 2020. "Real option duopolies with quasi-hyperbolic discounting," Journal of Economic Dynamics and Control, Elsevier, vol. 111(C).

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    More about this item

    Keywords

    Time-inconsistent preferences; Investment timing; Financial constraints; Cash flow hedging;
    All these keywords.

    JEL classification:

    • D92 - Microeconomics - - Micro-Based Behavioral Economics - - - Intertemporal Firm Choice, Investment, Capacity, and Financing
    • G02 - Financial Economics - - General - - - Behavioral Finance: Underlying Principles
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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